Despite the nation entering into the unlocking phase, the construction segment has not yet completely revived from the pandemic’s blow.

While new project awards are expected to get delayed due to the dried up kitties of the Central and State Governments; movement restrictions, manpower shortages and social distancing norms are hindering execution of existing projects, as well.

Healthy returns

Amidst this, many cement manufacturers seem to have regained investor traction. While most cement stocks recouped their losses from pre-Covid levels (for example, Shree Cement and UltraTech Cements), some even saw healthy returns from the start of the year.

JK Cement, for instance, has given a return of 30 per cent from January 2020. Heidelberg Cements, Birla Corporation and Ambuja Cements have risen 8-12 per cent (year to date). This rally came in despite a 10-15 per cent downward revision in earnings estimated for cement manufacturers in FY21 by analysts (Bloomberg), as compared to their estimates in the start of the year (pre-Covid).

In terms of valuations, stocks such as JK Cements and The Ramco Cements are currently trading at 28 and 16 per cent premium, respectively to their three-year average EV/EBITDA (Enterprise value to operating profits ratio) metrics. The stock of Shree Cements also trades 5 per cent higher compared to its three year average EV/EBITDA.

Reasons behind the rally

The rally in cement stocks could be due to a couple of reasons. One, the sales volumes in the first quarter of FY21 witnessed a much lower drop than expected, on the back of pent up demand and demand from rural and semi-urban regions. That apart, much of the recovery in stock prices of cement manufacturers can also be attributed to the increased liquidity in the market and easing uncertainties over the damage caused by the pandemic. Also, analysts believe that cement manufacturers are reaping benefits of consolidation in the industry.

“This re-rating in valuation estimates for most cement stocks is a function of resilience in retail demand across India, despite Covid-lockdown, low input cost inflation and considerable elasticity in fixed costs exhibited in 1QFY21”, according to Rajesh Ravi, Analyst, Cement and Building Materials, HDFC Securities. He adds “cement manufacturers, particularly those with presence in Northern and Central regions, are witnessing positive investor traction due to robust and stable earnings outlook owing to considerable regional consolidation, high capacity utilisation and low influx of new entrants."

While the cement sale volumes dropped, during the lockdown, companies reported significant savings in operating costs leading to decade high levels of EBITDA per tonne for most manufacturers. The savings in operating costs were largely due to benign input costs- prices of pet coke and diesel – and savings on power cost front due to ramp up in installation of WHRS (Waste Heat Recovery Systems).

That apart, according to Ravi, “Companies also cut down their fixed costs, that helped contain the overall drop in earnings, despite low volumes”.

Better pricing power

Another factor that played out well for the cement manufacturers was the buoyancy in cement prices. Despite the anticipated drop in demand, cement prices remained 3-10 per cent higher, from the year ago period, for most part of FY21, thus far.

In line with the anticipated demand drop, the cement production numbers, indicated in the 8-core industrial data, reflected a 13 and 15 per cent y-o-y drop in July and August 2020, respectively. However, cement prices continued to remain firm. According to a recent channel check report by ICICI Securities, the pan India prices of cement are still up 1 per cent (y-o-y) in September 2020, despite being a seasonally weak month.

The increased pricing power of cement manufacturers is a result of the recent consolidation in the industry. The market share of top 6 players now is 80/ 84/ 77 per cent of the cement demand in the Central, Western and Northern regions, respectively.

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