>Indian Cement Sector (ICICI Direct)

Near term macros improve…

With softening interest rates, sharp correction in coal and petcoke prices and firming up of cement prices due to strong demand, we believe the near term macroeconomic conditions for the cement industry have improved significantly. We believe that due to healthier balance sheets, moderate consolidation, use of more cost efficient technology and change in the macro environment over the last two quarters cement players will be better off compared to the earlier
down cycle. We are initiating coverage on the cement sector with a positive view on Shree Cement, Orient Paper, JK Cement and UltraTech Cement, neutral on India Cement and negative view on ACC, Ambuja and Dalmia Cement.

■ Demand growth accelerates
After reporting cement dispatch growth of merely 6.7% in the first seven months of FY09 (April-October ’08), cement growth has accelerated to 10.5% in November ’08-March ’09. We believe the Indian cement industry will continue to grow by 1.2x GDP growth in FY10.

■ Oversupply is inevitable
About 62 million tonnes (MT) of cement capacity is scheduled to come on stream by the end of FY10. We expect the capacity utilisation of the industry to drop from 88% in FY09 and further to
79% in FY10. Thus, cement prices are likely to come under pressure with the beginning of the monsoon season.

■ Subsiding cost pressure to cushion margins in near term
A 4% cut in excise duty, sharp correction in imported coal, petcoke and crude prices by 67.8%, 49% and 66% respectively from their peak levels have reduced cost pressures for the cement industry.Apart from this, softening of interest rates would reduce the interest burden of smaller cement players, who have funded their capex by debt and cushion their PAT margins. However, we believe that in the long run, the demand-supply situation will force cement players
to cut prices and pass on the benefits.

■ Recommendation
Some of the cement stocks are currently trading at valuations lower than the value given to loss making cement companies in the last 10 years. This is despite the fact that replacement cost for cement companies has increased significantly over the last decade. We believe that long-term value has emerged in select cement stocks. We also believe that companies that have completed a majority of their capacity addition, undertaken cost cutting measures or have
low cost structure with lower earning sensitivity to price declines will be better off compared to their peers. Timely capacity addition will reduce the payback period while a low cost structure will enable them to cut prices and push volumes in a down cycle. We prefer UltraTech Cement among large caps, Shree Cement in the mid cap space and JK Cement and Orient Paper in small caps.

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