Cement: rising coal costs dampen margins further

Tracking the hike in crude oil prices, international coal prices have risen 30 percent from their low of $55 per ton in March 2009 in the face of growing demand from India and China.
The surge means that domestic cement manufacturers would be taking a massive hit on their margins, as during such constraint times, cement makers would not be able to pass-on the impact of higher input cost to consumers.
Since, coal forms more than 40 percent of the total manufacturing cost, a $1 per ton rise in coal prices pushes the cost of production up by around Rs12 to Rs14 per ton.
Therefore, with aforementioned 30 percent increase in coal prices, production costs would be escalating by about Rs200 per ton or Rs10 per bag. Moreover, industry sources reveal that the proposed 18 percent increase in gas tariffs would jack up the cost of producing cement by around Rs2 per bag.
Thanks to inventory storage and forward contracts, the impact of soaring coal prices would be visible with a lag of 3 to 4 months - i.e. the period starting fourth quarter FY10.
But adding to the woes is the 15 to 20 percent fall in domestic cement prices that ranged between Rs240 to 250 per bag during 1QFY10, mainly due to weak domestic demand and the removal of cartels. Since then, the industry has not seen any adjustment in domestic cement prices. Moreover, the export prices of cement have also remained under pressure throughout the first half.
Therefore, the impact of depressed retention price in the form of reduced margins would be clearly visible in 2QFY10. In the prevailing situation, the pass-on ability of the local manufacturers seems frail. However, the likely revival of demand with the lapse of winter may provide some space to manufacturers for a price hike. Until then, the industry is left with no option.
The near-term outlook for the cement sector remains bleak given the subdued domestic cement demand amid halted construction activities after cut in developmental spending. Also, likely shrinkage in regional cement demand owing to global meltdown and the completion of pending regional expansions would continue to depress retention levels.
Yet, two firms bucking these pressures, LUCK and DGKC, would be in a better position to capitalize the expected recovery in demand after winter season, given their better market positioning, diversified business streams and leading brand name.