RBS on Construction Materials Worst may be over, we remain wary

Construction Materials
Worst may be over, we remain wary
We believe the sharp 2QFY11F EBITDA declines (15.8-95.26%) were widely
expected by the market. But, given strong price hikes (10-50%) towards the end
of the quarter, which we did not expect, the bigger question is whether or not we
are past the worst cement margins. We remain cautious on the sector.

2QFY11 results to reflect sharp margin pressure.
All-India average cement prices were 9-11% lower yoy in 2QFY11, with prices down 21-22%
in south India, 13-17% in the west and 10-12% in central areas. Northern and eastern
markets showed 2-3% yoy price declines in the same period. We expect all companies in our
coverage universe to show sharp EBITDA/mt declines yoy due to the sharp price fall. We
expect 2QFY11 EBITDA declines of 95% yoy for India Cements (which has more than 90%
exposure to southern markets), 42.8% yoy for ACC, 29.9% yoy for Grasim (consolidated)
and 15.8% yoy for Ambuja Cement.
Sharp price hikes towards quarter’s end improve earnings outlook
Cement prices in most markets, particularly in south India, posted sharp increases towards
end-September. Prices in Andhra Pradesh rose from Rs140-150/bag to Rs220-230/bag,
while other markets have seen modest 10-15% hikes. We believe the 2HFY11 earnings
outlook has improved due to these increases.
We were surprised by the price hikes and remain cautious
Recent prices hikes have been sharper than we expected. If prices remain at these levels,
we see significant upside to our FY11 and FY12 earnings forecasts. We estimate domestic
cement capacity of 285.5m metric tonnes by end-FY11 and 304.4m by end-FY12, against
demand of 220.2m and 239.6m mt. Considering the industry’s FY11-12F capacity utilisation
rate of 78%, we believe production discipline needs to be maintained for the next 12-15
months. However, based on historical trends, we are not confident that these price hikes can
be sustained, and remain cautious.