FOCUS: New capex plans by cement companies raise supply glut concerns

30 Jun 2022

The capacity expansion plans announced recently by major cement companies such as UltraTech Cement Ltd and Shree Cement Ltd, have tempered expectations of high earnings growth. This is because the capacity additions will lead to a supply glut over the next five years which will not be commensurate with demand growth.

There is also a view that speculation over whether Adani Group will aim to double the joint capacities of ACC Ltd and Ambuja Cements Ltd after legally completing its acquisition of the two companies has spurred existing major cement players to announce new capacity expansion plans.

The fact that these could be preemptive in nature is also indicated by the fact that much of the announced capex additions will get implemented after 2022-23 (Apr-Mar) is over and up to end of 2024-25 or even beyond.

UltraTech set the ball rolling early this month by announcing a 22.6-ml-tn annual capacity expansion till end of 2024-25, taking its total cement capacity to around 160 mln tn by end of 2025-25.

But the company hinted in an investor conference in mid-June that much of the new planned capacity additions, will take place after 2023-24 and not before it.

The company had earlier announced a capacity expansion of 20-mln-tn over 2021-22 and 2022-23 which is currently underway and which will likely expand its total capacity to 137 mln tn at the end of 2022-23.

According to brokerage Emkay Global, UltraTech is looking to add 16 mln tn of annual cement capacity in 2022-23, and expects delays in the commissioning of new capacities announced this month.

Unlike most other players in the cement industry, UltraTech does not shy away from using the greenfield route in any new phase of expansion and that will take time to commission.

In terms of cement capacity, UltraTech accounts for a little over one-fifth of the industry.

Following UltraTech’s footsteps, Shree Cement also announced a 3-mln-tn annual cement capacity expansion which will raise its total capacity to 49.4 mln tn by the end of December 2024. The company’s managing director, HM Bangur, told Business Today recently that the company will increase total capacity to 80 mln tn in five years from now.

According to estimates made by Jefferies India in May, the aggregate annual cement capacity in the industry will rise to 620 mln tn by the end of 2023-24 from the current level of around 560 mln tn.

After the new capacity hike plans announced by UltraTech and Shree Cement this month, the cement industry’s total capacity will likely rise further to 650 mln by the end of 2024-25.

“In the past, cement manufacturers have added capacities despite lower utilization rates and fall in return ratios,” Jefferies India said in a recent report. It attributed the rush to expand cement capacity by companies to multiple factors like fancy for dominant market share and time-to-time improvement in free cash flow with limited opportunities to invest elsewhere.

Further, state incentives for setting up manufacturing units goad cement companies to deploy incremental capex without considering the unit economics of the plant or region, the brokerage said.

The market has already factored in the capacity expansions that are already in play since the last one or two years. But it is worried about the supply glut that will take place from 2024-25 onwards assuming that UltraTech and Shree Cement would start executing their latest capacity expansion plans in a big way from that year.

The new capex plans took analysts by surprise. In a recent report, brokerage Nirmal Bang Equities listed “aggressive capacity expansion plans by multiple players” as the most significant headwind “which will inhibit earnings growth” of companies in the cement sector.

The brokerage said the new capacity addition by Ultratech was “aimed at pre-empting the capex that Adani may announce after completing the ACC and Ambuja acquisition process to establish a strong foothold” in the cement industry.

Some analysts say the impact of recent announcements will depend upon the type of expansion. According to Sumit Agrawal, equity fund manager at IDFC Mutual Fund, a brownfield capacity generally takes 2-3 years to come up post announcement and a greenfield takes 4-6 years.

Capacity expansion through the greenfield route involve setting up of new plants are set up or expanding existing ones, whereas brownfield capacity is through acquisitions of existing facilities of another company.

“FY23 (2022-23) supply may not be impacted at all by the new announcements. FY24 capacity will also have very little impact from new announcements. It is very difficult for any of the newly announced capacity to come up before FY 25,” said Agrawal.

WHERE IS DEMAND?
There was a strong revival in cement demand after the lockdowns were eased in 2020 which caught the street and the cement companies themselves off guard. Jefferies India said this an initial phase of pent-up demand from incomplete projects and houses which saw rural demand suddenly shoot up. Demand from cities followed significantly.

But recent inflationary pressures on consumers have muddied the waters for the cement companies. In post-March quarter conference calls with analysts in May, some cement companies have confirmed sluggishness in demand in the current quarter (Apr-Jun).

Inflation impact on government expenditure and current rural weakness may also belie market “anticipation of a surge in construction demand in the run-up to the general election (in 2024),” Jefferies India said. The brokerage pointed to the fact the recent slag in demand was partly on account of “a lack of infrastructure construction push due to government’s inaction”.

Further, input cost pressures have stayed high in the last three quarters and prevented companies from stroking demand through lower cement prices. Analysts are, however, more worried that the sustained rise in coal and other input costs will rein in companies from hiking cement prices and thereby hit the operating margins.

The cement sector is “passing through bumpy roads”, ICICI direct said in its report recently. A key factor, according to the brokerage, “will be the glut of new supplies over next three to four years.”

This view seems to be the market consensus. Time will tell, and particularly Adani Group’s action after completing acquisition of ACC and Ambuja Cements, whether the sector will manage to ride its way on the bumpy roads.