The Street is pricing in more benign profitability and utilization parameters, while one may not get the benefit of both in a modest demand environment.
A subdued demand environment could put to risk the aggressive ramp-up plans of cement players that have acquired over 42 mtpa of cement capacities over the past two years. Operating at low utilizations could lead to earnings dilution under current cost-realization parameters, while aggressive market share gains could hamper pricing discipline. The Street is pricing in more benign profitability and utilization parameters, while one may not get the benefit of both in a modest demand environment. After the aggressive capacity build-up over the last decade, cement companies appear to be taking a breather with only 11 companies looking to add close to 26 mtpa of cement capacity over the next few years. However, acquisition activity had increased substantially over the past two years, with continued capacity under utilisation forcing several players to put up capacities for sale—Jaiprakash Associates being most notable among those.
We highlight that as much as 42 mtpa of cement capacities have changed hands in the past 24 months. Of the acquired capacities as much as 22 mtpa is present in Central India. These capacities will likely be put to use with renewed vigor under new ownership and freshly infused capital. Cement players such as Ultratech will be keen to rapidly ramp up acquired capacities to minimise earnings dilution, or at least be able to service the acquisition debt. We highlight that an aggressive ramp-up of capacities will likely impact the competitive intensity in key markets, and could lead to large price disruption.
We highlight that over FY2013-15, Ultratech had grown at a pace lower than the industry, to allow continued price discipline and improved realizations. In FY2016, when Ultratech grew at a pace faster than the industry, it came at the cost of weaker realisations for the industry. We highlight that the acquired capacities are large relative to the market that they cater to, and a more moderate capacity ramp-up may be in order, unless industry growth surprises meaningfully, to keep price competition in check.