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Our analysis of the financial health of listed cement firms (>70% of total cement capacity) suggests that the stress in the system at small-and medium-sized firms is increasing: (i) 40% of companies made PBT (profit before tax) losses in the last two quarters (20% of system capacity—Jaiprakash Associates, Dalmia Bharat, Century Textiles, Kesoram Industries, Prism Cement, Heidelberg Cement, Sagar Cements, NCL Industries, Mangalam Cement, and KCP); (ii) 15% of firms (Kesoram Industries, Prism Cement, Sagar Cements, Mangalam Cements) are making cash losses; and (iii) 60% of small- and medium-sized firms have net debt/Ebitda>4x.
Our conclusions for large caps are: (i) they will have to sustain production discipline for longer and this makes their earnings growth more dependent on price increases than volume growth; and (ii) half the capacity addition over the next two years is by small and medium-sized firms which increases the demand threshold for large caps before they benefit from price increases or volume growth.
East is the next south: Our analysis on a regional basis suggests that capacity addition stress is high in east India, which accounts for 18-23% of current capacity for the large caps (Ultratech, Ambuja and ACC). East India capacity should grow by 25% next year. High additions have been impacted by a delay in commissioning of Ultratech's expansion in the east (earlier scheduled for FY14). With current expansion plans, utilisations in the east are expected to decline from 75% in FY14 to about 67% in FY16 (assuming demand growth of 8% for the next two years). This further puts stress on large-cap volume growth as half of capacity additions by large caps over the next two years is going to be in east India (Ultratech: 4.8 mn t; Shree Cement: 4 mn t; ACC: 3.5 mn t; Ambuja: 0.8 mn t). This has impact on volume upside from expansions and current margins.
One-third of large caps' capacity expansion is expected in the north. Total supply adds in the north are 10% in FY15 with half added by large caps. We expect large caps to benefit from some volume growth in the north but east capacity additions should weigh down overall.
Stocks price in a steep recovery over FY15 demand growth: With supply additions for FY15 certain, margin expansion and volume growth for the large caps mainly depend on FY15 demand growth.
At least 4% demand growth is required to break-even new capacity by the small