‘Strong H1FY21 margins to limit financial risk on Indian cement companies’

Strong margins during H1FY21 will limit the risks to Indian cement companies’ financial profiles, despite lower volumes stemming from the coronavirus pandemic, Fitch Ratings said on Tuesday.

“We expect companies to take a prudent approach to growth capex in FY21, which will underpin healthy free cash generation and support financial flexibility,” the ratings agency said in a report.

“We believe a gradual revival in cement demand, following the 1QFY21 drop of more than 30 per cent could cap the overall FY21 decline to the low double digits.”

The ratings agency pointed out that large producers, including “UltraTech Cement Limited, ACC Ltd and Ambuja Cements Ltd, subsidiaries of LafargeHolcim Ltd and Shree Cement Limited, reported higher yoy volume in 2QFY21, boosted by healthy demand from rural India and the affordable housing segment as well as a steady renovation component that offset weak new build activity in urban housing, infrastructure and commercial construction”.

It said that pent up demand has also kept selling prices firm during May and June, with the initial easing of pandemic-related lockdowns coinciding with a rush to complete construction ahead of the monsoon.

As per the report, lower energy and fuel costs – which together account for nearly 60 per cent of total cement production costs – and fixed cost savings helped increase the per tonne margins from a year ago and cushioned the overall decline in operating profit from weaker volume.

“Prices declined in the seasonally weak 2QFY20, but remained firm on a yoy basis.”

“This reflected continuing stabilisation in demand and a disciplined approach to pricing following increased industry consolidation over the past few years.”

Overall, it said that most large companies posted higher per tonne and overall operating profitability, despite higher energy and fuel costs from 1QFY21.

“This resulted in broadly stable or improved operating profit generation in 1HFY21 from a year ago.”

“Demand has remained steady and we do not expect a sharp drop in 2HFY21 due to the gradual stabilisation in previously weaker segments, even as the boost from the 1HFY21 backlog fades.”

According to the report, per tonne profitability is likely to fall in 2HFY21 as fuel and energy prices normalise and companies pursue volume more aggressively amid recovering demand.

“Nonetheless, we believe a strong operating performance in 1HFY21 has significantly reduced downside risks.”

“We expect India’s cement demand in FY22 to rise by high single digits from a low base in FY21, in line with the country’s broader economic stabilisation and an increase in infrastructure and commercial construction projects.”

In addition, the agency said that deferred new capacity additions from 2020 should also support profitability.

“Most large cement companies entered the pandemic with strong capital structures and liquidity buffers.”

“Healthy operating cash flow, combined with prudent growth capex during 1HFY21, has improved leverage and financial flexibility, which should cushion against any downside caused by the pandemic.”