Brokerage house Goldman Sachs is cautious in its outlook on the cement sector as it expects weakness in both demand for cement as well as cement prices. “We believe the industry is on the verge of a downcycle — fundamentals are likely to deteriorate over the next 12-18 months as demand loses steam and supply growth puts pressure on prices in an environment of unprecedented cost inflation,” the brokerage said in its report to clients.
Though the long-term outlook for the cement industry is positive, says Goldman Sachs, in the medium-term, the industry is on the verge of a downcycle. “Major macro indicators such as fixed asset investment (FAI), infrastructure index, and housing loan growth point towards a moderation in economic activity,” said the Goldman report. According to Goldman, aggressive supply growth during this period will drag utilisation rates to trough levels. It believes that consequent pricing pressure coupled with cost inflation would result in lower margins and average RoE (return on equities) reverting to 15% in the medium term.
Housing accounts for 60% of cement consumption in India, says the report. Over the past few years, deepening of financial sector, a benign interest rate environment, and favourable fiscal measures such as tax benefits on mortgages were the key drivers of growth in the property sector. However, high interest rates are now leading to many prospective protery buyers deferring their purchases.
Already, the Reserve Bank of India has tightened the repo rate by 125 basis points since March 2008. “Infrastructure and commercial construction segments too may face delays in the start-up of some projects. We, therefore, expect that cement demand growth is likely to moderate to 8.1% CAGR (compound annual growth rate) over the next three years compared with CAGR of 8.8% the industry witnessed over the past five years,” the report says.
The report estimates that 60% of cement industry’s costs are driven by energy directly through power and fuel consumption in the manufacturing process, and indirectly through freight and logistics. Given the steep increase in energy costs over the past year, the industry has been grappling with cost increases across the board, the report said. With a limited ability to pass the cost increases to consumers (due to the government’s concerns over inflation), the industry has experienced margin erosion over the past few quarters.
“We believe the margin compression has just begun and there is a long way to go. The twin impact of cost pressures and likely price erosion will compress margins over the next three years. As a result, we expect the sector average RoE to drop over the next two years,” the report added.