>India Cement Sector (CITI)

Sell: Great Climb; Precipice, or a Controlled Descent?*

■ Climbers dream — India’s Cement stocks have moved strongly, rising 36% since January 2009 (18% outperformance relative to Sensex) on the back of: a) Logistics pressures – wagon shortages on General Election compulsions, b) Demand pick up – in-spite of broader market pressures, c) Supply snags – mix of capacity delays and unplanned shutdowns, and resultant d) Cement price momentum – up 5-15% ytd, against odds and expectations. These are all real, but possibly ephemeral, stock value enhancers.

■ At the precipice, or a controlled descent? — We believe cement prices, profitability, and stock values will all fall and it’s only in the pace of these falls (more likely off the precipice) that our conviction is modest. It’s the over-supply hypothesis, with40% new supply during FY08-11E, ~1.3x the demand growth, and while there is skepticism on capacities coming on stream the capacity bunching up risk only rises. A demand surge is the only safety net to what lies ahead in our view.

■ At a higher altitude — The cement prices hike, even sharper cost dips, coal price collapse, robust demand levels, and the sheer operating leverage of cement businesses means that cement is likely to be more profitable than we previously estimated. Towards this end, we raise estimates meaningfully, by 42-116% over FY10-FY11E. Further price deceleration (-21% from current level to December 2010E), or demand drops (CIRA estimate +9-10%), are potential pressure points.

■ Downside from here, we remain sellers — While valuations appear attractive given earnings upgrades, we see FY10E as peak earnings (FY11E the collapse year). We value the stocks at 4.2-6.3x Sept-10 EV/EBITDA (vs. 4.5-7x Sept-09) and raise TPs by 26-52%. We see biggest downside in Grasim, and the least in ULTC.

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