>CEMENT SECTOR: Demand strong but price headwinds imminent (RELIGARE SECURITIES)

Cement dispatches have been robust in H2FY10 on account of higher government expenditure on infrastructure and steady rural consumption. We expect demand to hold firm, particularly in India’s northern market, with a growth of over 10% in the next two years. On the flip side, our analysis suggests that cement overcapacity is imminent in the medium term. This together with rising coal and freight costs signals a challenging road ahead in FY11. With the southern market at greatest risk of a supply glut, we maintain our preference for north-based players like Grasim Industries, Jaiprakash Associates and Shree Cement.

Mid caps register strong volume growth in Jan: Mid cap companies in the RHH cement universe led the way in terms of dispatch growth for January ’10. While India Cements’ volumes grew 30% YoY, JK Lakshmi Cement registered an increase of 27%. Orient Paper, Shree Cement and Birla Corp also logged strong growth rates of 20%, 18%, and 16% YoY respectively. Mangalam Cement was the only player in our universe to witness a decline, with volumes slipping 16% YoY due to a five-day maintenance shutdown at its plant.

Amongst large caps, the Aditya Birla group (Grasim and UltraTech) continued to outpace Holcim (ACC and Ambuja Cement). YTD, Shree Cement and Grasim were in the lead with volumes rising 24% and 20% respectively.

Demand to grow at 10%+ for next two years: With cement dispatches picking up over the last three months, we expect to close FY10 with demand growth of over 11%. Further, with the sustained government thrust on infrastructure spending and a revival in the real estate sector, demand for cement could exceed the traditional correlation range of 1.2–1.3x GDP to touch 1.4–1.45x in FY11 and FY12.

Price recovery in Q4 may be short-lived: After declining by Rs 15–80/bag in Q3FY10, cement prices have partially recovered (in the range of Rs 10–40/bag) on account of buoyant demand and logistics-related supply shortages. The price hikes have been spread across regions, barring the south. However, with a large quantum of fresh capacities set to be commissioned in FY11 (30mn tonnes), we expect pricing power to deteriorate post May’10.

Likely rollback of excise cut: Budget 2010 is likely to see a rollback of the excise duty cut from 8% to 10%. Railway freight could also increase. We believe cement players will pass on the duty hike by raising prices in the near term. Over the longer term, however, cost rationalisation will be the key to preserving profitability.

FY11 a testing time – S. India most vulnerable: We believe FY11 will be a difficult year for the industry as the risk of oversupply looms large. The southern market would be the hardest hit as a bulk of the planned capacities will be commissioned here (53% and 23% of all-India fresh capacity in FY10 and FY11 respectively). This coupled with a demand slowdown due to political turmoil in Andhra Pradesh (AP) makes it the most vulnerable to pricing headwinds. While the northern, central and eastern markets will also face pressures brought on by capacity expansion, buoyant demand in these regions is likely to mitigate the supply glut.

All roads head north: For the next six months at least, cement will continue to be a regional play. While demand remains strong in the north, the central and eastern areas are seeing the highest price hikes. We remain bullish on select companies based in these regions, namely Grasim, Jaiprakash Associates and Shree Cement in the large cap space and Birla Corp, JK Lakshmi and Mangalam Cement in mid caps. On the other hand, as the south moves into an oversupply phase and the troubled state of AP continues to weigh down demand, we remain bearish on India Cements.

To read the full report: CEMENT SECTOR