The recent rally in cement stocks is unlikely to last due to excess capacity and moderating demand, believe analysts.
In southern India, cement prices have shot up on expectations of higher demand and production cuts. Some cities even reported prices that were 10 per cent higher than the national average (Rs 230-Rs 235 a bag). However, analysts say the southern region also saw the highest corrections during April-August this year, with prices dropping about 40 per cent. So, what’s in store for the sector and the major companies?
| COSTLY CEMENT | ||||
| FY12 Estimates | Ebitda (%) | P/E (x) | EV / Ebitda (x) | EV / Tonne ($) |
| Ultratech | 21.6 | 16.1 | 9.0 | 157 |
| ACC* | 24.2 | 14.4 | 8.5 | 131 |
| Ambuja* | 29.1 | 14.5 | 9.4 | 165 |
| Grasim | 22.0 | 10.4 | 6.4 | 77 |
| India Cement | 10.5 | 24.8 | 12.9 | 84 |
| EV: Enterprise value * numbers are for CY11 Source: Analyst reports | ||||
Mismatch continues
The problem for the sector, whose installed capacity is 270 million tonnes (mt), continues to be excess capacity. The industry added about 100 mt between 2007 and 2010 and is expected to commission 75 mt between now and 2013, believes a CLSA report. Analysts estimate while demand is likely to increase by about 9.5 per cent in 2010-13, supply will be higher at 13 per cent. Says Hemant Nahata, research analyst at IIFL, “Demand is historically 1.2 times the GDP, which will translate to 10 per cent volume growth. However, even if demand were to just about match GDP growth of 8-8.5 per cent for the financial year, it could be enough to sustain prices in the short term.”
Though there has been a spurt in prices, analysts say demand is still lagging (the growth in supply) due to a slump in realty construction and delay in infrastructure projects. Analysts estimate prices will fall by about 10 per cent, once the busy January-May season ends next year. They expect capacity utilisation to be in the range of 78-85 per cent till 2011-12. Meanwhile, lower demand and soft prices impacted the performance of companies.
Poor quarterly results
Cement majors turned out numbers which were below expectations. ACC was among the hardest hit, with a 15 per cent fall in revenues on the back of lower volumes and softening of cement prices. Ambuja Cements saw revenues fall three per cent on lower realisations, Madras Cements’ sales also fell by about 20 per cent year-on-year. Says Revati Kasture, head, CARE Research, “September quarter results weren’t encouraging because of the increase in power and fuel costs, as well as fall in prices. Margins were also down because of increase in freight cost (fuel prices have increased by about five per cent in the September quarter over the June quarter, the railways have also increased freight rates for commodities).” Analysts say the drop in cement prices, with the exception of the eastern region, of between two and 11 per cent in the first half of 2010-11 reflected in the poor sales numbers.
Valuations
Though the demand-supply situation continues to be a major headache, cement stocks have rallied in the recent past. CLSA believes valuations have become expensive, with one-year forward price-to-earnings at 17-17.5 times and EV/Ebitda (EV is enterprise value) at 9-9.5 times. Asset valuations, too, are at a 20-50 premium to replacement costs, believes the research firm. Analysts, thus, say investors should avoid large caps and could look at small caps with EV/Ebitda in the five to six times range. This will help them benefit from the upturn in the cement cycle, when the demand outlook improves. That apart, they prefer Shree Cements and Grasim, on relatively cheap valuations.