Limited upside for cement majors

Inexpensive valuations, price hikes help ACC, Ambuja & UltraTech rebound but demand-supply equation remains unfavourable

The stocks of cement majors ACC, Ambuja Cements and UltraTech Cement have seen a good recovery since the second fortnight of February, after having fallen 10-25 per cent over the previous months. While the earlier underperformance of the stocks of India’s top three cement companies was due to low demand and muted realisations in the second half of CY2013, the rebound has been helped by a series of recent price hikes. These, though supported by some capacities temporarily going off stream, are also in anticipation of a demand recovery. The March to mid-June period is among the peak periods for cement demand before the monsoon season kicks in. Analysts say that month-on-month there has been some demand recovery in February.

While the signs are positive, the near-term demand is likely to be supported only by the consumer segment. There is little hope of government projects picking up, given the upcoming elections. In this backdrop that analysts are sceptical and believe prices and demand may could remain volatile in the coming days, keeping the stocks under check. However, looking at the cheap valuations, investors with a two-three years’ perspective can accumulate on dips.

Says Mihir Jhaveri of Religare Capital Markets, “The sector has largely underperformed the market over last year, reflecting earnings downgrades from the Street as demand failed to pick up, despite a favourable base.” He adds that under-owned, major large-caps are trading at near-replacement costs and can be accumulated on declines.

Price hikes positive, but…
The price rises undertaken by cement majors (in the range of Rs 20-70, according to analysts) are not merely led by a demand pick-up. Analysts at Credit Suisse observe supply disruptions in the north (Binani Cement) have temporarily pushed up prices in the region but they do not think these are structural shifts. They believe stock prices currently factor in steep a demand recovery in FY15.

Apart from the plant closure of Binani Cement, Birla Chetak Cement’s plant was also shut due to maintenance. Thus, with the supplies getting curtailed, cement prices in the north-west region gained momentum, with Rajasthan and Gujarat recording the highest gains. The price hikes in other regions have been in anticipation of a demand recovery in the peak cement season.

According to Religare channel checks, Rajasthan has seen sharp price hikes of up to Rs 70 a 50-kg bag, followed by Gujarat which saw price hikes of Rs 40-50 a bag while eastern and central India have seen increases of Rs 20-30 a bag. The south, in contrast, has seen a decline of Rs 10-30 a bag on continued demand weakness and excess supply.

Jhaveri feels that in the first week of March cement players may see another round of price hikes in the range of Rs 10-15 a bag. Given these price hikes (including Rs 5-25 a bag in January), the profitability of cement players is likely to be better in the March 2014 quarter compared to the dismal performance in the December 2013 quarter.

Challenges remain
Moving forward, though, there is a risk to realisations. While price hikes in the state of Rajasthan may not be sustainable as supply from Binani Cement and Birla Chetak resumes, there is also a risk of an adverse judgment from the Supreme Court on the sand mining issue, feel analysts.

Also, of the 50 million tonnes per annum (mtpa) of capacity addition planned over the next three years, as much as 15 mtpa is likely to be added as early as in the June 2014 quarter (the remaining 35 mtpa over a period of time). This will maintain pressure on the capacity utilisation rate of the cement industry, which is currently around multi-year lows of 70 per cent.

A sustainable demand recovery may take place only if demand from the housing (both urban and rural) and infra sectors picks up, which could happen only after the monsoon. Analysts at Kotak Institutional Equities suggest that the 3.4 per cent demand growth in the first half of FY14 may grow to 4 per cent in the second half, led by growth in the current (March 2014) quarter. According to their channel checks, the dealers have attributed the current state of subdued demand to the absence of offtake from infrastructure projects and the organised real estate sector, even as demand from individual house builders remains resilient.

In this backdrop and after the recent run-up on the bourses, the stocks of ACC, UltraTech and Ambuja may see limited gains in the near term. According to analysts polled by Bloomberg since the start of February, the one-year average target prices for the three stocks, now trading at Rs 1,135, Rs 1,893 and Rs 167 levels stand at Rs 1,110, Rs 1,780 and Rs 156, respectively, implying that they are fairly valued as of now.