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Challenges abound

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Dhiren Shah Mumbai

While some recent events may be beneficial for the cement industry, sustainable growth will depend on revival of the real estate sector.

Hopes of a revival in the cement sector, thanks to the stimulus package, sharp decline in commodity prices, historical low valuations and strong despatch numbers in the last two months, has improved investor sentiment towards companies in this space. Major cement stocks like Ambuja and ACC out-performed the broader markets in 3Q, FY09. However, analysts continue to believe that FY10 will be a challenging year for the sector on account of slump in real estate, over supply situation and a resulting drop in realisation.

 

An uptick or a mirage?
The all-India cement despatches have witnessed an impressive 11.2 per cent and 12.1 per cent y-o-y (year-on-year) growth in November and December respectively, compared to April-October 2008 growth of 6.3 per cent. Pre-election spending leading to a revival of demand from the infrastructure sector coupled with increase in capacity have driven cement volumes. Shree Cement has reported whopping y-o-y growth of 37.1 per cent due to capacity additions.

“It should also be noted that in December last year despatches had reported a y-o-y growth of only 4.8 per cent (as compared to FY08 average growth rate of 8 per cent). So, the growth in despatches is partly because of the base effect,” says an analyst. Also, the demand for cement in October 2008 grew by a dismal 4.1 per cent y-o-y due to the liquidity crunch. With easing of liquidity, the chocked demand seems to have spilled over in the following months.

Apart from this, cement players in anticipation of transporters strike had despatched higher quantity of cement to dealers. “Historically, December-March have been good months for the industry, during which the demand is generally at its peak. Though demand may remain robust in the near term, we don’t think it will be sustainable over a longer period,” opines Revathi Myneni, analyst, Edelweiss Securities.

The ‘real’ problem
The slowdown in real estate sector (residential and commercial), which accounts for about 65 per cent of the total cement consumption in India, affected the cement sector. Since most builders are facing a severe cash crunch, it is unlikely that too much real estate development will take place in the near future. The IT/ITES segments account for three-fourth of the office space across India and lower growth in employee recruitment for the sector shall translate into muted demand for cement.

Cement exports, too, have declined from 10 million tonne (mt) in FY05 to 2.1 mt between April-December 2008 on account of additional capacity addition and real estate slump in the Middle East region, which is the main export market of Indian cement producers. Demand for cement can be gauged from the country’s economic performance, with demand typically averaging 1.2 times the GDP growth. Assuming that India’s GDP will grow at 6.5 per cent and 6 per cent in FY09 and FY10 respectively, analysts expect demand for cement to grow at 7.8 per cent and 7.2 per cent in the mentioned two years, respectively. Additional capacity to the tune of 90-95 mt is expected to be added by the end of FY11. This would result in a surplus of about 10 mt and 35 mt in FY09 and FY10, respectively. “We believe with over capacity scenario inevitable and demand slowing down on account of real estate slump, further price cuts will happen post FY09,” feels Mihir Jhaveri, analyst, Religare Hichens & Co. All India average cement prices during December 2008 declined to Rs 234 per 50 kg bag (Rs 238 in November 2008). Analysts have factored a marginal decline in realisations during Q4 FY09, followed by a 5-10 per cent decline in prices during FY10. 

Feel good factors
The government recently responded to the industry woes by way of a four per cent cut in the excise duty, relief on exports, a bail-out package for the housing sector and the withdrawal of countervailing duty (CVD) exemption from imported cement; these have created a positive sentiment towards the sector. However, the benefit of reduced excise duty has been passed on in the form of cement-price reduction and the relaxation of ban on exports will have marginal impact as the government had allowed cement exports from the ports in Gujarat (accounts for India’s 80-85 per cent of cement export).

And, while the CVD and special duties would reduce the competitiveness of imported cement, the impact will be minimal as the quantum of the imported cement in India is very negligible (about half a per cent of the all-India consumption). Says Pawan Bhurde, analyst, Angel Broking, “The measures announced by the government will only support the falling cement demand rather than boosting it. The key for the cement sector lies in the revival of the real estate sector”.

Some respite
Due to the global slowdown and sharp correction in crude oil, prices of international coal (down 60 per cent from its high of $193 a tonne in July 2008) and petcoke have declined sharply from their peak levels. With shipping rates too down, this has trimmed the landed price of coal significantly. Power and fuel account for about 25 per cent of the production cost. However, material benefits will vary across companies due to their individual circumstances like dependence on imported coal (rupee has depreciated 12.4 per cent against the dollar in H2, CY08) and uncertainty regarding stability of international coal prices.

At the macro level, cement companies are hoping that interest rate cuts on housing loans will revive housing demand and thereby improve demand. Additionally, there are reports suggesting that many cement projects have been delayed, and as such, the industry will be able to add 20-25 mt of capacity as against the projected 32 mt for FY09; FY10 may also see some slippage in new capacity additions.

Top picks
ACC’s and Ambuja Cements’ expanded capacities will come up only at the end of CY09 and CY10, keeping volume growth muted. Analysts like Grasim Industries in the large-cap space and Ultratech Cement and Shree Cement from the mid-caps. That’s because, they believe that these companies are relatively less vulnerable to reduced volumes and pricing.

Also, these companies have already completed their capex programme, which signifies lower pressure on free cash flows going forward. Also, margin erosion for these companies is expected to be less on account of available cost-management levers, like lower dependence on imported coal and captive power among a few others. Further, these three companies are trading below their replacement cost of $100 per tonne.

EMERGING VALUE
          

in Rs crore   

     Financials of trailing four quartersEV/tonne ($)
NetSales% chgOp profit% chg    PAT% chgFY08FY09EFY10E
ACC#7,34715.41,820-0.41,136-1.8798173
Ambuja Cements*#6,119121,878-6.3925-35.4105111100
Ultratech Cement5,87611.91,7009.199211.5766567
Shree Cement2,41745.685323.2294-7.9524341
Source: Capitaline  E: Analyst estimates, * Standalone financials, # Year ending December
Note: Grasim derives about 40% of its revenues from non-cement businesses

Going forward, while valuations remain undemanding, investors would get better entry points in the sector later during 2009, as despatch growth is expected to slow down and pricing pressure to increase.

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First Published: Jan 19 2009 | 12:00 AM IST

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