Cement sector: Concrete upside in 2013
Over the last couple of years, the cement industry has paid for its excesses. During the boom years, the industry invested in massive capacities. Then the sector was struck by the slowdown years, which put pressure on prices. The Competition Commission of India (CCI) verdict on cartelisation have made it difficult to increase prices this year. Despite this, the Business Standard Cement Index has risen 56 per cent in 2012, while the benchmark Sensex is up 26 per cent. And, the good times are nowhere near ending.
With elections concluding in several states and general elections merely 18 months away, construction activity is expected to pick up. Analysts say for the first time in five years, demand will be higher than capacity additions. Demand for cement has risen this year, as several states have gone to elections and government spending on construction has increased. This is likely to continue. Brokerages expect pricing power to sustain even in 2013 and capacity utilisation to improve. Citi expects demand to grow seven per cent in FY13 and eight per cent in FY14, as infrastructure spending picks up.
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The industry is poised for an upcycle, as demand picks up and economic growth rebounds. Though cement prices across India are down five per cent compared to last year after the CCI’s verdict on cartelisation, which will have an impact on earnings, higher utilisation levels should come to the rescue. Bank of America Merrill Lynch (BofA-ML) expects pan-India capacity utilisation to improve from 71 per cent in FY13 to 76 per cent in FY15. Between FY10-12, 110 million tonnes (mt) of capacity was added (on a base of 220 mt). However, over FY13-15, only 62 mt of fresh capacity will be added.
Input prices are also expected to remain benign for the industry. While diesel and coal costs might increase marginally, analysts believe internationally coal prices will remain soft on weaker demand. This would benefit cement companies over the next two years. So, is there any upside left in cement stocks after the outperformance of 2012? Analysts believe there is. For starters, cement stocks are not trading near their peak levels. Given that an uptick in demand is expected, earnings of companies will only move up. BofA-ML recommends Ambuja and UltraTech and believes stocks should climb to the upper end of their valuation range at 10-12x EV/Ebitda for majors, despite the year-to-date outperformance. Cement majors are trading 15 per cent below their upcycle valuations.