Cement stocks have run up in the last three months largely on an upturn in cement prices due to volume cutbacks by producers. Stocks have outperformed the Sensex by 11-29% in the past three months and trade at EV/t (enterprise value per tonne) of $137-157, Sep12 PE (price-to-equity) of 17-19x and EV/Ebitda of 8.7-9.1x (times).
Grasim (best relative value: P/E 8.7x, EV/Ebitda 5.6x) continues to be our only Buy. Maintain Sell on Ambuja, UltraTech and ACC. Cement prices have downside risk; a stock correction would offer better value. Demand trends so far have come in below expectations. Domestic demand has risen only 3.4% year-on-year during Apr-Aug’11, and with faster growth for the remainder of the year, growth is likely to reach 8% in FY12. Growth has been impacted by slower infrastructure spending, particularly in south India and weak trends in some urban real estate markets.
India has been prolific in cement capacity addition with 93mtpa, an increase of 56% since FY08, more than double the cumulative demand growth of 26% since then. Another 65mtpa (+31%) is expected during FY12-14. The industry is more consolidated than before (top 5 = 51% of capacity), but a long tail of about 30 players will make co-ordination difficult to sustain for long periods. The surge in capacity combined with the slower demand led to a 5-29% fall in regional prices from April to July 2011, with southern prices remaining steady. Despite slower demand trends, prices have recovered most of the lost ground since July 2011. The higher prices may sustain for a while, but with utilisation levels at 70-80%, we believe there is strong downside price risk.
Companies are also struggling with costs for raw materials (fly ash, slag), fuel (coal) and freight, especially those companies which depend on imported coal (Ambuja, UltraTech). In our view, the cost pressures are likely to continue as more capacities come on stream.
We continue to use replacement cost of $120/t (in line with current capex trends) as our key valuation tool. We might turn more positive, all things being equal, on a correction below replacement costs. We believe there is an unjustified valuation dissonance with Grasim?at a CY11e EV/t of $82, and maintain a Buy (1L) on the stock. We see downside on Sell-rated Ambuja (EV/t of $156), UltraTech ($137) and ACC ($132)? in that order.
Cement majors have outperformed the Sensex in the last 6-12 months, with the biggest outperformance in the past three months (by 23-29%) largely on an upturn in cement prices (artificial scarcity), under-ownership and the domestic nature of the industry (unaffected by international price/demand trends). While the structural long-term outlook is positive, valuations seem to reflect that the cyclical pain is almost behind us. In our opinion, stocks have run ahead of the near-term concerns and we remain cautious on the sector. We believe valuations should be more balanced between the structural and cyclical outlook, with an EV/t closer to replacement cost at $120. We continue to use replacement costs of $120/t (in line with current capex trends) as our primary value tool. Stocks should trend closer to replacement cost over the next three-six months.
Ambuja, UltraTech, and ACC stocks trade at an EV/t of $137-157, Sep12 PE of 17-19x, and EV/Ebitda (earnings before interest, taxes, depreciation and amortisation) of 8.7- 9.1x. We believe Grasim looks cheap on a relative basis.
?Citi