Despite a strong demand growth of 10-11% in 2010 and the signs of recovery that have emerged since November 2009, a slower-than-expected recovery in real estate, together with an expected withdrawal of the fiscal stimulus, could potentially hold back growth in the Indian cement sector, according to rating major Fitch. The rating agency has taken a stable-to-negative outlook on the Indian cement industry in 2010 in the wake of record high capacity additions (especially in south and north India) and a significant decline in prices in the second half of 2009.
Fitch expects about 50 million metric tonne (mt) of capacity additions in 2010, if the total capacity is close to 300 million tonne. This expansion, if commissioned in time, will reduce capacity utilisation rates to about 75%, thereby capping any significant upside in prices. Pricing pressures will also continue, with increased pressure on utilisation rates and greater fragmentation of production?with many small players increasing capacity to become mid-sized players, thereby intensifying competition and reducing supplier discipline, says Fitch.
The regional variations in prices should continue?with the South being the most vulnerable and the North and the West being relatively resilient. The profitability of most producers should come down further in 2010 from the highs seen in mid-2009, as coal and freight costs have risen and cement prices are expected to stabilise at much lower than the peak levels.
Fitch, however, notes that a strong demand growth and a delay in commissioning new capacity may cushion the hit to some extent. The agency feels that large producers with strong balance sheets and improved cost structures should be able to present a stable credit profile in 2010 and be better equipped to withstand an industry slowdown than their peers with higher cost structures. Deterioration in credit profiles will be seen by smaller players that are conducting (or have announced) plans for significant capacity expansion.
Although demand conditions are expected to be strong and prices stable at higher than current levels, Fitch expects cement manufacturers to face relatively higher pressures on cash flow through 2010. Free cash flow (FCF) should continue to be negative for companies in the midst of significant capacity expansion. The comfortable liquidity scenario, seen in the last few years, may moderate, with increasing fund requirements for ongoing capex.
Interest coverage trends are also expected to show a declining trend, in line with declining profitability and an increase in debt service requirements. In the wake of recent lows in prices and looming overcapacities, cement manufacturers may take a less aggressive approach on ongoing expansion and defer greenfield expansions?especially those coming up between 2011 and 2013.
It would be interesting to see if the improvement in demand continues once these packages are taken back. Most players have focussed on improving their cost structures and strengthening their balance sheets in the last few years and can therefore, withstand a slowdown in the industry without a substantial alteration in their credit profiles.
According to Fitch, until H109, the sector had benefitted from the strong demand from construction, infrastructure and real estate. However, from Q309, with new capacity being commissioned, prices have come down considerably (by 10-30%, depending upon the region) from the peak levels reached in June 2009, with capacity utilisation levels expected to fall to about 75% by end-2010 from about 87% in 2009.
With existing capacity of approximately 250 million tonne as of December 2009, an increase in demand is not expected to have any further major impact on prices. There are a number of investments in the pipeline, including brownfield as well as greenfield projects. While some of the greenfield capacity may get delayed, Fitch expects about 50 million tonne capacity to be added in 2010?which may result in a significant surplus in the country by end-2010.