We are pleased to announce that Vaibhav Agarwal of Phillip Capital (India) Pvt. Ltd will be sharing his views on the movement of Cement Stocks through this column from now onwards.
Fundamentally, strong picks in the sector such as UltraTech Cement, Ambuja Cement, JK Cement, and Dalmia Bharat are trading at ~20-30 per cent discount to 52-week highs. Sector fundamentals are likely to turn favorable in the medium term and it?s now the time to relook at opportunities. The largest cement major – UltraTech Cement – reported in line operating earnings in Q3FY16, despite sluggish market sentiments. Recent industry interactions suggest that volumes have been robust in December 2015 and positive sentiments continued until mid-January 2016. There has been a dip in sentiment in the last 10-15 days, but it has not turned as bad as it was before December 2015. The industry is confident of delivering around 8 per cent volume growth in FY17, which is a healthy growth revival – given that FY16 is unlikely to close with much more than 4 per cent growth rate. Data published by DIPP suggests that the sector volumes have grow at meager 2.1 per cent y-o-y in April-November 2015.
Nearly 10 per cent of the sector?s capacity is up for sale – this includes capacities of Jaypee Cement, Binani Cement, Reliance Cement, and Lafarge India. Barring a few PEs and JSW Cement, no new entrants are looking at buying these capacities. Given an assumption that most of these capacities will flow to existing players, further consolidation in the sector is a given. However, players who have the appetite to absorb – such as UltraTech and Shree Cement – are not likely to bid aggressively as they await law amendments regarding mining laws. In a scenario that there are delays in law amendments, there is a strong possibility that these capacities become defunct. In other words – the structural dynamics of the sector are likely to turn favorable in the medium to long term.
Interestingly, most leading cement manufacturers are focusing on asset sweating and driving efficiencies – at least in the immediate term. Players are not really inclined to acquire capacities at high valuation premiums. This means that we may expect the leaders of the industry to remain focused on strengthening their financials. Debt reduction is on the cards for players such as Dalmia Bharat, for whom concerns of high debt have delayed valuation rerating. Players are cognisant of the fact that the demand-supply mismatch needs to be addressed before the industry can take the next leap towards fresh capex. Greenfield and brownfield announcements are unlikely. Only UltraTech is likely to make a few organic announcements – in line with the major?s aim to gain market share and sustain its leadership position.
In its recent Q3FY16 earnings conference call, UltraTech commented that it is in for a price hike in markets where prices remain subdued – this is a very strong statement for the industry and it is quite likely that the other players will follow; prices in a few large pockets of the country (barring the South) are near all-time lows. Costs are already under control and at this point of time, given that the pricing concerns are addressed, earnings for cement manufacturers can rise by as high as 40-50 per cent.
Overall, any stock price corrections in fundamentally strong companies such as UltraTech, Ambuja, Dalmia Bharat, and JK Cement should be considered as a buying opportunity. While UltraTech and Dalmia Bharat are more consolidation driven bets, Ambuja and JK Cement remain bets driven on efficiencies. Bets such as India Cements and HeidelbergCement are opportunistic – India Cements will emerge as a definite winner as and when we see a revival in demand in South India and HeidelbergCement has a huge opportunity to leverage on the management transition phase with the exit of Reliance Cement. One should stay away from manufacturers that are unlikely to see volume growth in FY17.