Will an increase in coal prices leave the cement margins singed?

Coal India's announcement on revising its coal pricing policy has left some hard landing for the cement industry, which has been struggling to sustain its margins. Lower demand, high raw material prices such as coal and freight charges and high interest expense has tested the persistence of these companies in the last one year. However, the companies have been keeping their head above the water by increasing the cement prices, which was done to offset the higher costs by cutting down production.

Earlier, coal pricing was based on the Useful Heat Value (UHV). This has now changed to Gross Calorific Value (GCV), in line with the global norms, which will lead to a steep hike in the coal prices. The company is yet to announce the prices on its website, and hence, the exact nature of the new pricing system is not yet known. However, a company official said in a media report that the rise in the coal prices for the cement sector, which largely consumes C and D grade coal, will see a rise of more than 25%.

Further, in a statement given to the media, Shailendra Chouksey, Director, JK Lakshmi Cement, said that the impact on pricing would be between Rs 8 and Rs 10 per bag. This may lead to a higher jump in the total expenditure for cement companies.

The cement industry largely consumes 5-6 MT of coal annually. However, due to the limited availability, a large part is diverted to the power sector, which is struggling with its coal requirements. Recently, the govt. has asked cement companies to look for alternative energy sources. Mr. PK Chaudhery, Secretary, Department of Industrial Policy and Promotion made the following statement in the media, "Let the cement industry be realistic about the domestic coal problem. I do not see any immediate relief from this problem."

We believe that the increase in the coal prices is across all the sectors, and this will become the new normal price trend for the industry. Therefore, cement companies will pass on the rise by increasing the prices of cement. Also, we are expecting some pickup in demand in the coming months, which may provide some support to these prices.

The Indian cement industry procures 40-45% of its coal requirement from the domestic open market, while the rest is taken from the international markets. With the increase in the coal prices, are we looking at some margin erosion if this hike is not passed on to the consumer? If yes, then by how much?

We took a few major cement producing companies to know how much impact this rise will have on the margins, if not passed on. As per our calculations, if the price rise is not passed on, the EBIT margin of these companies will come down by 250 bps. However, as stated earlier, the most probable situation is that cement companies will pass on the price to the consumers at Rs 8 or 10 per 50 kg bag. Thus, we may not actually see much impact on their margins.