Cement -Dual triggers - Rising demand & moderating costs:: Centrum

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Dual triggers - Rising demand & moderating costs



We resume coverage on the cement sector with a positive view on
account of improving demand visibility, which along with increasing
consolidation should boost the industry’s pricing power. Falling coal
and crude prices will further benefit the industry’s profitability.
We believe the valuation re-rating for the mid-caps (over the past six
months) will sustain as their profitability grows at a faster pace
reflecting strong volume growth, improving internal cost efficiencies
and lowering debt on books. While the 3QFY15E profitability should be
weak for north based companies, the same should rebound going forward.
In large caps, we like UltraTech & ACC and in mid-cap space, we
recommend JK Cements, Mangalam Cement & Orient Cement –quality
companies available at reasonable valuations.

$ Higher demand, rising industry utilisation & consolidation to boost
pricing power & volume growth: With the new Government at the centre
speeding up infrastructure project clearances and better placed
financially to fund infrastructure creation, we expect cement demand
to grow at a faster pace of 8% CAGR during FY14-17E vs 5% in the
preceding three years. Amid lower capacity additions, industry
utilisation should expand by 450bps to 77% by FY17E. Cement majors
have recently speeded up mergers and acquisitions in India leading to
a rise in industry consolidation and improving the industry’s pricing
power.

$ Industry’s cost pressure should benefit from declining coal & crude
prices: Power, fuel & freight account for ~57% of the industry’s total
operating costs hence lowering crude/coal prices is beneficial for the
cement industry. Persisting weak coal demand in China and stable crude
supply by OPEC members despite the sharp fall will keep operating
costs subdued for the cement industry driving better profitability. We
expect total sales/ EBITDA/ PAT of 10 companies under our coverage
(accounting for ~55% of industry sales) to grow at 18%/ 32%/ 35% CAGR
respectively during FY14-17E period.

$ Mid-caps re-rating sustainable: The mid-caps’ valuation discount to
its large cap peers narrowed to ~18% over the last six months vs
40-60% in FY14. This re-rating during FY15 should sustain as these
companies have expanded capacities ahead of demand up-tick and also
invested in improving cost efficiencies. The leverage on books will
moderate led by higher free cash flow as production ramps up. We
estimate net sales/ EBITDA/ PAT of the six mid-caps under our coverage
to grow at faster pace of 19%/ 47%/ 91% CAGR during FY14-17E period.

$ Top picks and key risks: We remain positive on the sector as a
whole. In large caps, we like UltraTech and ACC and in mid-cap space,
we recommend JK Cements, Mangalam Cement and Orient Cement – which are
quality companies at reasonable valuations. Prism Cement can also
deliver strong returns if it can generate the expected cost efficiency
in the TBK segment thereby boosting its balance sheet.  Key risks for
the sector are: lower than expected demand growth and sharp rise in
coal/ crude prices all of which will lead to lower profitability and
also delay the deleveraging for mid-caps.



Thanks & Regards