Not all seems well for local cement manufacturers

Not all seems to be well for local cement manufacturers as after margins improving on the back of improved demand and pricing the number of issues facing the manufacturers include: 1) CCP initiating inquiry over cement price increase and 2) sharp spike in coal prices (up 50% since October 2020). CCP has recently issued an enquiry report regarding alleged cartelization by cement manufacturers during April-May 2020, increasing prices by Rs50/bag.

The enquiry committee has recommended initiating proceedings against the APCMA and its member undertakings. To recall, the last time CCP proceeded against local cement manufacturers, it took 4-5 months from issuance of report till show cause notices being served and further 9-10 months from issuance of show cause notices to imposition of penalties. Though, cement prices in North increased by 41% from May 2008 to October 2008 majorly to pass-on increase in coal prices, from Oct’08 to Jun’09, prices in North declined by Rs37/bag. During this time period of declining prices, margins of the leading manufacturers declined from 34% in 2QFY09 to 26% in 3QFY09, though recovered to 36% in 4QFY09 as coal prices declined.

Cost pass-on to be staggered at best

Current scenario is different from what was witnessed earlier as the proceedings have coincided with a sharp spike in coal prices (up 50% since October 2020) and to wade off the impact of increase in fuel cost, manufacturers will need to increase prices. To note, assuming coal prices to average at US$90/ton against US$60-65/ton for 1QFY21, manufacturers will need to increase prices by Rs30-45/bag to maintain margins. Though, analysts do not rule out a cost pass-on by local manufacturers, with the sector on strict watch of CCP, they believe the increase in prices is going to be staggered at best. While in worst case, local manufactures will need to absorb costs and in case of the latter, margin suppression in 3QFY21 cannot be ruled out. We have incorporated an increase in prices of Rs20/bag during subsequent quarters with assumed coal prices of US$70/ton for 3QFY21 and 4QFY21. However, if local players will have to absorb the increased cost, assuming cement prices/coal at Rs550/US$90, gross margins will decline to 13% from 20% in our base case (with cement price/coal assumed at Rs565/US$70).

Outlook:

In light of aforesaid cost absorption, analysts continue to like preferred plays where they believe LUCK’s low cost base will continue to cushion against commodity spikes and company will continue to outperform peers in terms of margins. Though MLCF is comparatively more sensitive to change in coal prices than LUCK and DGKC (see table on RHS), option of switching towards petcoke gives the company an option in case coal prices continue to increase. MLCF currently is not using petcoke due to the fuel being expensive on cost per kcal basis (Rs3.9/kcal vs. Rs3.5/kcal of coal). However with refinery run rates increasing globally, short term scenario for petcoke looks better than coal. Overall, analysts expect the sector to tread sideways in near term as negative news flow and muted demand is expected to keep price performance in check however in medium term as coal prices cool down and demand picks up, sector is expected to outperform.

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