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The cement sector has witnessed strong recovery in prices as rationality has prevailed. We believe
that the worst is behind us, with trough operating performance witnessed in 2HCY10. Long-term
demand drivers are intact, which would ensure return of normal growth. We are upgrading our
FY12 estimates by 2-18% to partly factor in for current prices. However, sustenance of discipline and
current prices in FY12 could drive further upgrades of 9-33%. Valuations are attractive and offer a
good entry point for the next upcycle. We prefer Ambuja Cements, JP Associates and Grasim
among large-caps, and Birla Corp and India Cements among mid-caps.
Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its operating performance during 2HCY10. Muted demand (~4.5%
growth in 9MFY11) and excess capacity (~75% utilization) impacted realizations (~Rs35/bag decline from
peak of Rs255/bag) and profitability (decline of Rs1,100/ton from the peak to Rs450/ton in 2QFY11).
Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key catalyst for the next upcycle, especially considering limited
visibility in the short-run. Demand has disappointed in 9MFY11. However, long-term drivers in the form of
higher infrastructure spend, strong growth in rural housing and normal growth in urban housing remain intact.
While short-term visibility is limited, levers in the form of higher number of assembly elections over the next
3-5 years, FY12 being the terminal year of the Eleventh Five-year Plan, pent-up demand and low base of
FY11 could help to bring growth momentum back on track.
Peak capacity addition, bottom utilization behind; expect gradual improvement
Majority of the capacity additions are behind as only ~66mt of new capacities are expected to be added over
FY11-14 as against ~105mt over FY08-11. With expected pick-up in demand and decline in the pace of
capacity addition, we believe capacity utilization has bottomed out in 2HCY10 and should gradually improve.
Sharp recovery in cement prices to drive profitability 4QFY11 onwards
Cement prices have recovered by Rs30-40/bag. Peak construction season and production discipline would
lead to further price increases till 2QFY12 and would offset any cost inflation. We expect EBITDA/ton to
improve to ~Rs894/ton in FY12 and Rs993/ton in FY13 (v/s FY11 average of Rs760/ton) from the trough of
Rs525/ton in 2HCY10.
Upgrading FY12 EPS by 2-18% to partly factor in for current prices
We are upgrading our FY12 estimates by 2-18% to partly factor in current prices. This upgrade is on top of
the 3-9% upgrade post-Budget (to factor in the then prevailing cement prices and increase in coal prices by
Coal India). We are now assuming realization to be higher by Rs12/bag in FY12 (similar to 4QFY11 average
prices, but Rs10/bag lower than March 2011 exit prices).
What if discipline prevails for longer period?
Cement price recovery over the last two quarters can be largely attributed to discipline on production and
pricing in all the key markets, after a phase of irrationality. While it is futile to estimate longevity of these
arrangements, the longer they sustain, the higher would be the upgrades. If current prices sustain in FY12,
our EPS estimates would be upgraded by 9-33%.
Strong cash flows, cheap secondary market valuations drives stake increases by promoters
The Cement Industry has been generating strong operating cash flows driven by recovery in cement prices.
This coupled with limited capex plans have resulted in strong free cash flow generation for the industry.
Further, attractive secondary market valuations (at replacement cost of US$120/ton for large caps and
US$45-90/ton for mid-caps) is driving promoters to increase their stakes (Holcim’s creeping acquisition of
ACC/ Ambuja, A.V.Birla’s intention to increase stake in Grasim, Binani Industries de-listing Binani Cement,
Orient Paper’s issuing warrants at 20% premium to CMP etc).
Government intervention, breakdown in discipline and demand slowdown are key risks
We are positive on the cement industry, as we believe that operating performance has recovered from the
trough of 2HCY10. However, lack of pick-up in demand, government intervention in pricing and hyperinflation
in energy prices are the key risks to our view. While, supply issues and related pricing concern are addressed,
re-rating will be a function of revival in demand.
Good entry point – Buy
The worst is behind and we expect gradual improvement in operating performance. Though the sector would
continue to be plagued by over-capacity at least till December 11, cement prices would remain buoyant at
least till 2QFY12, driven by seasonality in demand and pricing discipline. However, long-term demand drivers
continue to be present. We believe current valuations offer a good entry point for the next upcycle. Valuations
for the cement stocks currently factor in bottom-of-the-cycle profitability. We prefer Ambuja Cements
(favorable market mix, return of superior profitability, creeping acquisition by Holcim and reasonable
valuations), JP Associates (emerging cement giant with pan India presence) and Grasim (positive outlook
for both Cement and VSF, and very attractive valuations) among large-caps, and Birla Corp (an efficient
player with strong balance sheet available at cheap valuations) and India Cements (very high operating
and financials leverage and option value in form of IPL and Indonesian coal mine) among mid-caps.
Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its
operating performance during 2HCY10, as muted
demand and excess capacity impacted realizations
and profitability.
Demand growth was muted at 4.5% in 9MFY11
as against estimated growth of 10-12%,
impacted by significant slowdown in
infrastructure activity and muted demand from
urban housing.
This coupled with full impact of ~68mt capacity
addition since April 2009 resulted in drop in
capacity utilization to ~75% in 9MFY11 as against
~86% in FY10 and ~92% in FY09.
Cement prices corrected significantly by ~Rs6/
bag in 9MFY11 (v/s average of FY10) and by
~Rs35/bag from peak to trough. This coupled
with cost push, in the form of higher energy cost,
higher freight cost and lower operating leverage
impacted EBITDA/ton by ~Rs620/ton in
9MFY11 (v/s Rs1,303/ton in FY10) and by
Rs1,100/ton to ~Rs450/ton from peak to trough.
Cement stocks have out-performed in-line with
the benchmark over the last 12 months, as the
industry witnessed headwinds resulting in bottomof-
the-cycle operating performance.
Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key
catalyst for the next upcycle, especially considering
limited visibility in the short-run. Demand has
disappointed in 9MFY11. However, long-term
drivers in the form of higher infrastructure spend,
strong growth in rural housing and normal growth in
urban housing remain intact. While short-term
visibility is limited, levers are in place to help bring
growth momentum back on track.
State elections: FY12 would witness assembly
election in five states viz. Assam, Kerala,
Pondicherry, Tamil Nadu and West Bengal. Spurt
in pre-election infrastructure development is
expected to drive cement demand. Recent
history corroborates this argument.
Eleventh Five-year Plan’s terminal year:
Being terminal year of the Eleventh Plan, FY12
would see heightened execution to complete
planned projects. Terminal years of the Ninth
and Tenth Plans witnessed cement volume
growth of 9.6% and 9.4%, respectively.
Pent-up demand: Pent-up demand due to
muted FY11 demand could support higher growth
in FY12. Historcially, demand growth has
bounced back after a muted year, with not a
single consecutive period of below average
demand growth.
Peak capacity addition is behind us, expect slowdown in pace of capacity addition
Majority of the capacity additions are behind only
~66mt of new capacities are expected to be added
over FY11-14 as against ~105mt over FY08-11. With
expected pick-up in demand and decline in the pace
of capacity addition, we believe capacity utilization
has bottomed out in 2HCY10.
Pace of capacity addition to slow down from
FY12: Based on announcements of capacity
additions so far, we estimate only ~66mt of new
capacity over FY11-14 as against ~105mt of new
capacities over FY08-11. Further, annual
capacity addition expected from FY12 is <25mt.
New capacity addition plans for FY15 and
beyond: Next round of capacity addition is
expected to begin now to prepare for meeting
growth for FY15 and beyond. There have been
announcements for new capacities by UltraTech
(~9.2mt by FY14) and Ambuja Cement (~3mt
by FY14).
Delays in execution, ramp-up not ruled out:
We note that short-term pressure on operating
performance influenced few companies to delay
their projects or ramp-up of their recently
commissioned plants. Such delays, though not
factored in, can positively surprise on demandsupply
equilibrium. Also, lack of M&A deals has
deterred opportunistic new entrants.
Bottom-of-the-cycle utilization witnessed in 2HCY10, should improve gradually
With expected pick-up in demand and decline in the
pace of capacity addition, we believe capacity
utilization has bottomed out in 2HCY10.
2HCY10 utilization at trough levels: Muted
demand and full impact of ~68mt capacity
addition since April 2009 resulted in 2HCY10
capacity utilization of ~72%, which we believe
is trough capacity utilization. We note that
capacity utilization in the previous down cycle
(FY02) also bottomed-out at ~72%.
Utilization to improve gradually from here:
With expected pick-up in demand and decline in
pace of capacity addition, we estimate gradual
improvement from here-on. We estimate
capacity utilization to improve from ~77% in
FY11 to ~78% in FY12 and 80% by FY13
(assuming no further delays in new capacities).
North & South regions – managing
utilization a key challenge: With significant
capacity addition happening in the North and the
South, capacity utilization in these regions is likely
to remain lower than national average. Any
predatory pricing in these regions will have
cascading impact on the other regions as well.
Cement prices recover sharply to near peak levels; expect further increases
Cement prices have witnessed sharp recovery of
Rs30-40/bag, after correcting from peak levels.
While cement prices are near peak levels, peak
construction season and production discipline would
lead to further price increases till 2QFY12.
Recovery in cement prices much sharper
and faster than correction: Cement prices
have witnessed very sharp recovery of Rs30-
40/bag in the last two months across markets,
after witnessing correction of ~Rs35/bag (from
peak to trough in current cycle). Recovery has
been aided by pick-up in demand since January-
2011 and adherence to production discipline.
Pricing stable despite trough utilization…:
As a result of production discipline, cement
prices have been stable in the medium term
despite bottom-of-the-cycle utilization levels.
While utilization levels have dropped from ~86%
in FY10 to ~77% in FY11, average cement
prices are expected to be lower by just Rs3/bag
in FY11 compare to FY10 cement prices.
…impliys up even better pricing power
when utilization picks up: The stability of
pricing during a trough makes a foundation for
higher pricing power when utilization picks up
over next few quarters.
Higher prices to offset any cost push and improve profitability
Cost inflation driven by higher energy prices is
expected to be off set by higher cement prices. We
believe that EBITDA/ton would witness meaningful
improvement from the 2HCY10 average of ~Rs525/
ton.
Cost inflation to persist…: Cost inflation is
expected to persist, driven by higher energy
prices (impacting power & fuel, freight and
packing costs). Coal cost is likely to remain high
and increase further as domestic linkage coal
supply shrinks and is progressively linked to
international prices. We are factoring in 5%
energy cost inflation for FY12.
…but would be passed on…: Cost push being
industry-wide phenomenon, we believe that the
industry would pass it to consumers, albeit with
a lag effect. This coupled with benefit of higher
operating leverage will off set cost push. We
assume average ~Rs12/bag increase in FY12
realizations over FY11 (similar to 4QFY11 levels
and increase Rs10/bag lower than March 2011
levels) and Rs10/bag in FY13.
…driving improvement in profitability: We
estimate improvement in EBITDA/ton from
trough levels of ~Rs525/ in 2HCY11. We
estimate EBITDA/ton at ~Rs894 in FY12 and
Rs993 in FY13 (v/s FY11 average of Rs760).
Prefer North region in short term as demand picks-up
For the short term, we prefer cement players focused
on North, Central and East India due to pick-up in
demand and sharp improvement in prices. However,
for the long term, we do not have regional bias.
North region to benefit the most in the
short term…: With pick-up in demand in the
North and rationality prevailing, cement prices
have increased sharply by Rs25-30/bag in
CY11YTD, having a cascading impact on
Central and East India. With relatively higher
level of consolidation in North, Central and East
India, cement prices are expected to remain
stronger. Also, visibility of demand pick-up is
better in the North as against the South.
…cascading impact in long run eliminates
any regional biases: Although cement is a
regional commodity, in the long run demandsupply
equilibrium in one region would have
cascading impact on other regions. We do not
have preference for any particular market in the
long run.
Discipline has prevailed so far…What if it prevails for longer period?
Cement price recovery over the last two quarters
can be largely attributed to discipline in production
and pricing in all the key markets, after going through
phase of irrationality. While it is futile to estimate
longevity of these arrangements, the longer they
sustain the higher would be the upgrades.
Discipline has led to ~Rs40/bag increase
from trough: Discipline in production and
pricing since September 2010 has led to ~Rs40/
bag recovery in national average cement prices
from trough levels of 3QCY10, with increase of
~Rs80/bag in the South and ~Rs25-30/bag in the
North. Disciplined approach was triggered by
significant erosion in profitability of the industry
and its to service debt.
What if it prevails for longer period?:
Disciplined approach has prevailed over the last
six months and has enabled recovery in
profitability despite muted demand and cost
inflation. What if this disciplined approach lasts
longer? Such cohesive discipline would enable
industry to take periodic price increases and passon
cost push, despite operating below optimal
utilization, and in turn positively surprise on
profitability and drive earnings upgrades.
Discipline has prevailed so far…What if it prevails for longer period?
Cement prices can remain high despite low
capacity utilization: While cement prices and
capacity utilizations are correlated, in the short
to medium term, production discipline would lead
to divergence in this correlation. If discipline
prevails for longer period, we may see extended
period of lower utilization and higher prices.
Focus on profitability rather than market
share: Smaller and marginal cement players did
not attempt to gain market share by dropping
prices. After witnessing significant erosion in
profitability (even cash losses for smaller player)
due to focus on market share, we believe these
smaller players are much more rational now. This
would aid sustenance of discipline.
How long does this discipline need to
sustain? Sustaining these production
arrangements over the medium term would be
difficult as demand-supply dynamics would be
the key determinants of pricing. However,
discipline needs to sustain, especially in the South,
at least till monsoon (seasonally weakest period
for demand).
Sharp price recovery to drive significant earnings upgrades
Sharp recovery in cement prices over the last few
months has been surprising, considering demandsupply
imbalance. Consensus estimates are yet to
factor in these price increases.
Sharp price increases to drive earnings
upgrades: The sharp recovery in cement prices
over the last few months has been surprising
and is not yet fully modeled in our and consensus
estimates. Our FY12 estimates partly model in
current cement prices and increase in coal prices
by Coal India. As a result, our estimates witness
upgrade of 2-18%. If we assume March 2011
exit prices to sustain for FY12, our FY12
estimates would see an upgrade of 9-33%.
Cement prices near peak, but well below
long-term viable prices: Cement prices have
increased sharply and might look unsustainable.
However, current prices are still well below longterm
viable prices by ~Rs25/bag based on 15%
RoIC requirement (~5 year average) and ~Rs3/
bag lower than 10% ROIC-based pricing (~15
year average).
Government intervention, breakdown in discipline, demand slowdown and cost inflation are key risks
We are positive on the cement industry. Operating
performance has been recovering from the trough
of 2HCY10. However, lack of pick-up in demand,
government intervention in pricing and hyperinflation
in energy prices are the key risks to our view.
Government intervention in pricing: Any
intervention of the government to curb cement
prices would be the key risk. The government
has in the past intervened in free pricing of
cement to curb inflation, severely impacting
operating performance by the cement compaines
and their stock prices.
Breakdown in discipline: Any disruption in
prevailing discipline of production and pricing
would have a short-term impact on the
profitability of the industry. However, given the
recent experience of cash losses, we do not
expect discipline to break down.
Demand slowdown: We are estimating strong
recovery in demand from ~5% growth in FY11
to 12% CAGR in FY12-14. Any failure of
demand pick-up would delay improvement in
utilization and operating performance.
Energy cost inflation: Any hyperinflation in
energy prices would impact profitability of the
industry, if it is not passed through.
Valuations reasonable; good entry point
The worst is behind and we expect gradual
improvement in operating performance, though
volatility would remain high. This coupled with longterm
demand drivers and current valuations makes
a compelling Buy case.
Trough behind us…: We believe that we have
already witnessed bottom-of-the-cycle
utilization, and expected gradual improvement
driven by of sustainable demand drivers.
…but volatility to prevail: Although the sector
would continue to be plagued by over-capacity
at least till December 2011, cement prices are
expected to remain buoyant at least till 2QFY12,
driven by seasonality in demand. We expect high
volatility in cement prices and cement companies
performance over the next 6-9 months.
Good entry point: Presence of sustainable
demand drivers and gradual recovery from the
trough of 2HCY10 would make the foundation
for the next upcycle. Valuations are attractive
and offer a good entry point for the next upcycle,
notwithstanding volatility in cement prices and
operating performance.
Prefer Ambuja Cement, JP Associates and
Grasim among large-caps, and Birla Corp and
India Cement among mid-caps.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
The cement sector has witnessed strong recovery in prices as rationality has prevailed. We believe
that the worst is behind us, with trough operating performance witnessed in 2HCY10. Long-term
demand drivers are intact, which would ensure return of normal growth. We are upgrading our
FY12 estimates by 2-18% to partly factor in for current prices. However, sustenance of discipline and
current prices in FY12 could drive further upgrades of 9-33%. Valuations are attractive and offer a
good entry point for the next upcycle. We prefer Ambuja Cements, JP Associates and Grasim
among large-caps, and Birla Corp and India Cements among mid-caps.
Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its operating performance during 2HCY10. Muted demand (~4.5%
growth in 9MFY11) and excess capacity (~75% utilization) impacted realizations (~Rs35/bag decline from
peak of Rs255/bag) and profitability (decline of Rs1,100/ton from the peak to Rs450/ton in 2QFY11).
Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key catalyst for the next upcycle, especially considering limited
visibility in the short-run. Demand has disappointed in 9MFY11. However, long-term drivers in the form of
higher infrastructure spend, strong growth in rural housing and normal growth in urban housing remain intact.
While short-term visibility is limited, levers in the form of higher number of assembly elections over the next
3-5 years, FY12 being the terminal year of the Eleventh Five-year Plan, pent-up demand and low base of
FY11 could help to bring growth momentum back on track.
Peak capacity addition, bottom utilization behind; expect gradual improvement
Majority of the capacity additions are behind as only ~66mt of new capacities are expected to be added over
FY11-14 as against ~105mt over FY08-11. With expected pick-up in demand and decline in the pace of
capacity addition, we believe capacity utilization has bottomed out in 2HCY10 and should gradually improve.
Sharp recovery in cement prices to drive profitability 4QFY11 onwards
Cement prices have recovered by Rs30-40/bag. Peak construction season and production discipline would
lead to further price increases till 2QFY12 and would offset any cost inflation. We expect EBITDA/ton to
improve to ~Rs894/ton in FY12 and Rs993/ton in FY13 (v/s FY11 average of Rs760/ton) from the trough of
Rs525/ton in 2HCY10.
Upgrading FY12 EPS by 2-18% to partly factor in for current prices
We are upgrading our FY12 estimates by 2-18% to partly factor in current prices. This upgrade is on top of
the 3-9% upgrade post-Budget (to factor in the then prevailing cement prices and increase in coal prices by
Coal India). We are now assuming realization to be higher by Rs12/bag in FY12 (similar to 4QFY11 average
prices, but Rs10/bag lower than March 2011 exit prices).
What if discipline prevails for longer period?
Cement price recovery over the last two quarters can be largely attributed to discipline on production and
pricing in all the key markets, after a phase of irrationality. While it is futile to estimate longevity of these
arrangements, the longer they sustain, the higher would be the upgrades. If current prices sustain in FY12,
our EPS estimates would be upgraded by 9-33%.
Strong cash flows, cheap secondary market valuations drives stake increases by promoters
The Cement Industry has been generating strong operating cash flows driven by recovery in cement prices.
This coupled with limited capex plans have resulted in strong free cash flow generation for the industry.
Further, attractive secondary market valuations (at replacement cost of US$120/ton for large caps and
US$45-90/ton for mid-caps) is driving promoters to increase their stakes (Holcim’s creeping acquisition of
ACC/ Ambuja, A.V.Birla’s intention to increase stake in Grasim, Binani Industries de-listing Binani Cement,
Orient Paper’s issuing warrants at 20% premium to CMP etc).
Government intervention, breakdown in discipline and demand slowdown are key risks
We are positive on the cement industry, as we believe that operating performance has recovered from the
trough of 2HCY10. However, lack of pick-up in demand, government intervention in pricing and hyperinflation
in energy prices are the key risks to our view. While, supply issues and related pricing concern are addressed,
re-rating will be a function of revival in demand.
Good entry point – Buy
The worst is behind and we expect gradual improvement in operating performance. Though the sector would
continue to be plagued by over-capacity at least till December 11, cement prices would remain buoyant at
least till 2QFY12, driven by seasonality in demand and pricing discipline. However, long-term demand drivers
continue to be present. We believe current valuations offer a good entry point for the next upcycle. Valuations
for the cement stocks currently factor in bottom-of-the-cycle profitability. We prefer Ambuja Cements
(favorable market mix, return of superior profitability, creeping acquisition by Holcim and reasonable
valuations), JP Associates (emerging cement giant with pan India presence) and Grasim (positive outlook
for both Cement and VSF, and very attractive valuations) among large-caps, and Birla Corp (an efficient
player with strong balance sheet available at cheap valuations) and India Cements (very high operating
and financials leverage and option value in form of IPL and Indonesian coal mine) among mid-caps.
Worst is behind, trough made in 2HCY10
The cement industry witnessed a trough in its
operating performance during 2HCY10, as muted
demand and excess capacity impacted realizations
and profitability.
Demand growth was muted at 4.5% in 9MFY11
as against estimated growth of 10-12%,
impacted by significant slowdown in
infrastructure activity and muted demand from
urban housing.
This coupled with full impact of ~68mt capacity
addition since April 2009 resulted in drop in
capacity utilization to ~75% in 9MFY11 as against
~86% in FY10 and ~92% in FY09.
Cement prices corrected significantly by ~Rs6/
bag in 9MFY11 (v/s average of FY10) and by
~Rs35/bag from peak to trough. This coupled
with cost push, in the form of higher energy cost,
higher freight cost and lower operating leverage
impacted EBITDA/ton by ~Rs620/ton in
9MFY11 (v/s Rs1,303/ton in FY10) and by
Rs1,100/ton to ~Rs450/ton from peak to trough.
Cement stocks have out-performed in-line with
the benchmark over the last 12 months, as the
industry witnessed headwinds resulting in bottomof-
the-cycle operating performance.
Revival in demand to be key catalyst for the next upcycle
Revival in demand is critical and would be the key
catalyst for the next upcycle, especially considering
limited visibility in the short-run. Demand has
disappointed in 9MFY11. However, long-term
drivers in the form of higher infrastructure spend,
strong growth in rural housing and normal growth in
urban housing remain intact. While short-term
visibility is limited, levers are in place to help bring
growth momentum back on track.
State elections: FY12 would witness assembly
election in five states viz. Assam, Kerala,
Pondicherry, Tamil Nadu and West Bengal. Spurt
in pre-election infrastructure development is
expected to drive cement demand. Recent
history corroborates this argument.
Eleventh Five-year Plan’s terminal year:
Being terminal year of the Eleventh Plan, FY12
would see heightened execution to complete
planned projects. Terminal years of the Ninth
and Tenth Plans witnessed cement volume
growth of 9.6% and 9.4%, respectively.
Pent-up demand: Pent-up demand due to
muted FY11 demand could support higher growth
in FY12. Historcially, demand growth has
bounced back after a muted year, with not a
single consecutive period of below average
demand growth.
Peak capacity addition is behind us, expect slowdown in pace of capacity addition
Majority of the capacity additions are behind only
~66mt of new capacities are expected to be added
over FY11-14 as against ~105mt over FY08-11. With
expected pick-up in demand and decline in the pace
of capacity addition, we believe capacity utilization
has bottomed out in 2HCY10.
Pace of capacity addition to slow down from
FY12: Based on announcements of capacity
additions so far, we estimate only ~66mt of new
capacity over FY11-14 as against ~105mt of new
capacities over FY08-11. Further, annual
capacity addition expected from FY12 is <25mt.
New capacity addition plans for FY15 and
beyond: Next round of capacity addition is
expected to begin now to prepare for meeting
growth for FY15 and beyond. There have been
announcements for new capacities by UltraTech
(~9.2mt by FY14) and Ambuja Cement (~3mt
by FY14).
Delays in execution, ramp-up not ruled out:
We note that short-term pressure on operating
performance influenced few companies to delay
their projects or ramp-up of their recently
commissioned plants. Such delays, though not
factored in, can positively surprise on demandsupply
equilibrium. Also, lack of M&A deals has
deterred opportunistic new entrants.
Bottom-of-the-cycle utilization witnessed in 2HCY10, should improve gradually
With expected pick-up in demand and decline in the
pace of capacity addition, we believe capacity
utilization has bottomed out in 2HCY10.
2HCY10 utilization at trough levels: Muted
demand and full impact of ~68mt capacity
addition since April 2009 resulted in 2HCY10
capacity utilization of ~72%, which we believe
is trough capacity utilization. We note that
capacity utilization in the previous down cycle
(FY02) also bottomed-out at ~72%.
Utilization to improve gradually from here:
With expected pick-up in demand and decline in
pace of capacity addition, we estimate gradual
improvement from here-on. We estimate
capacity utilization to improve from ~77% in
FY11 to ~78% in FY12 and 80% by FY13
(assuming no further delays in new capacities).
North & South regions – managing
utilization a key challenge: With significant
capacity addition happening in the North and the
South, capacity utilization in these regions is likely
to remain lower than national average. Any
predatory pricing in these regions will have
cascading impact on the other regions as well.
Cement prices recover sharply to near peak levels; expect further increases
Cement prices have witnessed sharp recovery of
Rs30-40/bag, after correcting from peak levels.
While cement prices are near peak levels, peak
construction season and production discipline would
lead to further price increases till 2QFY12.
Recovery in cement prices much sharper
and faster than correction: Cement prices
have witnessed very sharp recovery of Rs30-
40/bag in the last two months across markets,
after witnessing correction of ~Rs35/bag (from
peak to trough in current cycle). Recovery has
been aided by pick-up in demand since January-
2011 and adherence to production discipline.
Pricing stable despite trough utilization…:
As a result of production discipline, cement
prices have been stable in the medium term
despite bottom-of-the-cycle utilization levels.
While utilization levels have dropped from ~86%
in FY10 to ~77% in FY11, average cement
prices are expected to be lower by just Rs3/bag
in FY11 compare to FY10 cement prices.
…impliys up even better pricing power
when utilization picks up: The stability of
pricing during a trough makes a foundation for
higher pricing power when utilization picks up
over next few quarters.
Higher prices to offset any cost push and improve profitability
Cost inflation driven by higher energy prices is
expected to be off set by higher cement prices. We
believe that EBITDA/ton would witness meaningful
improvement from the 2HCY10 average of ~Rs525/
ton.
Cost inflation to persist…: Cost inflation is
expected to persist, driven by higher energy
prices (impacting power & fuel, freight and
packing costs). Coal cost is likely to remain high
and increase further as domestic linkage coal
supply shrinks and is progressively linked to
international prices. We are factoring in 5%
energy cost inflation for FY12.
…but would be passed on…: Cost push being
industry-wide phenomenon, we believe that the
industry would pass it to consumers, albeit with
a lag effect. This coupled with benefit of higher
operating leverage will off set cost push. We
assume average ~Rs12/bag increase in FY12
realizations over FY11 (similar to 4QFY11 levels
and increase Rs10/bag lower than March 2011
levels) and Rs10/bag in FY13.
…driving improvement in profitability: We
estimate improvement in EBITDA/ton from
trough levels of ~Rs525/ in 2HCY11. We
estimate EBITDA/ton at ~Rs894 in FY12 and
Rs993 in FY13 (v/s FY11 average of Rs760).
Prefer North region in short term as demand picks-up
For the short term, we prefer cement players focused
on North, Central and East India due to pick-up in
demand and sharp improvement in prices. However,
for the long term, we do not have regional bias.
North region to benefit the most in the
short term…: With pick-up in demand in the
North and rationality prevailing, cement prices
have increased sharply by Rs25-30/bag in
CY11YTD, having a cascading impact on
Central and East India. With relatively higher
level of consolidation in North, Central and East
India, cement prices are expected to remain
stronger. Also, visibility of demand pick-up is
better in the North as against the South.
…cascading impact in long run eliminates
any regional biases: Although cement is a
regional commodity, in the long run demandsupply
equilibrium in one region would have
cascading impact on other regions. We do not
have preference for any particular market in the
long run.
Discipline has prevailed so far…What if it prevails for longer period?
Cement price recovery over the last two quarters
can be largely attributed to discipline in production
and pricing in all the key markets, after going through
phase of irrationality. While it is futile to estimate
longevity of these arrangements, the longer they
sustain the higher would be the upgrades.
Discipline has led to ~Rs40/bag increase
from trough: Discipline in production and
pricing since September 2010 has led to ~Rs40/
bag recovery in national average cement prices
from trough levels of 3QCY10, with increase of
~Rs80/bag in the South and ~Rs25-30/bag in the
North. Disciplined approach was triggered by
significant erosion in profitability of the industry
and its to service debt.
What if it prevails for longer period?:
Disciplined approach has prevailed over the last
six months and has enabled recovery in
profitability despite muted demand and cost
inflation. What if this disciplined approach lasts
longer? Such cohesive discipline would enable
industry to take periodic price increases and passon
cost push, despite operating below optimal
utilization, and in turn positively surprise on
profitability and drive earnings upgrades.
Discipline has prevailed so far…What if it prevails for longer period?
Cement prices can remain high despite low
capacity utilization: While cement prices and
capacity utilizations are correlated, in the short
to medium term, production discipline would lead
to divergence in this correlation. If discipline
prevails for longer period, we may see extended
period of lower utilization and higher prices.
Focus on profitability rather than market
share: Smaller and marginal cement players did
not attempt to gain market share by dropping
prices. After witnessing significant erosion in
profitability (even cash losses for smaller player)
due to focus on market share, we believe these
smaller players are much more rational now. This
would aid sustenance of discipline.
How long does this discipline need to
sustain? Sustaining these production
arrangements over the medium term would be
difficult as demand-supply dynamics would be
the key determinants of pricing. However,
discipline needs to sustain, especially in the South,
at least till monsoon (seasonally weakest period
for demand).
Sharp price recovery to drive significant earnings upgrades
Sharp recovery in cement prices over the last few
months has been surprising, considering demandsupply
imbalance. Consensus estimates are yet to
factor in these price increases.
Sharp price increases to drive earnings
upgrades: The sharp recovery in cement prices
over the last few months has been surprising
and is not yet fully modeled in our and consensus
estimates. Our FY12 estimates partly model in
current cement prices and increase in coal prices
by Coal India. As a result, our estimates witness
upgrade of 2-18%. If we assume March 2011
exit prices to sustain for FY12, our FY12
estimates would see an upgrade of 9-33%.
Cement prices near peak, but well below
long-term viable prices: Cement prices have
increased sharply and might look unsustainable.
However, current prices are still well below longterm
viable prices by ~Rs25/bag based on 15%
RoIC requirement (~5 year average) and ~Rs3/
bag lower than 10% ROIC-based pricing (~15
year average).
Government intervention, breakdown in discipline, demand slowdown and cost inflation are key risks
We are positive on the cement industry. Operating
performance has been recovering from the trough
of 2HCY10. However, lack of pick-up in demand,
government intervention in pricing and hyperinflation
in energy prices are the key risks to our view.
Government intervention in pricing: Any
intervention of the government to curb cement
prices would be the key risk. The government
has in the past intervened in free pricing of
cement to curb inflation, severely impacting
operating performance by the cement compaines
and their stock prices.
Breakdown in discipline: Any disruption in
prevailing discipline of production and pricing
would have a short-term impact on the
profitability of the industry. However, given the
recent experience of cash losses, we do not
expect discipline to break down.
Demand slowdown: We are estimating strong
recovery in demand from ~5% growth in FY11
to 12% CAGR in FY12-14. Any failure of
demand pick-up would delay improvement in
utilization and operating performance.
Energy cost inflation: Any hyperinflation in
energy prices would impact profitability of the
industry, if it is not passed through.
Valuations reasonable; good entry point
The worst is behind and we expect gradual
improvement in operating performance, though
volatility would remain high. This coupled with longterm
demand drivers and current valuations makes
a compelling Buy case.
Trough behind us…: We believe that we have
already witnessed bottom-of-the-cycle
utilization, and expected gradual improvement
driven by of sustainable demand drivers.
…but volatility to prevail: Although the sector
would continue to be plagued by over-capacity
at least till December 2011, cement prices are
expected to remain buoyant at least till 2QFY12,
driven by seasonality in demand. We expect high
volatility in cement prices and cement companies
performance over the next 6-9 months.
Good entry point: Presence of sustainable
demand drivers and gradual recovery from the
trough of 2HCY10 would make the foundation
for the next upcycle. Valuations are attractive
and offer a good entry point for the next upcycle,
notwithstanding volatility in cement prices and
operating performance.
Prefer Ambuja Cement, JP Associates and
Grasim among large-caps, and Birla Corp and
India Cement among mid-caps.
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