Rising rural income, pick-up in construction should boost demand
Housing constitutes about two-thirds of Indian cement demand, with rural housing constituting 40% of total demand. In the last ten years, total housing stock in rural India increased at 2.2% CAGR (compound annual growth rate), but housing stock with cemented walls grew at a higher CAGR of 5%. This was driven by cemented houses increasing from 39% to 52%. Growth from rural housing should increase materially given the sharp increase in rural wages.
Rural wage growth has increased sharply in the last five years and is sustaining at 18-20%. We believe that high rural wage growth is due to (i) the increasing connectivity of rural India through rural roads, (ii) the increasing electrification of rural India increases the number of hours worked in a day, as well as household automation, (iii) increasing penetration of cellphones has improved price discovery in agricultural produce, and (iv) improving cooking gas and water availability is also freeing up critical time for workers. We believe most of these schemes have some way to go, and spending on them is likely to accelerate at least until 2017: rural road construction programme is only 60-65% done and a third of India?s households still do not have electricity connections.
Urban housing?still weak, but recovering: Residential sales volume growth has been negative for the last 18 months; however, the trend has been reversing. Weak sales volume trend resulted in inventory months (inventory to consumption ratio) increasing to 20 months. However, given the recent recovery in sales volumes, both absolute inventory and inventory months have started falling. Our interaction with cement companies suggests demand from urban housing has started recovering.
Commercial property sales growth continues to be weak, with volumes still declining by more than 20%.
Infrastructure weak but roads and railways recovering: The 12th Five-Year Plan presented an optimistic scenario, with investment in infrastructure growing at 18% CAGR till 2017. But the ground reality was different in the first year. Trends in roads and railways are encouraging but demand prospects from irrigation and power are still not bright. Overall cement demand from infrastructure should grow 5% in FY14. Construction activities in the road sector are expected to recover with NHAI (National Highway Authority) taking several steps to revive stuck projects. We expect cement demand from the road sector to grow at a 15% CAGR. Investment by railways is growing in the high teens. Increasing project awards for Eastern- and Western-dedicated freight corridors should support momentum in railway investment. On irrigation, our analysis suggest that six states in India account for two-thirds of the total irrigation spend, and FY14 state budget estimates suggest that the total irrigation spend should grow in the high single digits (as budgeted spend for Maharashtra and Andhra Pradesh is weak). In the power sector, we expect flattish to low single digit growth for the capacity addition, given the shortage of coal.
Accretive price increase requires demand growth >6% in FY14: Overall, we expect cement demand growth of 7% in FY14 with housing demand growing at 8% and infrastructure at 5%. We expect cement capacity addition of 30 million tonnes in FY14, which requires demand growth of 6% for cash break-even. Therefore, with the expectation of 7% demand growth, we build in accretive price increase and margin recovery in FY14.
Prefer Ambuja and ACC: We prefer Ambuja because of its superior regional exposure. We are positive on Ambuja Cements with an Outperform rating and a target price of R205. Unlike ACC and Ultratech, which have a pan-India presence, Ambuja is more concentrated in northern, western and eastern India with almost no exposure to southern India. Ambuja commands 9% cement market share and is the fourth-largest cement player in India with capacity of 28 million tonnes, operating at 78% (CY12).
Ambuja trading at three-year low P/E. We like Ambuja?s regional exposure and strong balance sheet (net cash at 15% of market cap and RoE of 18% and dividend yield of 2%). We expect a 17% earnings CAGR for Ambuja for the next two years. Ambuja is trading at 14x forward P/E, which is close to the bottom of its range in the last three years, and therefore, we find valuations attractive.
We are positive on ACC with an Outperform rating and a target price of R1,545. ACC has the highest sensitivity to both price and volumes and low exposure to western and central India, which are our least preferred regions due to high supply pressure.The company commands 10% cement market share and is the third-largest cement manufacturer in India with 30 million tonnes of capacity, and has a pan-India presence. Strong ROE (return on equity) of 20% despite net cash at 14% of market cap. We expect ACC to remain FCF (free cash flow) positive despite expanding capacity by 17% over the next three years.
Credit Suisse