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UBS Investment Research
India Cement Sector
W eaker for longer; re-rating unlikely [EXTRACT]
Stocks unlikely to re-rate given extent and duration of overcapacity
We expect industry utilisation to remain weak in FY12-13 (at about 76% compared
with the historical average of 85%), and forecast capacity additions to exceed
incremental demand (FY11 utilisation was the lowest in the past 15 years). We
believe the sector’s risk-reward profile is not favourable at current levels
(valuations at a premium to replacement cost while, historically, stocks have traded
at discounts during periods of overcapacity) and valuations are not attractive (about
13x FY13E EPS for 10-14% earnings growth).
Earnings risk is high, in our view
Cement companies’ recent results were above our expectations. While pricing
discipline could be sustained, it increases earnings risk, in our view, given the high
sensitivity of earnings to cement prices (if the cement price increase is 1% less than
we estimate, this would impact our valuations by 3-4%). Also, prolonged
overcapacity increases uncertainty on the sustainability of earnings. Q2 FY11
EBITDA/t was the lowest in the past five years due to a lack of pricing discipline.
Demand could revert to historical GDP correlation, but utilisation is key
We think demand growth could revert to the historical correlation of 1.2x GDP
growth over the next two years—historical data indicates demand growth bounces
back when it is lower than GDP growth. However, we believe utilisation, not
demand growth, is the key to industry profitability, and that is unlikely to improve
significantly (even if demand surprises) given the severity of overcapacity.
Lower multiple given weak outlook; Grasim is our preferred pick
Given our overcapacity expectation, we lower our valuation multiple from 6.5x to
6x EV/EBITDA. Grasim Industries remains our preferred pick in the sector.
ACC Limited Investment Case
ACC, India’s second largest cement company, is likely to have strong volume
growth on recently commissioned capacities. However, it is likely to be
impacted by severe overcapacity in the industry, which could last for the next
two to three years, impacting pricing and profitability. We forecast average
earnings growth of 22% (coming off a low base) and expect margins to remain
at about 20% over the next two years.
Grasim Industries Investment Case
Grasim, one of the largest manufacturers of viscose staple fibre (VSF) globally
with a 10% market share, has shown a steady performance in this business. We
like the company’s strategy of backward integration with a large proportion of
inputs sourced captively. Although the near-term outlook for VSF is negative,
Grasim expects demand and prices to stabilise. VSF margins have averaged 27%
over the past decade and we expect them to be sustained at this level. The
company is also expanding capacity by about 50%, which we believe is timely
given that current utilisation levels are close to 90%.
India Cements Investment Case
We believe India Cements’ earnings are at high risk given that its capacity is
mostly in the southern region of the country, which is suffering from high
overcapacity. South India has recorded the largest capacity additions in the
country and demand has also remained weak. Although profitability is likely to
increase in FY12 on producer supply discipline, we believe downside could be
significant if supply discipline is not maintained.
UltraTech Cement Investment Case
Although UltraTech has a number of strong positives including large scale and
size (it is India’s largest cement company) with a pan-India presence and a
strong brand, we believe its profitability would be impacted by the severe
overcapacity in the industry. In addition, its overseas business, though a very
small contributor to the overall business, is facing headwinds due to weak
demand. Though we forecast margins to remain stable at about 23%, we believe
the risk to earnings is quite high.
Statement of Risk
We believe the key risk to our outlook for the sector could come from an
unexpected fall in cement prices, increase in input costs, such as coal/freight,
and any government intervention to lower cement prices.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
UBS Investment Research
India Cement Sector
W eaker for longer; re-rating unlikely [EXTRACT]
Stocks unlikely to re-rate given extent and duration of overcapacity
We expect industry utilisation to remain weak in FY12-13 (at about 76% compared
with the historical average of 85%), and forecast capacity additions to exceed
incremental demand (FY11 utilisation was the lowest in the past 15 years). We
believe the sector’s risk-reward profile is not favourable at current levels
(valuations at a premium to replacement cost while, historically, stocks have traded
at discounts during periods of overcapacity) and valuations are not attractive (about
13x FY13E EPS for 10-14% earnings growth).
Earnings risk is high, in our view
Cement companies’ recent results were above our expectations. While pricing
discipline could be sustained, it increases earnings risk, in our view, given the high
sensitivity of earnings to cement prices (if the cement price increase is 1% less than
we estimate, this would impact our valuations by 3-4%). Also, prolonged
overcapacity increases uncertainty on the sustainability of earnings. Q2 FY11
EBITDA/t was the lowest in the past five years due to a lack of pricing discipline.
Demand could revert to historical GDP correlation, but utilisation is key
We think demand growth could revert to the historical correlation of 1.2x GDP
growth over the next two years—historical data indicates demand growth bounces
back when it is lower than GDP growth. However, we believe utilisation, not
demand growth, is the key to industry profitability, and that is unlikely to improve
significantly (even if demand surprises) given the severity of overcapacity.
Lower multiple given weak outlook; Grasim is our preferred pick
Given our overcapacity expectation, we lower our valuation multiple from 6.5x to
6x EV/EBITDA. Grasim Industries remains our preferred pick in the sector.
ACC Limited Investment Case
ACC, India’s second largest cement company, is likely to have strong volume
growth on recently commissioned capacities. However, it is likely to be
impacted by severe overcapacity in the industry, which could last for the next
two to three years, impacting pricing and profitability. We forecast average
earnings growth of 22% (coming off a low base) and expect margins to remain
at about 20% over the next two years.
Grasim Industries Investment Case
Grasim, one of the largest manufacturers of viscose staple fibre (VSF) globally
with a 10% market share, has shown a steady performance in this business. We
like the company’s strategy of backward integration with a large proportion of
inputs sourced captively. Although the near-term outlook for VSF is negative,
Grasim expects demand and prices to stabilise. VSF margins have averaged 27%
over the past decade and we expect them to be sustained at this level. The
company is also expanding capacity by about 50%, which we believe is timely
given that current utilisation levels are close to 90%.
India Cements Investment Case
We believe India Cements’ earnings are at high risk given that its capacity is
mostly in the southern region of the country, which is suffering from high
overcapacity. South India has recorded the largest capacity additions in the
country and demand has also remained weak. Although profitability is likely to
increase in FY12 on producer supply discipline, we believe downside could be
significant if supply discipline is not maintained.
UltraTech Cement Investment Case
Although UltraTech has a number of strong positives including large scale and
size (it is India’s largest cement company) with a pan-India presence and a
strong brand, we believe its profitability would be impacted by the severe
overcapacity in the industry. In addition, its overseas business, though a very
small contributor to the overall business, is facing headwinds due to weak
demand. Though we forecast margins to remain stable at about 23%, we believe
the risk to earnings is quite high.
Statement of Risk
We believe the key risk to our outlook for the sector could come from an
unexpected fall in cement prices, increase in input costs, such as coal/freight,
and any government intervention to lower cement prices.
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