ICICI Securities: maintain our positive stance on cement stocks

Despite the recent ~15% run-up, we maintain our positive stance on cement
stocks as we believe earnings could surprise and sector could re-rate with
utilisation increasing to 86% from 80% over next three years. We raise our FY11-
12E earnings 2-16% and target price 4-27% as we roll forward our valuations on
average of FY12-13E and increase our target multiple to a higher range of midcycle
valuation. We expect the pace of capacity additions to decelerate and
demand to surprise positively. We believe next 12 months would lay the
foundation for the next up-cycle. Recent ‘unreasonable and arguably
unsustainable’ price hikes in the South could lead to gradual pan-India price hike,
as busy construction season resumes post monsoon and festive season. We
factor in ~2-4% YoY increase in average price realisation for FY12-13E. We expect
EPS CAGR of 14-17% over FY11-13E for top three pure play cement companies.
􀁦 Demand could surprise positively in H2FY11E and FY12E given: i) in the last 18
months of XI Five Year Plan (FYP), the Government would accelerate infrastructure
spend; ii) higher rural housing demand on better monsoon this year; iii) forthcoming
elections in few large states; and iv) low base effect of H1FY11. We believe the
cement industry is at inflection point led by structural shift in demand drivers. Hence
the demand is expected to be in low double digits over the next three to five years.
􀁦 Pace of supply to decelerate. Capacities of ~52mnte were added in FY10;
however lesser 37mnte and 16mnte are expected to be added in FY11E and FY12E
respectively. Utilisation is expected to increase from 72% in Q2FY11E to 84% by
Q4FY11E. Hence, prices are unlikely to touch the recent lows of August ’10. Also,
unlike the last year, we expect prices in most regions to move in identical direction.
Prices in the South seem to have bottomed out; though would remain volatile.
􀁦 Higher concentration and cost escalations may result in better pricing
discipline. Top 10 cement groups constitute almost three-fourth of the industry;
whereas top five enjoy ~55% market share. Costs have spiked 10-12% YoY and we
believe that the companies would attempt to protect their margins by raising prices.
On the other hand, consensus (including us) is factoring in an average 3-7% decline
in realisation in FY11E owing to over-supply. Thus, any price hike to mitigate cost
rise would lead to an earnings surprise.
􀁦 Sector likely to get re-rated. We replace Ambuja Cement (strong outperformance
of 23% YoY) with ACC (volumes to pick up; cost efficient) as our top pick, followed
by Grasim Industries (strong VSF; higher unjustified holding company discount) and
Shree Cement (diversified).
􀁦 Key risks: Lower-than-expected demand; higher cost escalations.