Weak Outlook for Indian Property Developers to Affect Cement and Steel Demand: Fitch
Weak property demand and a sluggish construction cycle to cause India's cement consumption to drop by more than 15% in the financial year ending March 2021 (FY21), as more than 65% of domestic cement demand is driven by the housing segment, says Fitch Ratings.
Fitch says it expects property developers' operating cash flow to deteriorate on weak demand stemming from low consumer confidence caused by business uncertainty and unemployment concerns, despite falling home-loan interest rates and cuts in transaction costs by some local governments. Lower labour availability and disrupted raw-material supply chains are also leading to construction delays.
"We expect a contraction in pre-sales to slow the reduction of unsold inventory, which has come down to 450,000 units, from around 700,000 units in 2015. New project launches are also likely to slow as developers look to preserve liquidity and given customers’ preference for completed properties to mitigate execution risk. This could improve the demand and supply balance in the medium term," it added.
The Reserve Bank of India (RBI)'s recent measures, including loan restructuring, moratoriums and relaxed lending limits, provide temporary funding relief to the property sector. However, Fitch says, the underlying appetite of financial institutions to lend to the sector is likely to remain weak until there is a broader improvement in the sector's operation, with better end-user demand and pricing support.
Even before the pandemic, India’s property market faced weak investor demand, high unsold completed inventory and stagnant prices. The weak sector fundamentals coincided with regulatory changes, like the implementation of the Real Estate (Regulation and Development) Act, 2016 and the demonetisation of currency notes, which limited advance collections and cash flow fungibility across projects.
Credit availability from non-bank financial institutions also fell following the default of two non-bank financial institutions in September 2018 and June 2019.
According to the ratings agency, the multitude of issues at Indian financial institutions has allowed private equity to emerge as a major investor in the country’s property sector, with more than $40 billion invested over the last decade. However, it says, the near-term outlook for the continued inflow of private-equity capital remains uncertain, given the global nature of the current downturn.
Fitch says it expects developers with weak financial profiles or a focus on high-end projects, who are unable to avail the benefits of the reserve bank's restructuring scheme, to be most affected. It feels, narrower capital access would lead such developers to tie up with large and reputable ones with strong financial profiles, creating significant opportunities for consolidation and market share gains for the stronger developers.
The ratings agency believes an ability to cut property prices to revive demand and improve collections varies across segments and depends on the strength of developers’ financial profiles. It says, "This is notwithstanding our expectation that weakness in property demand is broad based across pricing segments, as the uncertain business environment affects the luxury segment and weak consumer confidence impacts the mid-income and affordable-housing segments."
"We expect luxury real estate to see the greatest price moderation in light of its discretionary nature and headroom from higher profit margins. Developers in the mid-income and affordable-housing segments may try to spur demand, especially during the upcoming festival season, by offering flexible payment and price protection plans or waiving registration charges, among other incentives. We expect limited price moderation in affordable housing, given the segment’s better demand dynamics and thinner," Fitch added.
According to the ratings agency, a slowdown in real estate and overall gross domestic product (GDP) growth to cause a decline of more than 15% in cement consumption in FY21, following a low-single-digit drop in FY20. Easing of lockdowns spurred pent-up demand and softened the yoy fall in India’s monthly cement production to 7% in June 2020, from a drop of 86% in April and 22% in May, according to government data.
Nonetheless, cement production declined by 14% in July, as weak demand coincided with the seasonal onset of the monsoon.
Many large cement companies reported strong profitability in 1QFY21, with disciplined pricing underpinning realisations. In addition, lower operating leverage, coupled with low energy costs and fixed-cost savings, cushioned the blow of a more than 30% plunge in volume.
Fitch says, "We believe larger producers are better positioned to navigate the downturn, as their strong brand recognition supports pricing in India’s largely retail-oriented cement market. In addition, strong distribution capability, captive raw-material sourcing and investments in energy efficiency (waste heat recovery) drive cost efficiency. We expect financial flexibility to remain strong for larger companies, considering their strong capital structures and prudent investment approaches in the current environment."
Meanwhile, steel demand is likely to fall by around 10%, supported by a lower hit to demand from other sectors, the ratings agency says adding, "Steel producers that focus on long steel products for construction, such as bars, wires and beams, tend to be small in scale and less efficient; we expect these producers to see a larger drop in volume than for larger steel manufacturers."
Fitch says steel’s exposure to real estate is lower than for cement, with sectors other than construction and infrastructure accounting for around 40% of overall demand. "Producers of long products that are used for construction, such as bars, wires, beams, angles and other structural shapes, comprise many small entities whose access to funding and technology is weaker than for Fitch-rated names," the ratings agency concludes.