Cement Sector Update – December 2011 - Higher realization sealing the cracks - Angel Broking

Top-line growth impressive, but margins under pressure in 2QFY2012: Our cement universe (comprising ACC, Ambuja, UltraTech, India Cements, Madras Cements and JK Lakshmi Cement) posted top-line growth of 24.1% during 2QFY2012. Companies in our universe reported top-line growth of 15-33%, driven by 7-47% (on low base) improvement in yoy realization due to adoption of a strong production discipline (particularly in south). Four of the six companies under coverage posted growth of 2-19% in their dispatches, while southern players, India Cements and Madras Cements, witnessed a decline in their dispatches. While all the companies under coverage posted realization growth, the southern players showed meaningful improvement in operating margins as the increase in realization was considerably offset by a steep increase in input costs (up 14% yoy). During the quarter, OPM of India Cements and Madras Cements expanded by 1,972bp yoy and 1,490bp yoy, respectively, while Ambuja alone declined by 167bp yoy to 17%.

All-India capacity utilization to decline in FY2012E, but set to improve from FY2013E: The rate of capacity addition is set to moderate, with only 31mtpa of capacity expected to be added over FY2012-13E which is much lower than 55mtpa added over FY2010-11. But demand slowdown has become a bigger concern. Over FY2001-10, cement demand grew at 1x the GDP growth. However, all-India cement demand, after being mediocre at 4.5% in FY2011, is expected to remain muted at 5% during FY2012 as well (1HFY2012 demand growth was 3.1%) vs. GDP growth of 8.5% and 7% in FY2011 and FY2012E, respectively. Even if we factor in 8% demand growth rate for FY2013E, capacity utilization for the year is expected to be 75.4% (although higher than 73.8% and 72.4% in FY2011 and FY2012E respectively).

For FY2013E, we expect the central region to report the highest capacity utilization of 87%, followed by the northern, eastern and western regions with capacity utilization of 83%, 80% and 79%, respectively. However, we expect the southern region to continue to be a laggard with capacity utilization of 64% due to minimal growth in demand and 13.5mtpa of capacity expected to be added over FY2012-13E.

Outlook and valuation: In our view, the cement sector's valuations in terms of EV/sales and EV/tonne are trading ahead of the cycle when compared to utilization levels and are almost 27% more expensive than historical valuations during periods of similar utilization levels. But, despite low capacity utilization, cement companies have managed to maintain relatively healthy pricing due to production discipline adopted by them, which has led to high valuations currently. However, in our view, this is a thin investment thesis to rely on, as there exists persistent risk of a breakdown in production discipline. Hence, we maintain our Neutral view on the sector. That said, we maintain our Buy recommendation on JK Lakshmi Cement due to its attractive valuations as it is trading at EV/tonne of US$39 on current capacity. Also, we are initiating coverage on Shree Cements with a Neutral recommendation.

Source : Equity Bulls

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