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Construction materials (cement)
Action
We believe the downcycle that the sector has entered is here to stay for a while
and that the demand-supply mismatch will not improve significantly by FY13F. We
do not expect any pricing discipline to sustain for long, given the fragmented nature
of the industry. We think valuations have some more room for corrections to adjust
to the lower profitability regime that the sector is facing. We maintain our Bearish
stance on the sector.
Catalysts
Low pricing power due to adverse demand-supply equation resulting in lower
profitability for the sector should keep valuations in check.
Anchor themes
Cement companies saw high profitability during FY07-FY10, delivering record high
ROCEs on a tight demand-supply equation, which resulted in solid pricing. FY11-
FY13 may be the opposite but valuations have yet to adjust to this, in our view.
No meaningful recovery in 2011
We expect the pain to continue
Unlike the Street we are not so optimistic on the prospects of the Indian Cement
sector for 2011, as we believe the demand-supply mismatch will continue to be
severe as the capacity that was added in 2010 stabilises and incremental
capacity additions keep pace with incremental demand.
Pricing discipline unlikely to be sustained
We do not believe that the industry will be able to tide over the current phase
through pricing discipline, as it is too fragmented. Also, the current arrangement
would result in new capacity generating sub-par returns for a long time.
Return ratios to deteriorate
The Indian cement industry has enjoyed a very high ROCE during the FY07-
FY10 period, as delayed capacity resulted in high pricing power and higher
profitability. Over the next three years, we expect the industry’s average ROCE
to deteriorate significantly on continued overcapacity.
Valuations to see more correction, in our view
We expect Indian cement companies to generate very low returns in FY11-
FY13F compared with the past four years. Valuations, on the other hand, have
yet to adjust to this reality, and we see room for a correction in most of the stocks.
Maintain Bearish stance; ACEM and ICEM top REDUCE ideas
We maintain our Bearish view on the sector and retain REDUCE on Ambuja
Cement, India Cement, ACC and Ultratech. Ambuja Cement and India Cement
are our top REDUCE ideas for their relatively high valuations (adjusted for the
returns that their assets generate). We rate Shree Cement and Grasim as
NEUTRAL on relatively inexpensive valuations.
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