Cement - Resilience unsustainable; sector update : Edelweiss, PDF link

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We maintain our negative view on the Cement sector citing-

•       Nearing of the peak prices for this season. Expect prices to decline (like last two years) gradually towards end of Q1 and in Q2 of FY13. Last two years show high co-relation of cement stocks to cement prices.

•       Continued volatility in prices due to low capacity utilisation of ~78% for FY13/FY14. (vs 79%/77% in FY11/FY12)

•       Expected pressure on cement prices in the initial phase due to entry of new players like ABG Cement in West, KJS Cement in Central and Wonder Cement in North region. Estimate Central region to be impacted the most.

•       Continued cost pressures. We expect domestic coal prices and diesel prices to increase ~10% and 8% respectively in FY13.

•       Huge penalty threat from the Competition Commission of India (CCI) accusing the industry of cartelization and risk to pricing power from state governments (like in case of Himachal Pradesh and Chhattisgarh).

•       Current valuations factoring peak EBITDA/t scenario which we believe is unlikely. Last two years, the EBITDA/t for major players has remained nearly flat despite prices touching a new peak in each of years.

Our view is cognizant of the fact that-

•       Industry has shown great resilience by taking margin accretive price hikes to compensate for the rail freight hike and increased excise duty. Expect full benefits of the price hikes to accrue in Q1FY13.

•       Capacity utilisation in North expected to be ~86% in FY13 (assuming 10% demand growth) vs 80% in FY12 due to delays in commissioning of few capacities in the Central region.

•       Demand has shown signs of improvement in last few months and due to low base will appear robust in Q1FY13. We maintain our 9% YoY demand growth assumptions for FY13 & FY14 each.

Risk reward unfavorable despite earnings upgrade and rolling over of price target to FY14 earnings 

Factoring the high base created by the recent price hikes, we are revising up our EBITDA/t estimates in the range of 2% to 7% for our coverage universe. We continue to value cement stocks at mid-cycle valuation multiples (last 10 years average EV/EBITDA multiple). Even rolling over the valuations to FY14/CY13E earnings do not yield a significant upside. In our view, the risk reward ratio at current valuations is unfavorable and hence reiterate our negative view on the sector.

Cement - Resilience unsustainable; sector update

Regards,