Capacity utilisation may fall

Cement: Growth in capacity addition may outpace consumption.

There’s an interesting correlation between the performance of cement stocks and capacity utilisation levels. Higher the capacity utilisation levels in a company, the better its stock price. Over the last three quarters, cement stocks have outperformed the Nifty, as capacity utilisation improved from 71.4 per cent in the September 2010 quarter to 77.9 per cent in the March 2011 quarter. As utilisation levels improved, cement stocks were re-rated despite unprecedented increase in raw material prices.

A majority of analysts remain bullish as fresh capacity additions are nearly over. One of the reason behind the poor utilisation levels was 105 million tonnes (Mt) capacity that came up between FY08 and FY11. New capacity additions are expected to be around 66 Mt between FY11 and FY14. Most analysts deduce that this will improve capacity utilisation and gradually improve realisation per bag.

However, Avendus Securities has taken a contrarian view. It forecasts grinding capacity utilisation will decline from 80.6 per cent in the June quarter to 71.1 per cent in the September quarter and 71.3 per cent in the December quarter.

The research house says capacity addition for FY11–FY13 is estimated to grow at a compounded annual growth rate (CAGR) of 8.2 per cent, while consumption growth during the same period is likely to increase by a CAGR of 8 per cent. Hence, capacity utilisation for FY12 and FY13 will remain in the range of 75-76 per cent. During FY09-FY11, capacity addition grew at a CAGR of 16.3 per cent, while consumption grew at a CAGR of 10 per cent. This led capacity utilisation to decline from 88.3 per cent in FY09 to 75.3 per cent in FY11.

Companies with better utilisation levels will score over stocks which have lower utilisation and higher valuation. And from this point of view, Avendus expects UltraTech’s capacity utilisation to be 90.6 per cent in FY12, whereas it estimates 75.6 per cent for ACC and 81.5 per cent for Ambuja Cement. “Broad-based market correction is a risk to our call as the Cement Index and EV/tonne valuation range of Rs 5,400–5,850 limit the downside in stocks.”