Cement companies exit H1FY22 with low free cash flow

An analysis by IIFL Securities Ltd showed that the free cash flow (FCF) for cement companies under its coverage has declined by around 78% year-on-year (y-o-y). 2,150 crore in H1FY22. One of the reasons cited for this decline was working capital expansion against the backdrop of higher fuel prices.

Channel checks by various brokerages have revealed that domestic petroleum coke prices have increased by almost 90% and have increased by 22% sequentially in Q2FY22. Inflation in imported coal prices was sharp, with an increase of around 150% year-on-year and 45% quarter-on-quarter (QoQ). It should be noted that many cement companies import their fuel requirements.

No wonder, operating cash flow declined by about 36 per cent in the first half of FY22 due to increase in working capital. 4,200 crore as compared to reduction in working capital 2,000 crore in H1FY21, says IIFL report. Of course, the prices of some of these fuels have started coming down, but their gains will be visible with a lag.

Another factor reducing FCF was increase in capital expenditure by large cement manufacturers. “FCF in H1FY22 is low, given the significant increase in capital expenditure by UltraTech Cement (3.5x yoy), Shree Cement (+134% yoy), Dalmia Bharat (+111% yoy) and ACC (+97% yoy). IIFL report added.

In a post-earnings conference call, the management of UltraTech Cement Ltd said that the company’s capacity expansion of around 20 MTPA will be commissioned in phases in FY22-23E. Mtpa is short for million tonnes per year. Peer Shree Cement announced commissioning of 6.5 MTPA capacity by FY25. ACC has a 3 MTPA clinker line at Ametha and Auxiliary Grinding Units in central and northern regions will be commissioned in phases in CY22 and CY24.

“Most cement companies have reported that their capex plans are on track with a delay of two-three months in some cases due to COVID-19. Overall, we expect the industry to add 80 million tonnes of capacity in FY 2011-24 against a similar increase in incremental demand,” analysts at Nirmal Bang Equities Ltd said in a report.

In addition, some cement companies used higher free cash flow to reduce debt and strengthen their balance sheets.

Meanwhile, the demand outlook for the cement sector remains strong, and is likely to be aided by a revival in the housing sector, a major contributor to cement demand. However, what remains to be seen is the stability of the price hike that has been recently announced across India. Dealers’ channel checks by various brokerages showed that cement prices rose on an average by 7-8% in October for cement bags weighing 50 kg from the all-India level in October.

“Most of the cement companies have already announced the hike in October 2021. However, full transmission of the cost increase does not seem possible. We expect mid-teens growth in cement volumes based on FY12. They are expanding with demand momentum for industry players backed by strong balance sheets and healthy liquidity,” said Sachin Gupta, Chief Rating Officer, CARE Ratings Ltd.

“While margin contraction and ongoing capex may impact free cash flow, volume growth on a year-on-year basis will offset the impact to some extent,” Gupta said. “Currently, we are seeing some relief in input prices and raw material availability. The volatility trend in the prices of key raw materials is still to be monitored and the potential for the industry to rise further.”

In other words, volatility in cement prices will be a primary factor that will determine the free cash flow outlook for cement companies.