India Cement- Weak Cyclical Outlook :: Citi

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India Cement Sector
Weak Cyclical Outlook, But Pricing In A Strong Structural One
 Cement stocks have run ahead of near-term fundamentals, we remain cautious —
Cement stocks have bounced over the last three months, on sustained underperformance
(6-18 months), artificially bolstered cement prices, and also on
under-ownership/contrarian investing. While there is ‘long-term outlook’ support to
this bounce, with the weak prices/earnings outlook (12 months), high valuations,
and cost pressures, we view that stock prices have run ahead. We remain cautious
on the sector, maintaining Sell ratings on Ambuja, ACC, and UltraTech, but upgrade
Grasim to Buy (from Sell) on its cheap absolute and relative valuations.
 Structural outlook strong… — You don’t get such a positive outlook in too many
places/sectors, even in India. Medium to long-term demand growth of 10-12% (as
it builds housing, infrastructure, and rural India), extended capex and supply
cycle (3-4 years), physical barriers to imports/global competition, a long tail with
subscale competitors, consolidation upsides, and strong balance-sheets. It should
be a heady mix – great for profit/cash generation and valuations – its time will come.
 …but cyclical outlook suggests this is not the time — The current quarters
results (PAT down 52-82% YoY) tells a different tale: 1) Over-supply at near all
time high (utilization levels at a relative low: 70-75%) – unlikely to improve over
the next 12-18 months; 2) Recent sharp cement price moves unjustified – set to
fall (the long capacity tail will wag); 3) Demand sluggishness – 7% YoY growth
in FY11E, the lowest in seven years; and 4) Meaningful cost pressures (raw
materials, coal, freight). This is one cycle you should not be mounting, just yet.
 Valuations biased towards structural upside, but should be more balanced —
Cement stocks trade at an EV/t of US$125-163 (Grasim US$82), 12-22x Dec-11E
PE and 6-11x Dec-11E EV/EBITDA, suggesting cyclical pains are almost behind.
However, we believe valuations should be more balanced between the structural
and cyclical outlook, with EV/t closer to replacement cost at US$120. Stocks should
start hugging this benchmark over the next 3-6 months, and, all things being equal,
we might become more constructive on the stocks if they dip below this benchmark.
 Upgrade Grasim to Buy, maintain Sells on ACC, Ultra Tech and Ambuja — We
believe there is an unjustified valuation dissonance with Grasim – at a CY11E EV/t
of US$82 and upgrade to Buy (1L) from Sell (3M). We see downside on Sell-rated
Ambuja (EV/t of US$163), UltraTech (US$137) and ACC (US$125) – in that order.