Cement: Earnings to rise 24% CAGR over FY15-17

After recent correction, sector's risk-reward turns favourable

Like many other sectors, the good days have eluded the cement sector, too, in FY15. For the past five years, demand has been growing at a CAGR of less than five per cent. The current financial year will not be an exception, even if economic growth shows a sharp rebound. Analysts are now pushing demand revival to FY17, as the first two months of the current financial year have not shown any meaningful pick-up in demand. With the onset of monsoon, demand is expected to remain weak for the next three months also.

Cement stocks have corrected eight per cent over the last one month, while the Sensex is down 3.5 per cent. In June, cement prices in North and Central India dipped, while in the East, South and West prices improved marginally. In Delhi and Gurgaon, prices fell Rs 10-20 a bag to Rs 240. Prices have shown a similar pattern in Bhopal, Lucknow, Noida and Kanpur. AnandRathi claims dealer checks have shown that demand is expected to remain muted in the coming months, too. IDFC Securities says, "Non-South companies are likely to see lower operating income per tonne on a quarter-on-quarter basis due to weak pricing and cost escalation (higher freight charges). Pricing in the South has seen some correction in May, hence, Ebitda (earnings before interest, tax, depreciation and amortisation)/tonne for South-based players would see some sequential moderation."

So far, there is no visible sign of any pick up in infrastructure spending and, as a result, the demand has remained muted. The Street is expecting a rebound in demand to happen in the second half of FY16 for cement too. JPMorgan expects a sharp rebound in cement demand, as government spending on infrastructure is expected to rise and is building in pan-India demand growth of cement at 6.5 per cent in FY16 and nine per cent in FY17.

Analysts also believe existing players would also command a premium as building a greenfield cement plan would not be very difficult, given the norms around land acquisition and access to raw materials. In addition, large cement companies are trading at close to their mean valuations over the last three years. In addition, these companies are expected to see operating income grow 25 per cent CAGE over FY15-17, making the risk reward attractive. JPMorgan is overweight on Ultratech, Ambuja Cement and Grasim.