19 April 2014

Cement - Sector Update - Rich valuations in a challenging environment :Centrum

Rich valuations in a challenging environment



We assert that cement stocks post recent rally do not offer favorable
risk-reward and maintain negative stance on the sector. However,
cement prices have sustained at higher levels due to supply
constraints and we believe improved supply will soften prices,
especially in North and West regions. Cement dealers confirmed our
view that prices will drop when production resumes at Binani’s Cement
plants. On the other hand, cement prices at higher levels in North and
West regions will help improve profitability of Shree Cement, JK
Lakshmi Cement, JK Cement (60% capacity in North) and pan-India
players Ambuja and UltraTech Cement (higher presence in the West and
North regions).

$ Price remains at higher levels: Average pan-India price increased
1.5% MoM to Rs320/bag in Apr ’14 led by price hikes in West (Gujarat),
South and Central regions. In South, price continues to remain
volatile, but in the West region prices have been supported by
slightly improved demand and low supply. We believe elevated cement
prices in North and West regions (up 16-17% YoY) are largely due to
tightening supply but resumption of operations at Binani Cement’s
plants will lead to softening of prices.

$ Delay in some capacity addition in FY14; higher capacities expected
in FY15E: Some capacities got delayed in commissioning in FY14 which
are expected to come on stream in Q1FY15E. We believe that capacity
addition in FY14 was 15.8mt against our initial estimate of 21.3mt due
to delays in commissioning (Reliance Cementation plant in the Central
region and ABG Cement plant in the West). Our interaction with
industry participants suggest that delayed capacities will be
commissioned in Q1FY15E. We believe the commissioning of these
capacities will impact the pricing power of manufacturers adversely if
demand does not pick up.

$ Demand-supply situation yet not favorable: We expect effective
capacity utilization rate of the industry to be at 72.9%/75.3% in
FY15E/FY16E against 73.4% in FY14. Though the street expects sharp
recovery in cement consumption post favorable elections, we will be
surprised if volume growth surpasses our expectation in FY15E. Even
ex-South region, utilization rate is expected to be at 79.9%/81.9% in
FY15E/FY16E against 81.7% in FY14.  Subdued utilization rates will
continue to lead to volatility in cement prices as in FY14. However,
factors beyond our analysis (closure of Binani Cement’s operations)
and pricing discipline may help sharp hike in prices.

$ Outlook & Valuation: We believe that post recent run-up in cement
stocks, valuations (large cap companies trading at near to or above
mean+sd1 EV/EBITDA) are at elevated levels and risk-reward seems
unfavorable. Cement prices may come under pressure (Rs20-25/bag) if
production resumes at Binani Cement plants in the North region. Also,
Lafarge has commissioned its 2.6mt capacity in the North region
(Chittor, Rajasthan) which may put pressure on cement prices in the
region if demand does not improve. Cement companies’ earnings were
revised downwards sharply in FY14 and we expect the same scenario in
FY15E if demand does not improve. We prefer to wait for signs of
demand revival and pricing stability before turning positive on the
sector.





Thanks & Regards
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