Improved Demand Support's Cement Players To Pass Higher Freight Cost

The cement companies over the past few months have hiked the cement prices in order to offset the high input costs and increasing freight charges thanks to an upward spiral in the demand for cement. The increase in the freight rate by Indian Railways has not left much room for the commodity players in terms of the profit margins. Freight rates on all the commodities, including food grains, fertiliser, cement, coal and petroleum products have been raised by an average 20 per cent ahead of the Railway Budget. This move has come as a setback to most of the commodity players who are anyway going through a rough patch. One of the sectors that will be impacted very negatively is that of cement which has just started recovering after a lull over the last one year.

The cost of transporting by railway accounts for 30-40 per cent of the freight cost in the cement industry and therefore any such hike can lead to a jump of up to 10-12 per cent on the current cost of Rs 700 per tonne. A hike of Rs 70-84 per tonne will be seen on the cost side in the coming year FY13. Depending on the mode of transport used by the different cement companies, we expect an impact of 3-6 per cent on the EBITDA front of most of the cement companies.

This would have been a bigger blow to the industry if the demand had remained subdued. However, the current demand looks good as of now and therefore we may see the cement companies passing on the freight hike by increasing the cement prices between Rs 10-15 on a 50 per kg bag to Rs 295-300. And this would help the cement companies to report better numbers in the March 2012 quarter. However, do not expect margin expansion as any gain through the price hike would have been negated by the higher freight cost.

Moreover, concerns hover around the sustainability of the margins from a long-term point of view. Cement makes for a cyclical business because construction and infrastructure projects slow down during the monsoons. During such periods, lower capacity utilisation and high input costs restrict them from imposing any hike in the prices, thereby leading to margin erosion. Additionally, the hike in the freight rates will concurrently lead to higher power and fuel cost as the raw material suppliers too will pass on the freight hike to the cement players, thus creating a double whammy impact for the cement players.