Indian Cement Sector -- You blinked…and missed it :: Macquarie Research

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Indian Cement Sector
You blinked…and missed it
Event
 Demand outlook remains weak: Many investors were excited to note the
11% YoY demand growth in July, but our channel checks reveal that this
number was just a statistical aberration and demand growth has fallen off
again. We expect 5–6% YoY demand growth in August. We recommend
investors stay away, as Q2 results are likely to show a sharp drop, and the
overhang of penalties for cartelisation remains real. Our key Underperform is
ACEM IN.
Impact
 Demand – after-effect of breakdown in supply discipline: It appears that
the supply discipline that was in place broke down in July, and this led to a
free-for-all in despatches. Apart from the South, which maintained supply
discipline and hence registered a 6% YoY decline in despatches in July, the
rest of the country saw 19% YoY growth in despatches. But most of the
material went into restocking, and now we are hearing stagnation of
despatches from our channel checks.
 Prices – inversely correlated to volumes: All-India cement prices are down
6% from the peak seen in May–June. However, cement prices have largely
remained firm in the South, where supply discipline has been maintained,
while the rest of the country has seen an 8% drop in prices. Prices in Eastern
and Central India have dropped by 9-11% since May and less steeply by 5–
6% in the North and the West.
 Inventories at 13-yr high even as capacity utilisation remains low: The
industry is operating at 75% capacity utilisation, while clinker inventory is now
above 10mnt, or 22 days of consumption. Normally, the storage space at
plants is not much beyond 25 days, so any further slowdown in demand
growth would mean more production cuts. Fortunately for the industry, the
current slowdown in demand coincides with the annual maintenance season.
 Competition Commission enquiry not closed: It does appear that a mix-up
on the part of CCI (Competition Commission of India) to attach data on all 10
companies being investigated as part of the show-cause notice has forced it
to withdraw the notice. But given the zeal that CCI has displayed in slapping
penalties on real estate developers, the risk of a big penalty on the cement
sector can’t be ruled out. In a separate enquiry, SFIO (Serious Fraud
Investigation Office) has already submitted its report, hinting there is a cartel
at work.
Outlook
 Maintain Underweight: Global concerns have prompted investors to look for
a lesser evil – domestic commodities. However, cement is no place to hide.
Valuations of most large cement companies, at US$125/t, look reasonable,
but are by no means cheap in our view. Only Grasim and India Cements look
really cheap – and these too, only for brave hearts!