Cement - Done & Dusted? Not Yet - Karvy

Industry's profitability deteriorated to multi-year low during 2QFY14: The industry's EBITDA almost halved YoY driven by weak demand during one of the best monsoons witnessed in last 20 years. Cement sales rose a 6% YoY (down 8% QoQ) while cement prices dipped 3% QoQ (down 7% YoY).

Infrastructure execution remains uncertain; rural pick up on good monsoon can lead to demand growth: Over the last two years, infrastructure project execution has been declining continuously and projects being shelved have risen at an alarming rate. This in turn slowed down cement consumption to ~6% CAGR during FY11-13 vs 8-10% earlier. This along-with poor monsoon in FY13 should further decelerate FY14E cement demand growth to 5% YoY. Sand non-availability across various parts of India is increasingly becoming a bottleneck thereby slowing down cement demand. Going forward, we expect the 2HFY14E/FY15E cement demand growth rate to be better than 1HFY14E which was further impacted by timely arrival of monsoon this year (and one of the best in last 2 decades). As a good monsoon has historically boosted rural cash flow in the subsequent year, we expect overall cement demand to improve from 4QFY14E onwards – driven by higher demand from rural parts of India & tier-2/3 cities. This along-with an expected recovery in infrastructure projects going forward, we expect cement demand to improve to 7.5% CAGR in FY15-16E.

Rising competition, cost pressure has further strained the balance sheets: Ongoing capacity expansion at ~7% CAGR during FY13-16E period would result in industry utilization to remain subdued at ~73% (one of the lowest level in last 25 years!). As most of these expansions are from new/smaller players, competitive pressure amid weak demand has strained the industry's working capital (higher receivables days & loans/advances. Rising input costs & depreciating INR also led to rise in companies' inventory levels. Weakening of the industry fundamentals should result in rise in new capex deferment as well as exit from this business by non-serious companies.

The storm seems over but headwind persists; Outlook cautious: While the worst period for the industry seems over for now, we expect the industry's EBITDA to continue to decline in 3QFY14 albeit at a slower pace of ~10%YoY. As per our channel check, cement consumption has not firmed up significantly in 3QFY14 even though it has improved QoQ (seasonal impact). Cement demand need to firm up from 4QFY14 onwards for the industry to pass on rising cost pressure and to deliver EBITDA growth after a gap of six quarters. Hence, we remain cautious on the sector. We maintain our "SELL" recommendations on ACC, Ambuja, India Cements and JK Cements. We recommend "BUY" on dips UltraTech, Shree Cement & JK Lakshmi Cement which have consistently outperformed the industry on operational parameters as well as their balance sheets have been less impacted during the on-going demand weakness. We have a "HOLD" recommend on Ramco Cements – whose poor 1HFY14 profitability has severely strained its balance sheet & FY14E return ratios.

Source : Equity Bulls

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