Indian Cement - Bouncing Back - Motilal Oswal

INDIAN CEMENT: Bouncing back; top picks - Ambuja, Grasim, JP Associates (large-caps); Birla Corp, India Cements (mid-caps)

The cement sector has witnessed strong recovery in prices as rationality has prevailed. We believe that the worst is behind us, with trough operating performance witnessed in 2HCY10. Long-term demand drivers are intact, which would ensure return of normal growth. We are upgrading our FY12 estimates by 2-18% to partly factor in for current prices. However, sustenance of discipline and current prices in FY12 could drive further upgrades of 9-33%. Valuations are attractive and offer a good entry point for the next upcycle. We prefer Ambuja Cements, JP Associates and Grasim among large-caps, and Birla Corp and India Cements among mid-caps.

Worst is behind, trough made in 2HCY10

The cement industry witnessed a trough in its operating performance during 2HCY10. Muted demand (~4.5% growth in 9MFY11) and excess capacity (~75% utilization) impacted realizations (~Rs35/bag decline from peak of Rs255/bag) and profitability (decline of Rs1,100/ton from the peak to Rs450/ton in 2QFY11).

Sharp recovery in cement prices to drive profitability 4QFY11 onwards

Cement prices have recovered by Rs30-40/bag. Peak construction season and production discipline would lead to further price increases till 2QFY12 and would offset any cost inflation. We expect EBITDA/ton to improve to ~Rs894/ton in FY12 and Rs993/ton in FY13 (v/s FY11 average of Rs760/ton) from the trough of Rs525/ton in 2HCY10.

Upgrading FY12 EPS by 2-18% to partly factor in for current prices

We are upgrading our FY12 estimates by 2-18% to partly factor in current prices. This upgrade is on top of the 3-9% upgrade post-Budget (to factor in the then prevailing cement prices and increase in coal prices by Coal India). We are now assuming realization to be higher by Rs12/bag in FY12 (similar to 4QFY11 average prices, but Rs10/bag lower than March 2011 exit prices).

Strong cash flows, cheap secondary market valuations drives stake increases by promoters

The Cement Industry has been generating strong operating cash flows driven by recovery in cement prices. This coupled with limited capex plans have resulted in strong free cash flow generation for the industry. Further, attractive secondary market valuations (at replacement cost of US$120/ton for large caps and ~US$45-90/ton for mid-caps) is driving promoters to increase their stakes (Holcim’s creeping acquisition of ACC/ Ambuja, A.V.Birla’s intention to increase stake in Grasim, Binani Industries de-listing Binani Cement, Orient Paper’s issuing warrants at 20% premium to CMP etc).

Good entry point – Buy

The worst is behind and we expect gradual improvement in operating performance. Though the sector would continue to be plagued by over-capacity at least till December 11, cement prices would remain buoyant at least till 2QFY12, driven by seasonality in demand and pricing discipline. However, long-term demand drivers continue to be present. We believe current valuations offer a good entry point for the next upcycle. Valuations for the cement stocks currently factor in bottom-of-the-cycle profitability. We prefer Ambuja Cements (favorable market mix, return of superior profitability, creeping acquisition by Holcim and reasonable valuations), JP Associates (emerging cement giant with pan India presence) and Grasim (positive outlook for both Cement and VSF, and very attractive valuations) among large-caps, and Birla Corp (an efficient player with strong balance sheet available at cheap valuations) and India Cements (very high operating and financials leverage and option value in form of IPL and Indonesian coal mine) among mid-caps.

Source : Equity Bulls

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