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We believe that the domestic cement cycle is at a trough; from
here on all key industry metrics should improve, particularly for
players in the eastern, northern and western regions. We
estimate capacity utilisation levels in these three regions to rise
to 85-93% by FY14 (up 6-8% from current levels), aiding the
return of pricing power. Incremental demand will likely outpace
fresh capacity additions, driven by a mean reversion in demand
growth and a slowdown in new supply. Ambuja Cements, Shree
Cement and UltraTech Cement are best positioned to capitalise
on the coming cyclical upturn and are our top BUYs.
Capacity utilisation – bottoming out: In contrast to the FY08-11
period when capacity additions outpaced incremental demand by
120%, we believe that during FY11-14, incremental demand will rise
faster than new supply. India’s cement demand has historically
grown at 1.2x real GDP growth. Over the past two years, cement
demand has grown at just 6% YoY and a likely reversion to mean
will drive a pick-up in growth rates. Incremental capacity addition in
the next three years, compared with FY08-11, will almost halve to
54m tonnes. We expect utilisation levels to bottom out in the current
quarter and gradually but sustainably improve from here on.
Pricing power – coming back: Rising capacity utilisation, improving
competitive environment (due to a fall in the number of new entrants)
and better industry discipline will aid the return of pricing power, in our
view. However, the gains will be uneven across regions. While producers
in the eastern, northern and western regions will gain the most, those in
the south will likely see no improvement in pricing power. For the three
regions with a favourable swing, we estimate prices to go up by 8-9%
and correspondingly, Ebidta margins to rise 200-300bps by FY14. We
believe consensus estimates will see sustained upgrades.
Playing the upturn: We estimate earnings of IIFL’s coverage
universe to rise by 18% Cagr over FY11-14, in contrast to a 6%
compounded decline during FY08-11. The three best proxies to play
the upturn in the cement cycle are: Ambuja Cements (ACL),
UltraTech Cement (UCL) and Shree Cements (SCL). ACL derives
90% of its sales from the regions that have the most favourable
swing; UCL derives 65% of its sales and SCL 72% of its sales from
these regions. Our current earnings estimates suggest a 16-18%
EPS Cagr between FY11-14 for our top BUYs. ACC and Grasim are
less leveraged to the cyclical upturn and we rate them as ADDs.
Capacity utilisation - bottoming out
Cement producers have slowed down capacity expansion plans
owing to dwindling utilisation for the past two years and a
sharp decline in demand growth for the past five quarters.
Capacity additions for the next three years are likely to be at
54m tonnes, just half of the additions made in the past three
years. Cement demand growth was at 5% for FY11 and it was
flat YoY in 1QFY12. This is sharply lower compared with GDP
growth of 8.5% in FY11 and a likely 7.5% in 1QFY12. Cement
demand has grown at average of 1.2x of GDP growth for the
past two decades. We find that in the past the growth
multiplier has bounced back whenever it fell sharply. Capacity
utilisation for the industry was on a declining trend for the
past three years and we expect the same to bottom out in
FY12 due to likely deceleration in pace of capacity addition and
bounce-back in demand growth from FY13.
Producers have reduced pace of capacity additions: None of
the large existing producers have placed orders for capacity
expansion in the past year. The top two groups, Holcim and AV Birla,
will not have any additions in clinker capacity in FY12 and FY13. UCL
had indicated in FY10 that it would add 25m tonnes capacity by
FY15; however, the company has placed orders for only 9.2m tonnes
capacity so far, which would likely be operational in 2HFY14. Most of
the capacity additions announced by new producers are behind
schedule. Thus, considering the delay in capacity expansion by
existing and new players, effective cement capacity is likely at 315m
tonnes in FY13, vs our earlier expectation of 320m tonnes.
Some mid-size players have shelved expansion plans: Most of
the mid-size players do not have expansion plans until FY14 and a
few have shelved their plans, due to poor demand growth and tight
liquidity. ACC and ACL are yet to firm up expansion plans;
considering the time taken to place orders, we believe if new
capacities for ACC and ACL are ordered now, they are unlikely to
start production before FY15. Any major expansion plans hereon are
likely to materialise only after FY14 and stabilisation may happen in
2HFY15.
Pricing power – coming back
Cement prices have declined sharply in the past four months
owing to the monsoon and increasing competition from new
producers in all regions except the south. We expect a
seasonal recovery in cement prices from 2HFY12 and cyclical
improvement from 2HFY13 led by improvement in utilisation
and reduction in fight for market share as number of new
producers will reduce. Improvement in utilisation will be
sharp for the eastern, northern, and western regions, and we
expect improved pricing and margin environment in these
regions. The south and central regions, however, would see
volatility in prices with a downward bias owing to declining
fundamentals.
Cement prices have declined sharply in the past four months:
Cement prices have declined sharply in the past four months (except
in the south) on decline in construction activity in the monsoon
season and intensifying fight for market share. Prices declined by
Rs40-100 per bag (15-35%). The sharpest fall was seen in Gujarat,
where fight for market share intensified due to stabilisation of
capacities of two new producers.
Prices in few markets have declined to unsustainable levels:
We find that prices in few markets such as Gujarat, Kolkata and
Lucknow reached unsustainable levels (negative Ebitda per tonne)
in July; this is likely to reverse after the monsoon season on
improvement in demand (prices have already recovered partially in
Gujarat and the eastern region). Fight for market share in the
Gujarat market intensified with the entry of two new producers in
the past two years; however, competition would reduce as a large
portion of new capacities are absorbed. ABG Cement is likely to start
production in 2HFY13, which may stabilise in FY14; prices are likely
to be volatile only for a shorter period on improved utilisation in the
west.
We expect cement prices to improve: We expect a seasonal
recovery in cement prices in 2HFY12 in all regions (except south)
with sequential improvement in utilisation; we see a gradual and
cyclical improvement in prices from 2HFY13 with reduction in surplus
capacities. Improved demand growth in FY14ii, with elections
nearing at that time, should boost pricing power in FY14.
Furthermore, the volatility in cement prices would reduce after
2HFY13, with decline in the number of new producers and surplus
capacities.
Utilisation of ~80% is unlikely to be a major concern in
FY14ii: Historically, cement producers have had strong pricing
power when utilisation was above 85%. Pricing power reduces when
utilisation declines below 80% and it worsens when a new producer
enters a market/region in such a scenario. We believe the number of
new producers making an entry during 2HFY13-2HFY14 would be
lower; thus, the pricing power of the producers would be largely
shielded during the monsoon season in FY14 particularly for east,
north and west regions.
East – Supply shortage in FY14 to boost pricing
power
Supply shortage likely in FY14
The east is likely to experience supply shortage in FY14 as most capacity
additions are likely to be back-ended and demand would continue to be
strong. Utilisation would improve to 93% in FY14ii, from 86% in FY11.
Capacity additions of JK Lakshmi Cement and UltraTech Cement in FY14
are unlikely to materially contribute to supply, as they may not stabilise
in FY14.
Orissa to be a major demand driver in the east after Bihar:
Demand grew at a fast pace in the east during the past two years,
with the Bihar government focussing on infrastructure development.
Based on our interaction with cement dealers, we believe the focus
has reduced slightly in FY12, (visible in allocation for the
infrastructure segment in the budget).
Orissa is likely to make up for the demand slowdown in Bihar.
Recently, the Chief Minister of Orissa ordered completion of 4,130km
of concrete roads in rural areas in FY12. Our channel checks indicate
that Orissa built ~1,000km of concrete roads annually in the past
two years. This segment alone should create additional demand of
1.6m tonnes of cement (assuming single-lane roads in rural areas),
which is 4.5% of the consumption in the east in FY11.
Fight for market share to reduce substantially from 2HFY13 in
eastern region: Jaiprakash Associates expanded its capacity in the
eastern region in Bhilai (2.2mtpa) through a JV with SAIL in 1HFY11;
the plant stabilised recently. This has led to severe pressure on
cement prices in the region. Another plant in Bokaro (2.2mtpa)
would commence production from 3QFY12; we expect it to stabilise
in 1QFY13, resulting in stress on prices in 1HFY13. With no new
capacities in the region stabilising over 2HFY13-2HFY14, we expect
fight for market share to reduce substantially and pricing power to
return from 2HFY13
North – Low capacity additions to boost utilisation
Slowdown in capacity additions to result in utilisation moving
above 90% in FY14ii: With capacity increases likely to be lower vs.
incremental demand in the north, we expect a sharp bounce-back in
utilisation. We do not expect any capacity additions in the north in
FY12ii and FY14ii; orders placed for 8mtpa would likely be
commissioned in FY13ii. Thus, utilisation would increase to 92% in
FY14ii, vs. 82% in FY11.
Despatch growth to continue to outperform all-India average
in north: The north recorded the highest YoY growth in despatches
among all regions in FY11, despite the slowdown in demand from the
infrastructure segment (as construction related to the
Commonwealth Games was completed). Despatch growth was
largely driven by capacity shortage in the central region. However,
the central region would see a surplus in capacity, as more capacities
are in the pipeline and demand growth is unlikely to improve in the
coming quarters, in our view. Despatch growth in the north was 300-
400bps higher than all-India growth in the past 2-3 years. We expect
this gap to reduce, with decline in capacity shortage in the central
region.
Pricing decline to be marginal in FY14 monsoon season in
north: Wonder Cement and Lafarge Cement are likely to commence
production in FY13. These plants may stabilise in 1QFY14, and thus,
price erosion may be slightly higher than normal in the monsoon
months of FY14. However, we expect prices to revive swiftly as
utilisation in the region would be 92% in FY14ii. Jaiprakash
Associates’ multi-fold expansion in FY11 in the region resulted in a
sharp decline in prices, as utilisation was low at 82%.
West – Fight for market share to reduce
Capacity additions to decline sharply in west: We expect an
addition of 4mtpa capacity in the west during FY12-14, as against
12mtpa in FY09-11. We expect pricing discipline to increase, barring
the monsoon season in FY14, when ABG Cement’s new capacity
stabilises. The fight for market share in the Gujarat market would
subside from FY13, as a large part of Jaiprakash Associates’ new
capacity should be absorbed by then.
Supply from other regions to continue; severe pricing
pressure unlikely: With continued surplus capacity in the south,
supply into the west would remain high. However, this is unlikely to
affect prices in the west materially from the current levels, as
capacity expansion in Karnataka (key supplier for the west markets)
would be back-ended.
Demand growth continues to be robust in the west: The west
recorded the highest consumption growth of 12% in FY11. Demand
from the housing and infrastructure segments was strong in the
region in FY11 (based on our channel checks). In FY12, we expect
demand from housing to be sluggish considering a high interest rate
scenario; however, we expect growth to improve from FY13, owing
to pent-up demand.
South – Pricing discipline to be tested through FY14
Supply pressure in south to continue: The southern cement
market was affected by increasing supply and dwindling demand
over the past two years. We expect an addition of 18mtpa capacity
in the region during FY12–14, of which two new players, Jaiprakash
Associates and JSW Cement, would contribute 9mtpa.
Deceleration in capacity growth not enough to reduce surplus
in south: During FY09-11, the south saw an addition of 60mtpa
(including non-CMA members), but the pace would decelerate to
18mtpa over FY12-14ii. Nevertheless, surplus capacity is unlikely to
come down, as demand has not risen in the past two years and
going forward, it may not exceed supply significantly.
Discipline to be tested through FY14 in south: The southern
market has displayed strong volume and pricing discipline in the past
year, despite a sharp decline in utilisation. However, we expect
disruption in pricing discipline in FY13 when capacities of Jaiprakash
Associates and JSW Cement stabilise. Cement prices and profitability
are likely to be highly volatile for the next two years in the region, as
utilisation is likely to continue at low levels and new capacities stabilise.
Consolidation a primary requirement for earnings volatility to
reduce in south: The south would record utilisation of 65% in FY14ii.
We expect earnings volatility to continue in the region, owing to huge
surplus capacity. Profitability of the players hinges on continued pricing
discipline. The huge supply overhang has depressed the valuations of
south-based companies. If consolidation materialises, going forward, it
would have a positive impact on the performance of these companies.
Central region – Utilisation to deteriorate from here on
Central region volatility to increase: The central region recorded
robust demand growth in the past two years, with improvement in
semi-urban and rural housing segments and increase in
infrastructure spending by the Uttar Pradesh government. We expect
this scenario to continue for the next year as state elections are due
in May 2012. Demand growth may moderate from 2HFY13 after the
elections, based on the trend in a few states in the past two years.
Supply would increase in FY14, with incumbents undertaking
manifold expansions and a new producer making an entry.
Pricing power to be volatile through FY14 in central region:
Utilisation would decline in the central region over the next two
years. Pricing power in the region has been impacted for the past
year on increase in capacity of incumbents and higher inflow from
the northern and southern players; this is despite healthy utilisation
levels in the region. The central region is accessible to all the
regions, and particularly to the Nalgonda cluster in the south, which
is saddled by surplus capacities. The south producers dumped excess
production in the central region whenever prices increased in the
past two years.
Capacity growth is likely to exceed demand growth sharply in the
next three years. We expect pricing power to improve between
2HFY12 and 1HFY13, with no major new capacities stabilising; prices
should come under stress in FY14, as new capacities would start to
stabilise in 3QFY13.
Playing the upturn
We expect improvement in pricing power in the eastern,
northern and western regions to result in earnings Cagr of
18% between FY11-14 for companies in our coverage
universe. We expect ACL to be the biggest beneficiary
because of improved pricing power in these regions as 90%
of its sales come from these favourable regions. We expect
UCL to be the next biggest beneficiary among large-cap
cement companies as 65% of its sales volumes come from
these regions. Among mid-caps, SCL, a north-based cement
player, will be the biggest beneficiary of improvement in the
northern region. We expect ACC and Grasim to partially
benefit from the cement upcycle in the eastern, northern and
western regions and rate them as ADD.
Cement stocks have rallied when utilisation improved in the
past: We expect cement stocks to do well, going forward, with likely
improvement in utilisation and pricing power in FY14. In the past, we
found that when utilisation turned positive, stocks offered positive
returns. In FY95, FY2000 and FY03, cement stocks rallied, when
utilisation increased from a low level. We turn positive on the cement
sector, with utilisation set to bottom out in FY12ii.
ACL and UCL to be major beneficiaries: Our top picks are ACL
and UCL in the large-cap space, given their reasonable valuations
and presence in better-positioned regions; we rate these stocks as
BUY. ACL’s volumes from the north, west, and east comprise ~90%
of its total sales. With utilisation set to revive in these three regions,
we believe ACL would be the biggest beneficiary among pan-India
players. UCL would be the second-biggest beneficiary, considering
that ~65% of its sales originate from the northern, western and
eastern regions.
We rate ACC and Grasim as ADD. Around 55% of ACC’s sales
volumes come from the north, west and east; upside to earnings is
likely to be lower vs. ACL and UCL; Grasim’s earnings are likely to
improve in FY14 on UCL’s improved performance, but headwinds in
the VSF division may depress FY13ii earnings.
Northern region’s utilisation improvement to boost SCL’s
earnings: In the mid-cap space, we rate Shree Cement as BUY, with
the northern region expected to record 92% utilisation in FY14ii. We
recommend a BUY on India Cements considering its cheap valuations
and efficiency improvement programmes. We rate Madras Cements
and Kesoram Industries as ADD, as they are available at a sharp
discount to the replacement cost, following sharp decline in their
share prices; however, earnings are likely to be volatile on the
southern region’s poor fundamentals.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We believe that the domestic cement cycle is at a trough; from
here on all key industry metrics should improve, particularly for
players in the eastern, northern and western regions. We
estimate capacity utilisation levels in these three regions to rise
to 85-93% by FY14 (up 6-8% from current levels), aiding the
return of pricing power. Incremental demand will likely outpace
fresh capacity additions, driven by a mean reversion in demand
growth and a slowdown in new supply. Ambuja Cements, Shree
Cement and UltraTech Cement are best positioned to capitalise
on the coming cyclical upturn and are our top BUYs.
Capacity utilisation – bottoming out: In contrast to the FY08-11
period when capacity additions outpaced incremental demand by
120%, we believe that during FY11-14, incremental demand will rise
faster than new supply. India’s cement demand has historically
grown at 1.2x real GDP growth. Over the past two years, cement
demand has grown at just 6% YoY and a likely reversion to mean
will drive a pick-up in growth rates. Incremental capacity addition in
the next three years, compared with FY08-11, will almost halve to
54m tonnes. We expect utilisation levels to bottom out in the current
quarter and gradually but sustainably improve from here on.
Pricing power – coming back: Rising capacity utilisation, improving
competitive environment (due to a fall in the number of new entrants)
and better industry discipline will aid the return of pricing power, in our
view. However, the gains will be uneven across regions. While producers
in the eastern, northern and western regions will gain the most, those in
the south will likely see no improvement in pricing power. For the three
regions with a favourable swing, we estimate prices to go up by 8-9%
and correspondingly, Ebidta margins to rise 200-300bps by FY14. We
believe consensus estimates will see sustained upgrades.
Playing the upturn: We estimate earnings of IIFL’s coverage
universe to rise by 18% Cagr over FY11-14, in contrast to a 6%
compounded decline during FY08-11. The three best proxies to play
the upturn in the cement cycle are: Ambuja Cements (ACL),
UltraTech Cement (UCL) and Shree Cements (SCL). ACL derives
90% of its sales from the regions that have the most favourable
swing; UCL derives 65% of its sales and SCL 72% of its sales from
these regions. Our current earnings estimates suggest a 16-18%
EPS Cagr between FY11-14 for our top BUYs. ACC and Grasim are
less leveraged to the cyclical upturn and we rate them as ADDs.
Capacity utilisation - bottoming out
Cement producers have slowed down capacity expansion plans
owing to dwindling utilisation for the past two years and a
sharp decline in demand growth for the past five quarters.
Capacity additions for the next three years are likely to be at
54m tonnes, just half of the additions made in the past three
years. Cement demand growth was at 5% for FY11 and it was
flat YoY in 1QFY12. This is sharply lower compared with GDP
growth of 8.5% in FY11 and a likely 7.5% in 1QFY12. Cement
demand has grown at average of 1.2x of GDP growth for the
past two decades. We find that in the past the growth
multiplier has bounced back whenever it fell sharply. Capacity
utilisation for the industry was on a declining trend for the
past three years and we expect the same to bottom out in
FY12 due to likely deceleration in pace of capacity addition and
bounce-back in demand growth from FY13.
Producers have reduced pace of capacity additions: None of
the large existing producers have placed orders for capacity
expansion in the past year. The top two groups, Holcim and AV Birla,
will not have any additions in clinker capacity in FY12 and FY13. UCL
had indicated in FY10 that it would add 25m tonnes capacity by
FY15; however, the company has placed orders for only 9.2m tonnes
capacity so far, which would likely be operational in 2HFY14. Most of
the capacity additions announced by new producers are behind
schedule. Thus, considering the delay in capacity expansion by
existing and new players, effective cement capacity is likely at 315m
tonnes in FY13, vs our earlier expectation of 320m tonnes.
Some mid-size players have shelved expansion plans: Most of
the mid-size players do not have expansion plans until FY14 and a
few have shelved their plans, due to poor demand growth and tight
liquidity. ACC and ACL are yet to firm up expansion plans;
considering the time taken to place orders, we believe if new
capacities for ACC and ACL are ordered now, they are unlikely to
start production before FY15. Any major expansion plans hereon are
likely to materialise only after FY14 and stabilisation may happen in
2HFY15.
Pricing power – coming back
Cement prices have declined sharply in the past four months
owing to the monsoon and increasing competition from new
producers in all regions except the south. We expect a
seasonal recovery in cement prices from 2HFY12 and cyclical
improvement from 2HFY13 led by improvement in utilisation
and reduction in fight for market share as number of new
producers will reduce. Improvement in utilisation will be
sharp for the eastern, northern, and western regions, and we
expect improved pricing and margin environment in these
regions. The south and central regions, however, would see
volatility in prices with a downward bias owing to declining
fundamentals.
Cement prices have declined sharply in the past four months:
Cement prices have declined sharply in the past four months (except
in the south) on decline in construction activity in the monsoon
season and intensifying fight for market share. Prices declined by
Rs40-100 per bag (15-35%). The sharpest fall was seen in Gujarat,
where fight for market share intensified due to stabilisation of
capacities of two new producers.
Prices in few markets have declined to unsustainable levels:
We find that prices in few markets such as Gujarat, Kolkata and
Lucknow reached unsustainable levels (negative Ebitda per tonne)
in July; this is likely to reverse after the monsoon season on
improvement in demand (prices have already recovered partially in
Gujarat and the eastern region). Fight for market share in the
Gujarat market intensified with the entry of two new producers in
the past two years; however, competition would reduce as a large
portion of new capacities are absorbed. ABG Cement is likely to start
production in 2HFY13, which may stabilise in FY14; prices are likely
to be volatile only for a shorter period on improved utilisation in the
west.
We expect cement prices to improve: We expect a seasonal
recovery in cement prices in 2HFY12 in all regions (except south)
with sequential improvement in utilisation; we see a gradual and
cyclical improvement in prices from 2HFY13 with reduction in surplus
capacities. Improved demand growth in FY14ii, with elections
nearing at that time, should boost pricing power in FY14.
Furthermore, the volatility in cement prices would reduce after
2HFY13, with decline in the number of new producers and surplus
capacities.
Utilisation of ~80% is unlikely to be a major concern in
FY14ii: Historically, cement producers have had strong pricing
power when utilisation was above 85%. Pricing power reduces when
utilisation declines below 80% and it worsens when a new producer
enters a market/region in such a scenario. We believe the number of
new producers making an entry during 2HFY13-2HFY14 would be
lower; thus, the pricing power of the producers would be largely
shielded during the monsoon season in FY14 particularly for east,
north and west regions.
East – Supply shortage in FY14 to boost pricing
power
Supply shortage likely in FY14
The east is likely to experience supply shortage in FY14 as most capacity
additions are likely to be back-ended and demand would continue to be
strong. Utilisation would improve to 93% in FY14ii, from 86% in FY11.
Capacity additions of JK Lakshmi Cement and UltraTech Cement in FY14
are unlikely to materially contribute to supply, as they may not stabilise
in FY14.
Orissa to be a major demand driver in the east after Bihar:
Demand grew at a fast pace in the east during the past two years,
with the Bihar government focussing on infrastructure development.
Based on our interaction with cement dealers, we believe the focus
has reduced slightly in FY12, (visible in allocation for the
infrastructure segment in the budget).
Orissa is likely to make up for the demand slowdown in Bihar.
Recently, the Chief Minister of Orissa ordered completion of 4,130km
of concrete roads in rural areas in FY12. Our channel checks indicate
that Orissa built ~1,000km of concrete roads annually in the past
two years. This segment alone should create additional demand of
1.6m tonnes of cement (assuming single-lane roads in rural areas),
which is 4.5% of the consumption in the east in FY11.
Fight for market share to reduce substantially from 2HFY13 in
eastern region: Jaiprakash Associates expanded its capacity in the
eastern region in Bhilai (2.2mtpa) through a JV with SAIL in 1HFY11;
the plant stabilised recently. This has led to severe pressure on
cement prices in the region. Another plant in Bokaro (2.2mtpa)
would commence production from 3QFY12; we expect it to stabilise
in 1QFY13, resulting in stress on prices in 1HFY13. With no new
capacities in the region stabilising over 2HFY13-2HFY14, we expect
fight for market share to reduce substantially and pricing power to
return from 2HFY13
North – Low capacity additions to boost utilisation
Slowdown in capacity additions to result in utilisation moving
above 90% in FY14ii: With capacity increases likely to be lower vs.
incremental demand in the north, we expect a sharp bounce-back in
utilisation. We do not expect any capacity additions in the north in
FY12ii and FY14ii; orders placed for 8mtpa would likely be
commissioned in FY13ii. Thus, utilisation would increase to 92% in
FY14ii, vs. 82% in FY11.
Despatch growth to continue to outperform all-India average
in north: The north recorded the highest YoY growth in despatches
among all regions in FY11, despite the slowdown in demand from the
infrastructure segment (as construction related to the
Commonwealth Games was completed). Despatch growth was
largely driven by capacity shortage in the central region. However,
the central region would see a surplus in capacity, as more capacities
are in the pipeline and demand growth is unlikely to improve in the
coming quarters, in our view. Despatch growth in the north was 300-
400bps higher than all-India growth in the past 2-3 years. We expect
this gap to reduce, with decline in capacity shortage in the central
region.
Pricing decline to be marginal in FY14 monsoon season in
north: Wonder Cement and Lafarge Cement are likely to commence
production in FY13. These plants may stabilise in 1QFY14, and thus,
price erosion may be slightly higher than normal in the monsoon
months of FY14. However, we expect prices to revive swiftly as
utilisation in the region would be 92% in FY14ii. Jaiprakash
Associates’ multi-fold expansion in FY11 in the region resulted in a
sharp decline in prices, as utilisation was low at 82%.
West – Fight for market share to reduce
Capacity additions to decline sharply in west: We expect an
addition of 4mtpa capacity in the west during FY12-14, as against
12mtpa in FY09-11. We expect pricing discipline to increase, barring
the monsoon season in FY14, when ABG Cement’s new capacity
stabilises. The fight for market share in the Gujarat market would
subside from FY13, as a large part of Jaiprakash Associates’ new
capacity should be absorbed by then.
Supply from other regions to continue; severe pricing
pressure unlikely: With continued surplus capacity in the south,
supply into the west would remain high. However, this is unlikely to
affect prices in the west materially from the current levels, as
capacity expansion in Karnataka (key supplier for the west markets)
would be back-ended.
Demand growth continues to be robust in the west: The west
recorded the highest consumption growth of 12% in FY11. Demand
from the housing and infrastructure segments was strong in the
region in FY11 (based on our channel checks). In FY12, we expect
demand from housing to be sluggish considering a high interest rate
scenario; however, we expect growth to improve from FY13, owing
to pent-up demand.
South – Pricing discipline to be tested through FY14
Supply pressure in south to continue: The southern cement
market was affected by increasing supply and dwindling demand
over the past two years. We expect an addition of 18mtpa capacity
in the region during FY12–14, of which two new players, Jaiprakash
Associates and JSW Cement, would contribute 9mtpa.
Deceleration in capacity growth not enough to reduce surplus
in south: During FY09-11, the south saw an addition of 60mtpa
(including non-CMA members), but the pace would decelerate to
18mtpa over FY12-14ii. Nevertheless, surplus capacity is unlikely to
come down, as demand has not risen in the past two years and
going forward, it may not exceed supply significantly.
Discipline to be tested through FY14 in south: The southern
market has displayed strong volume and pricing discipline in the past
year, despite a sharp decline in utilisation. However, we expect
disruption in pricing discipline in FY13 when capacities of Jaiprakash
Associates and JSW Cement stabilise. Cement prices and profitability
are likely to be highly volatile for the next two years in the region, as
utilisation is likely to continue at low levels and new capacities stabilise.
Consolidation a primary requirement for earnings volatility to
reduce in south: The south would record utilisation of 65% in FY14ii.
We expect earnings volatility to continue in the region, owing to huge
surplus capacity. Profitability of the players hinges on continued pricing
discipline. The huge supply overhang has depressed the valuations of
south-based companies. If consolidation materialises, going forward, it
would have a positive impact on the performance of these companies.
Central region – Utilisation to deteriorate from here on
Central region volatility to increase: The central region recorded
robust demand growth in the past two years, with improvement in
semi-urban and rural housing segments and increase in
infrastructure spending by the Uttar Pradesh government. We expect
this scenario to continue for the next year as state elections are due
in May 2012. Demand growth may moderate from 2HFY13 after the
elections, based on the trend in a few states in the past two years.
Supply would increase in FY14, with incumbents undertaking
manifold expansions and a new producer making an entry.
Pricing power to be volatile through FY14 in central region:
Utilisation would decline in the central region over the next two
years. Pricing power in the region has been impacted for the past
year on increase in capacity of incumbents and higher inflow from
the northern and southern players; this is despite healthy utilisation
levels in the region. The central region is accessible to all the
regions, and particularly to the Nalgonda cluster in the south, which
is saddled by surplus capacities. The south producers dumped excess
production in the central region whenever prices increased in the
past two years.
Capacity growth is likely to exceed demand growth sharply in the
next three years. We expect pricing power to improve between
2HFY12 and 1HFY13, with no major new capacities stabilising; prices
should come under stress in FY14, as new capacities would start to
stabilise in 3QFY13.
Playing the upturn
We expect improvement in pricing power in the eastern,
northern and western regions to result in earnings Cagr of
18% between FY11-14 for companies in our coverage
universe. We expect ACL to be the biggest beneficiary
because of improved pricing power in these regions as 90%
of its sales come from these favourable regions. We expect
UCL to be the next biggest beneficiary among large-cap
cement companies as 65% of its sales volumes come from
these regions. Among mid-caps, SCL, a north-based cement
player, will be the biggest beneficiary of improvement in the
northern region. We expect ACC and Grasim to partially
benefit from the cement upcycle in the eastern, northern and
western regions and rate them as ADD.
Cement stocks have rallied when utilisation improved in the
past: We expect cement stocks to do well, going forward, with likely
improvement in utilisation and pricing power in FY14. In the past, we
found that when utilisation turned positive, stocks offered positive
returns. In FY95, FY2000 and FY03, cement stocks rallied, when
utilisation increased from a low level. We turn positive on the cement
sector, with utilisation set to bottom out in FY12ii.
ACL and UCL to be major beneficiaries: Our top picks are ACL
and UCL in the large-cap space, given their reasonable valuations
and presence in better-positioned regions; we rate these stocks as
BUY. ACL’s volumes from the north, west, and east comprise ~90%
of its total sales. With utilisation set to revive in these three regions,
we believe ACL would be the biggest beneficiary among pan-India
players. UCL would be the second-biggest beneficiary, considering
that ~65% of its sales originate from the northern, western and
eastern regions.
We rate ACC and Grasim as ADD. Around 55% of ACC’s sales
volumes come from the north, west and east; upside to earnings is
likely to be lower vs. ACL and UCL; Grasim’s earnings are likely to
improve in FY14 on UCL’s improved performance, but headwinds in
the VSF division may depress FY13ii earnings.
Northern region’s utilisation improvement to boost SCL’s
earnings: In the mid-cap space, we rate Shree Cement as BUY, with
the northern region expected to record 92% utilisation in FY14ii. We
recommend a BUY on India Cements considering its cheap valuations
and efficiency improvement programmes. We rate Madras Cements
and Kesoram Industries as ADD, as they are available at a sharp
discount to the replacement cost, following sharp decline in their
share prices; however, earnings are likely to be volatile on the
southern region’s poor fundamentals.
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