Motilal Oswal has come out with its report on cement sector. The research firm expects strong earnings growth to drive stock performance, hereon. They prefer Ambuja Cement and UltraTech / Grasim among large-caps, andShree Cement among mid-caps.
1QFY13 numbers decipher more positives, no negatives-The cement majors have reported strong numbers for 1QFY13 (EBITDA 9-18% ahead of estimates), amidst a mixed bag of expectations improvement in operations coupled with regulatory concerns post the adverse verdict by the Competition Commission of India (CCI). The robust performance is attributable to (1) strong QoQ improvement in realizations (6-8%), and (2) in-line volumes and cost push (which has been showing signs of stabilization). Given our positive outlook, we have upgraded our earnings estimates (4-11% for ACC, Ambuja and UltraTech), backed by 10-12% upward revision in realization assumptions.
Favorable trends portend further upgrades- We expect stabilization in costs, driven by (1) declining prices of imported coal, (2) stabilization in freights, and (3) improving operating leverage, backed by higher utilization. Realizations are likely to remain healthy, even over seasonally weak periods, with only a moderate dip. Though we have significantly upgraded our realization estimates (10-12%), we see further upsides, as (1) implied realizations for FY13/FY14 are within 2-3% range of 1QFY13 levels, and (2) for new capacities to be viable (based on 15% CRoIC), realizations need to be ~12% higher than the current cement prices. Based on our current estimates, the large-cap cement companies are trading at historical average valuations (EV of ~8x FY14E EBITDA). While consensus estimates are upto 17% lower than our estimates, we expect meaningful upgrades in the same with positive outlook on price resilience, which should drive valuations.
Worst behind; expect gradual improvement- We believe that the worst is behind for the cement industry. We expect gradual and consistent improvement in capacity utilization and operating performance. Longterm demand drivers remain in place. After the recent outperformance, cement stocks are trading at historical average valuations, leaving limited room for further re-rating. We expect strong earnings growth to drive stock performance, hereon. We prefer Ambuja Cement and UltraTech/Grasim among large-caps, and Shree Cement among mid-caps.
Government intervention- key risk: Any intervention by the government to curb cement prices is a key risk for the industry. In the past, the government has intervened (driven by the then Finance Minister, Mr P Chidambaram) in free pricing of cement to curb inflation. This had severely impacted operating performance of the cement companies and their stock prices.
Valuations: The worst is behind for the cement industry. We expect gradual and consistent improvement in capacity utilization and operating performance. Long-term demand drivers remain in place. After the recent outperformance, cement stocks are trading at historical average valuations. We expect strong earnings growth to drive stock performance, hereon. We prefer Ambuja Cement and UltraTech/Grasim among large-caps, and Shree Cement among mid-caps.
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