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Although the optimism for the cement space remains valid with the government focus on infrastructure, the energy cost inflation in September 2022 quarter has raised the input cost for cement manufacturers. Q2 FY23 being the monsoon period that generally sees subdued demand, price hike could not be achieved to set off the increased energy and fuel cost. This has led to a hefty operating bill without the requisite revenue — taking a toll on the margins of the company.
Overall, cement stocks have had a volatile year as better demand was offset by higher costs. India Cements is one of the stocks that manged to generate positive returns of around 9 per cent during the year amidst the volatility. A prominent cement manufacturer in South India, it is now trading at a one-year forward P/E of 34.6x against historical average (5-year) of 19.8x and one-year forward EV (Enterprise Value)/EBITDA at 16.7x against historical average (5-year) of 9.6x. While this might appear expensive, the stock is trading cheap on a replacement cost basis, at an EV/tonne of ₹6,291, amongst the cheapest in the industry. Given long-term growth prospects, investors can continue to hold the stock.
Business
India Cements is a major player in South India with a total capacity of 15.5 million tonnes, just behind Ramco Cements (21 million tonnes per annum). The Southern markets, historically, have had higher absolute price as compared to other markets but are also fragmented. The demand for cement is muted during monsoon months and therefore the second quarter of the year is generally dull for the industry, but the second half of the year sees a pick-up in demand. The pricing scenario in the southern markets has been encouraging over the past few months. In November 2022, cement price saw a 2 per cent growth month-on-month in southern markets after being flat in the September 2022 quarter.
The major costs the players of this industry face are Power and Fuel cost and Logistics cost, which is 20-25 per cent of sales as the energy prices are mainly dependent on international markets — which function on factors generally not in control of these players. The steep price rise in September 2022 quarter was a major reason that the company posted loss on EBITDA level, the operating expenses grew to 105 per cent of sales in the September 2022 quarter due to rise in energy prices.
Management stated that its fuel mix comprises 84 per cent of coal and 11 per cent petcoke; this explains the steep rise in the cost of power and fuel as coal is generally costlier than petcoke. The cost of power and fuel as a percentage of sales in September 2022 was 45 per cent against 29 per cent in September 2021 whereas the power and fuel cost to sales has been 20-25 per cent for top companies from FY18 to FY22. In the wake of rising power cost, the management stated that it has stopped producing power in its power plants and is sourcing power through exchanges.
Financials
The company reported a de-growth of 11 per cent in volume during September 2022 over June 2022. Operating expenses grew to 105 per cent of sales in September 2022 against 88 per cent in September 2021. The EBITDA margin was -5 per cent in Q2FY23 against 12 per cent in Q2FY22. The net loss was ₹121.6 crore in September 2022 quarter whereas in September 2021 the company reported PAT of ₹32.53 crore and in June 2022 quarter the PAT was ₹83.3 crore. The FY23 consensus estimate (Bloomberg) for the EBITDA is ₹104.4 crore whereas for FY24 the consensus estimate (Bloomberg) is ₹746.1 crore. The consensus estimate for bottom line of FY23 is a net loss of ₹ 112.7 crore while for FY24 the estimate is net profit of ₹241 crore.
Investment thesis
At an EV/EBITDA and PE (both one-year forward; Bloomberg consensus) of 16.7x and 34.6x respectively, the valuation is on the higher side, but the replacement cost of the company i.e., EV/tonne of the company is ₹6,291, which is lower than most of its peers’. For some of the other prominent players in South India — Ramco and Dalmia Cement — the EV/tonne is around ₹10,149, and ₹9,472 respectively.
Energy prices also seem to be cooling off, of late. According to an Emkay report, South African coal is currently trading in the range of $250-$300 per tonne whereas in August-September 2022 it was trading at $350-$400 per tonne. The cost of imported petcoke has also come down to $180 per tonne from the recent high of around $200. This trend is positive for the industry as this can bring it back to profitability. As mentioned above, financials for India Cements are also expected to improve in FY24 as per consensus estimates, with EPS expected to improve significantly from -₹4.44 in FY23 to ₹9.91 in FY24. While there may be risks to FY24 estimates, considering the macro uncertainties, the improvement is still likely to be good.
Risks
The company operates in an industry that is cyclical, and energy prices are decided in the international markets, which are generally beyond the control of these players. Second, the cement industry in India is witnessing consolidation; in May 2022, Adani bought a controlling stake in Ambuja and ACC, making it the second largest cement producer in India overnight. On December 12, 2022, Dalmia announced its acquisition of residual assets of Jaiprakash Associates. The entry of players with deep pockets will lead to competitive intensity in the industry.
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