Why analysts are betting on these cement stocks in mid-cycle downturn

Cement stocks had a rocky ride for much of last year. After healthy growth in the preceding financial year, the cement sector visibly slowed down. Demand for cement has been on shaky ground for a while now, keeping prices subdued. But analysts contend that select stocks could be ripe for rebound.

Cement prices had witnessed a decent uptick in the March quarter of last year, but then saw multiple rollbacks across India from the June quarter. Lower off-take owing to muted infrastructure construction activity and extended monsoon were the main culprits. The price trend has partially reversed over the past three months, with pan-India average cement prices rising around 8% y-o-y in the October-December quarter. While prices continue trending down in east, south and west, they are up in the north and central regions.

The price uptick should aid realisation for cement firms, supporting margins. “We believe that better pricing will drive strong earnings growth (aggregate EBITDA growth of 28.1% y-o-y), operating profit margin expansion and EBITDA/tonne growth (up 21% y-o-y),” says a report by Emkay.

Owing to seasonality factor, downside risk to prices also remains limited. However, for the industry to see sustainable pricing power, utilisation will have to start improving materially, contend analysts. The industry has maintained good discipline in terms of capacity addition in the past five years—contrary to the furious capacity expansion in the preceding 5-10 years that drove down utilisation levels and cement prices.

Improvement in utilisation levels would only be visible once demand CAGR surpassed supply CAGR on a sustainable basis, which looks difficult in the near term, according to a report by Equirus Securities. “Pricing power won’t come to the industry in a hurry, but some geographical pockets are likely to do better than the rest of the country,” adds the Equirus report.

Industry utilisation levels set to improve
Cement firms will command better pricing power only after the improvement.

Source: Equirus Securities

Meanwhile, demand continues to remain a dampener, with sales growth for the October-December quarter expected to come in flat at 1% y-o-y. But analysts expect demand revival in the coming months on the back of increased government spending on infrastructure. Strong follow through by the government on its proposal to invest Rs 102 lakh crore in infra projects will fuel cement demand. The continued focus on low cost housing will also support cement absorption.

Construction under PMAY-U and PMAY-G is expected to generate 80-85mt of cement demand over the next 1.5-2 years. “We expect demand to improve from late second half of the financial year 2019-20 and further recover in financial year 2020-2021 led by the government’s continued focus on infra and a possible recovery in individual housing, particularly at rural level,” the Equirus report adds.

Amid the demand woes, continued easing in input costs is providing support to margins. Domestic pet coke prices have corrected sharply in the past one year. This should aid margins of cement firms with a lag of 3-6 months. “There should be an additional cost reduction in the last quarter of financial year 2019-20 as companies keep 2-3 months of fuel inventory. This will delay the full absorption of lower petcoke cost in the third quarter,” mentions a Motilal Oswal report.

Given the gradual price recovery and likely uptick in demand, analysts are positive on the prospects of select cement firms with heavy presence in the Northern and Central belts of the country. “Prices in North and Central regions should continue to perform better given their best utilisation outlook (>80%) even in a limited demand growth environment. We prefer companies with higher exposure to these regions, as they are moving down the cost curve and provide valuation comfort,” says the Motilal Oswal report. Equirus offers a similar perspective. “We expect demand -supply dynamics to be more favourable in India’s Northern and Central regions. Therefore, we prefer companies with relatively higher exposure to these regions, balance-sheet discipline and reasonable valuation upside,” it says. UltraTech Cement, Shree Cement and JK Cement are prominent players in these regions. Dalmia Bharat, India Cement, ACC, Ambuja and Ramco have higher presence in the South, East and West.

UltraTech Cement remains analysts’ top pick in this basket. Limited capacity additions on the anvil and improving debt position are in its favour. Apart from an ongoing 3.4 MMTPA capacity expansion in East India, the company’s focus is to sweat existing assets. Net debt of the company is expected to decline, led by limited capex spends and stronger cash flows from the ramp-up in existing capacities. Besides, the company has already started to turn around its recently acquired cement assets of Century Textiles, aided by logistics realignment and a few other cost-saving initiatives. UltraTech plans to transition from Birla Gold (cement brand of Century Textiles) to its namesake brand in most states by June this year, which should improve realisation by Rs 12-15/bag, according to Motilal Oswal.

Meanwhile, Shree Cement’s cost leadership among peers should continue to provide it competitive edge. But while its low utilisation levels give it enough headroom to capitalise on any recovery in cement demand, its premium valuations limit upside, according to Equirus Securities. JK Cement is one of the top mid cap picks from this basket.