INDIA: Foreign brokerages turn positive on large-cap cement stocks

Some foreign brokerages have started favouring select large-cap cement companies due to better pricing power of the sector and attractive valuation. Nomura finds the risk-reward favourable in the large-cap cement space as stocks in this segment are trading at a discount or at par with the average trading multiple (since 2011).

Except UltraTech Cement, Ambuja and ACC, large-cap cement sector stocks have unperformed the BSE Sensex in the last two years. In contrast, mid-cap cement stocks, such as India Cements, Shree Cements, Prism Cements, The Ramco Cements and Heidelberg Cement India has significantly outperformed the benchmark in the said period.

UBS has initiated coverage on UltraTech and ACC with ‘buy’ ratings and sees an upside potential of 17-19 per cent. It has a neutral rating on Ambuja Cements.

Demand is expected to improve with rising government spending on infrastructure. Nomura pointed out that cement volume growth should improve as government spending on roads and railways accelerates.

Improving pricing power

On the other hand, supply is not set to come up soon with limited incremental capacity additions made by players on account of the slowdown. Further sharp fall in input costs (coal and diesel) will provide a tailwind to earnings. All this will lead to improving pricing power and better margin profile.

UBS estimates strong cash flows in the coming years as it expects a compounded annual growth rate of 22 per cent in operating profit between FY15 and FY17, compared with a decline witnessed during FY12-15. However, UBS has cautioned that an improvement in realisations could lag as utilisation rates would need to move beyond 70 per cent. Nevertheless, it has a positive view on the sector.

But weak Q2 likely

In the medium-term, cement companies’ fortunes will continue to be dismal due to the double whammy of absence of capex and lacklustre monsoons. According to Reliance Securities, profitability will be hurt in Q2FY16 due to subdued demand growth, pricing pressure and low utilisation. Motilal Oswal pointed out that re-rating of the sector depends on the second half.