>CEMENT SECTOR: STRUCTURAL SHIFT (MOTILAL OSWAL)

Preface: In 2007, we launched our landmark India NTD (Next Trillion Dollar) report. This report brought out a simple, yet profound, fact: it took India 60 years since independence to generate the first trillion dollar of GDP. Its next trillion dollar (NTD) would take only 5-6 years, based on 12-15% nominal GDP growth.

This NTD era spells exponential growth for several businesses which, in turn, throws up several investment themes and opportunities. Since our first NTD report, we have captured such ideas in an "NTD Thematic" series. We already see the NTD opportunity playing out in Gas and in Consumer non-durables.

We now release a TRILOGY of reports - Cement, Construction and Engineering - all of which offer a play on the India NTD theme.

We have lined up many more NTD Thematics in 2010. Stay tuned!

■ Cement demand to enter new growth trajectory: Driven by a structural shift in demand drivers, the cement industry is at an inflection point as growth trajectory is estimated to shift upwards from its historical average of 8% to 10-12% over 5 years. Higher cement consumption (~1.5x from 1.25x of real GDP growth) is expected in the next trillion dollar (NTD) phase of GDP. We believe all ingredients are in place for the cement industry to move from a cyclical to a secular growth story.

■ Capacity utilization will surprise positively…: With most of the capacity addition expected to be operational by FY11, we estimate the industry's capacity utilization will bottom out by 2HFY11. With strong demand growth, excess capacity is expected to be absorbed faster by FY12. This will lay a solid foundation for the next growth phase as no major capacity additions have been planned beyond FY12. We estimate capacity utilization will bottom-out at 75% in 2QFY11 against 71% in 2QFY02 (the previous cycle).

■ …leading to positive surprise on pricing, profitability…: Given strong volume growth (10-12% v/s flat in FY01) and higher consolidation (the top 5 groups control 56% of capacity v/s 48% in FY01) will result in better operating parameters than in previous cycles. Hence, we anticipate the return of pricing power to the industry by 2HFY12 for a longer period, supported by strong secular demand growth and higher consolidation in the industry. A decline in average cement prices will be lower and operating margins (26% in FY11 v/s 13% in FY03) will be higher than the trough of the previous cycle.

■ …driving sector re-rating: Strong secular growth, higher consolidation and a stronger balance sheet would act as a catalyst for re-rating of the cement sector. We estimate cement stocks will bottom-out at higher valuations (than pervious cycles) over the next 2-3 quarters as cement prices remain volatile due to the impact of new capacities. However, a structural shift would be the key driver of premium valuations in the next upcycle. Cement stock valuations are attractive and offer a good entry point for the next upcycle. We prefer companies offering strong volume growth, cost saving possibilities and a strong balance sheet. Among large cap stocks, ACC and UltraTech are our top picks and we prefer Birla Corp, India Cement and Shree Cement among mid-caps.

To read the full report: CEMENT SECTOR