Fitch Ratings says that the 2012 outlook for the Indian cement sector is negative, driven by a cyclical moderation in demand and structural overcapacity in the industry. Cement volumes are largely the result of real estate construction and infrastructure projects. Fitch expects future activity in both these sectors to remain muted given low real credit growth, leading to cement dispatch volume growth to range from 2 to 5 per cent in 2012.

Cement volumes were relatively stable until early 2011, when a slowdown in construction activity (driven by private sector) was off-set by governmental spending in infrastructure. However, a rise in interest rates moderated the growth in the real estate construction to 18.7 per cent in November 2011, while a weakening of government finances may adversely impact infrastructure spending in 2012.

Fitch expects most cement companies to experience pressure on margins in the financial year to end-March 2012 (FY12) and the medium term due to the rise in operating costs, which, due to the expected muted demand, have not been passed onto customers. Operating costs, particularly the cost of power and coal, have increased due to a rise in the cost of international coal. Freight costs have also increased as railways raised freight rates by almost 6 per cent in 2011.

Fitch expects over-capacity in the sector to continue in 2012 due to lower off-take by construction and real estate industry. The widening demand supply gap is expected to affect utilisation levels of the cement companies. The agency notes that regional variation would play a significant role. The large demand-supply gap in the Southern region is expected to widen further, leading to the region witnessing lower capacity utilisation, followed by the eastern and western regions. Fitch notes that capacity utilisation could recover with an increase in demand from real estate and construction which will be followed by a decline in interest rates.

Cement companies are expected to generate lower cash flows in 2012 than in the previous year due to lower profitability, and thus to face liquidity pressure, possibly leading to higher working capital requirements. Fitch notes that credit profiles of large companies are likely to remain stable due to their strong balance sheets and moderate capex plans. Small and mid-sized cement companies with high debt-driven capex and limited flexibility in cost structures may have a deterioration of debt coverage.