IIFL recommendations on Cement: Castle in air

Cement stocks in our universe have appreciated by 7–25% in the past two months, as against the
Sensex’s appreciation of 10%. More stocks are trading at a premium to replacement cost compared to
the previous down-cycle. To assess whether this steep re-rating is warranted, we have compared the
current cycle with the previous one on four key parameters: 1) visibility on acceleration in demand
growth; 2) capacity utilisation; 3) industry fragmentation; and 4) ratio of earnings to replacement
cost. We find that on most of these parameters, industry fundamentals have deteriorated compared to
the previous down-cycle. We have compared valuations of ACC and Ambuja Cements (ACL) in both
these cycles, as their market shares and business profiles are pretty similar. We continue to be
negative on the sector, as valuations do not reflect the deterioration in fundamentals. Ambuja
Cements is the top SELL in our sector.
1. Acceleration in demand growth – visibility not as strong as in the previous cycle: In the current
cycle, we see no trigger for demand growth to accelerate beyond 10% in FY12 and FY13, compared with the
estimated domestic demand CAGR of 9% over FY09-FY11. In contrast, outlook for cement demand growth had
strengthened markedly in FY01, owing to: a) the four-fold increase in interest exemption on loans for selfoccupied
property; b) approval of the Golden Quadrilateral and NSEW corridor road projects.
2. Capacity utilisation – sharply lower: Based on our assumption of 10% demand growth, the industry’s capacity
utilisation would be 76% in FY12, as against 83% in FY02. This will constrain players’ pricing power.
3. Industry fragmentation – more severe this time: The top ten players’ market share was 74% in FY01, as
against 70% in FY10. Fragmentation is likely to intensify going forward, as more new producers enter the industry.
4. EBITDA-to-replacement cost ratio likely to be lower in the current down-cycle: ACL’s EBITDA in
FY02 was US$13 (Rs616) per tonne, and replacement cost for the industry was US$50-70 per tonne in FY01.
At present, replacement cost is US$110-130/tonne, and CY11 EBITDA estimate for ACL as per ours and
consensus is US$21 per tonne. We believe the decline will be substantially steeper in this down-cycle, because
of increased competition.