>Cement Sector (EDELWEISS)

While price correction in FY10 is a near certainty, the frequent question of “how much” yet remains unanswered. Current assumptions by both analysts and companies about the extent of correction are, at best, only guesstimates. While the actual extent by which prices will fall will be known only post facto, in this piece, we attempt to explore “What is likely to be the ceiling of price correction in the sector? While companies slipped into the red in the earlier downcycle, did price corrections result in EBITDA losses? What is different this time around?” Inferences from the past lead us to conclude that sector realisations move in tandem with changes in utilisation rates. Now, with average utilisation expected to correct to 85% in FY10E from 95% currently, we expect FY10 to set the stage for price corrections in the cement sector. Apart from supply side influx, we believe soft demand will further dampen sector fundamentals. We have used base case demand growth of 8% in FY10-11E for our computations. With GDP expected to grow by only ~6% in FY10 and ~60% of cement demand arising from housing (which is not witnessing revival as yet), actual cement demand growth could be lower at ~5-6% in FY10-11E (implying utilisation rate of 82% in FY10E and 75% in FY11E).

In FY03, at 8.7% domestic demand growth and 86.8% utilisation level, sector realisations corrected 13%. Hence, this time around, with a lower demand growth, lower utilisation level, and sharp run up that cement prices have witnessed (during FY06-09E, realisation increase of 74% vis-à-vis 39% cost increase), price fall is likely to be higher. One can argue that players can come together and voluntarily reduce supply and thereby protect prices. However, maintaining market share is an important consideration which makes curtailing volumes through voluntary measures difficult. Also, the reasoning that “the industry is more consolidated now than during the previous downturn which will help avert price cuts” holds little ground in our view as consolidation levels are not too different (capacity share of top 8 groups is likely to be ~62% in FY10E compared to ~60% in FY03).

To see full report: CEMENT SECTOR