2011 Outlook: Cement (Supply overhang elongated, large cap lack valuation comfort ): ICICI Securities

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Cement (Supply overhang elongated, large cap lack
valuation comfort ) Negative
Cement dispatches have been subdued during the current financial year as
they registered 5.4% growth in YTDFY11. This was on account of a
prolonged monsoon, delay in infrastructure activities and political turmoil in
the major cement consuming state of Andhra Pradesh. We expect demand
growth of ~7% for FY11E against our previous expectation of ~10%.
Moreover, huge effective capacity addition of ~40 MTPA has been
witnessed in YTDFY11 as the majority of capacities commissioned in FY10
and FY11 have stabilised during this year. Cement prices have been
showing weakness. It declined by | 10-15 per bag in December after an
artificial hike in prices by cement players in October by taking production
cuts. We believe prices will remain under pressure in the medium term on
account of the unfavourable demand supply situation.

⇒ For FY11E, the capacity utilisation rate is expected to decline to 78%
from 87% in FY10 as we expect ~44 MTPA of effective capacity
addition during the year against ~14 MTPA of incremental demand.
However, utilisation rates are expected to improve to 82% in FY12E as
the pace of incremental capacity addition (~13 MTPA) would slow
down as compared to incremental demand (~21 MTPA). Further, the
utilisation rate is expected to increase to 85% in FY13E
⇒ Increase in fuel and freight cost coupled with a decline in realisations
have squeezed margins in Q1FY11 and Q2FY11. We expect margins to
remain under pressure in FY11E and FY12E on account of increasing
input costs coupled with subdued realisations
⇒ We believe the valuations of frontline cement companies are not
attractive as they are trading at a 5-10% premium to the replacement
cost of $125 per tonne. The high valuations of these companies seem
unjustified considering the margin pressure and deteriorating return
ratios
⇒ However, there is a selective buying opportunity in the cement space
considering the companies that have a better market mix and cheap
valuations. Regional cement players like JK Cement, JK Lakshmi and
Mangalam Cement are trading at a 40-50% discount to the
replacement cost. This seems unjustified as these companies had been
enjoying valuations near their replacement cost in the last down cycles
despite having better return ratios in the current cycle compared to the
last down cycle.