Cement sector re-rated on hopes of infra push

Stocks' target prices raised by 50-100% on better demand outlook

The BS Cement Index has risen 60 per cent over three months, on hopes of a big push to infrastructure. After the run-up, cement stocks are trading at 9.8x-11.6x EV/Ebitda on FY16 estimates  and 13.2x-16.7x FY15 estimates, which is considered expensive. However, a select set of analysts are claiming the sector is at the start of an up-cycle and that demand will outpace capacity additions soon. The sector, which has been suffering from weak pricing power, slowing demand and excess capacity, has been re-rated and upgraded after the BJP-led NDA won the general elections.

The Street expects demand to grow faster than capacity additions and the sector's profitability to improve substantially on higher utilisation levels. Weak demand and rising input costs hurt the industry's earnings in FY14. During the year, the industry’s operating profit declined 26 per cent compared to a 11 per cent rise in FY13. Demand growth remained weak at three per cent in FY14 due to weak project execution.

The Street, however, believes the worst is over. Historically, cement demand in India has grown at a multiple of 1.1x of GDP growth, but analysts now believe that given the new government is expected to give a big push to infrastructure, per capita consumption of cement should rise faster than expected. Goldman Sachs believes India’s per capita cement consumption is set to double in nine years.

The concern that has bothered analysts so far is the sharp increase in capacities, which has impacted pricing power. Consolidation by global players and exits of smaller players will further reduce competitive intensity. Analysts expect the sector’s operating profit to expand by a 25 per cent CAGR over four years. Based on improved outlook, target prices of leading cement stocks have been raised by 50-100 per cent. Goldman Sachs has added Grasim to its conviction buy list, seeing a mispricing opportunity at a 56 per cent discount to NAV. The brokerage has also upgraded UltraTech to buy (from neutral) and ACC, Ambuja, to neutral (from sell).