Cost savings to be reflected in Q4; reason for caution given moderate earnings prospects and valuations.
All-India cement prices declined by Rs 3/bag m-o-m in December, 2018, per our channel checks —this is the sixth consecutive month of price decline with prices falling by Rs 15/bag since July, 2018. We estimate Q3FY19 realisations for cement companies to decline by 1-3% q-o-q. Even though cost pressures have eased due to a decline in pet-coke costs, the spreads (difference between prices and energy costs) for Q3FY19 are down by 2% q-o-q due to the decline in cement prices. We expect full cost savings to reflect from Q4FY19 onwards due to high cost inventories. We maintain our cautious stance on the sector on expensive valuations.
Costs eased on lower energy prices but likely to reflect in earnings from Q4FY19: Imported pet-coke prices declined by 4% m-o-m to $94/ton in December, 2018—prices are down 23% from average of Q2FY19. Domestic pet-coke prices declined by 9% to Rs 9,350/ ton in December, 2018—domestic prices are down 9% from average of Q2FY19. We expect cost savings from lower pet-coke prices to largely reflect from Q4FY19 due to (i) high cost inventories—companies usually carry 45-60 days of inventory, and (ii) moderate fall in domestic prices.
Q3FY19e spreads to remain low: The spreads are down 1% q-o-q for pan-India names in Q3FY19 due to 1-3% q-o-q decline in cement prices—gains from lower global pet-coke costs does not fully offset the decline in cement prices.
We maintain our cautious stance on sector: We maintain cautious stance on the cement sector on expensive valuations and on expectation of moderate improvement in earnings over the next two years. Earnings improvement is dependent on increase in cement prices which is contingent on improvement in industry utilisations. However, we believe large capacity addition will keep industry utilisations low (<70%) over the next two years. Valuations of large cap. cement names is expensive at 13-22X FY2019e EV/Ebitda.