Cement stocks under IIFL Securities’ coverage have corrected by 30-40% (excluding ACC, Ambuja) given concerns over: i) sustained cost pressure, ii) Adani’s cement foray, leading to increased competition in the sector, and iii) step jump in new capacities by incumbents to maintain capacity-share. Although, impact of the last two would be seen only over time, higher costs have led to a 15-20% cut in the last 6 months (for both, IIFL/Consensus) in FY23/FY24 EBITDA estimates. Valuations too have corrected from the peak, by 30-35%, and large-caps are now trading at a marginal discount to the long-term average.
Analysts at IIFL Securities believe that in the near term, stocks would remain under pressure as we enter a seasonally lean period; but any news flow on cost easing or cement price hikes will trigger a re-rating. Given the uncertain macro, IIFL Securities prefers stocks with a higher safety margin.
Key rating changes
· Upgraded JK Cement to BUY from Add
· Changed recommendation on Ambuja Cement to ADD from Buy
Top sector-picks: UltratTech Cement, ACC, JK Cement, Dalmia Bharat and JK Lakshmi
Negative rating: Shree Cement, The Ramco Cement and India Cement
Near-term profitability to remain under pressure
Fuel-cost inflation has sustained longer than initial expectations; the Russia-Ukraine war has again pushed up fuel prices. Domestic pet coke prices are up 55% since February 2022, while Indonesian coal prices are up 78%.
Companies are trying to cushion the cost impact by increasing usage of alternate fuels. Analysts at IIFL Securities estimate operating cost to rise by Rs350-400/t, which is 8-10% of the Q4 costs. With fuel prices remaining elevated even in June 2022, cost pressures would sustain till Q2FY22 at least. Their latest dealer-checks suggest that despite the cost pressures, cement prices have corrected from mid-May – all-India prices are down 4% in the past month. Moderation in demand due to inflationary pressures and increasing competitive intensity to garner volumes is pushing down cement prices. In base case, they build-in a 10% YoY drop in sector EBITDA/t to Rs1,026 in FY23 (for the 10 companies under their coverage); it would be down 20% from the FY21 peak (benefit of low energy prices).
Adani’s foray increases perceived risk
With foray of an aggressive player like the Adani Group into the cement sector (through the acquisition of Ambuja-ACC, the second-largest player with combined capacity of 66m MT), there is uncertainty around whether Adani: i) would cut prices to increase its market-share, and ii) would expedite capacity addition much faster than the erstwhile promoter, the Holcim Group.
Analysts at IIFL Securities see lower probability of the former, given that: i) ACC Ambuja on a combined basis operates at 85-90% utilization and thus has little scope to push volumes aggressively, ii) an aggressive pricing may dilute the premium positioning of the brand in the market, and iii) Adani would fund the acquisition via significant debt (based on media reports, it would raise US$7 billion to fund the US$10 billion acquisition – assuming 100% success in the open offer) – it would require Rs800-Rs1,000/t of EBITDA to service such a debt. On new capacity addition, Adani – as mentioned in a media article − plans to increase capacity from the current 70m MT to 130m MT in 6 years, i.e. 11% CAGR which is not overly aggressive. Also, if the capacity addition is via acquisitions (another sector consolidation is likely), then net adds for the industry are likely to be lower.
Aggressive capacity adds by incumbents to weigh on sector return ratios
The risk of incumbents announcing aggressive capacity addition plans to maintain their capacity-share would eventually weigh on sector profitability and return ratios. UltraTech Cement recently announced adding 22.6m MT by FY25 (this would lead to its domestic capacity increasing from 114m MT to 153m MT, including the on-going expansion), at 10% CAGR. Even some other large players have shared their long-term plans on capacity adds; e.g. Dalmia Bharat said it targets increasing capacity to 110-130m MT in coming 10 years, from 36m MT now (12-13% CAGR); similarly, Shree Cement aims to increase capacity to 80m MT by 2030 vs. 50m Mt now (6% CAGR). In the near term (over FY22-24), analysts at IIFL Securities expect the pace of capacity additions to equate the demand growth (at ~8%) and thus see no pressure on industry utilization (~65%); however, capacity additions can outpace demand growth post FY24. In the past, when industry capacity utilization has declined from near-100% in FY08 to 64% in FY17, sector ROEs declined from the highs of 20-25% to 8-10%.
Concerns over cost and competition lead to sector de-rating
Most stocks under the coverage of IIFL Securities have declined by 30-40% from the peak seen in the last 6 months (except ACC and Ambuja Cements, which are down only 10-12%, given the open offer by Adani Group – to be completed in July 2022) as against the 16% decline in the Nifty Index. Analysts at IIFL Securities note that compared with this stock-price decline, the cut in the Bloomberg consensus EBITDA in the last 6 months is 19% for FY23 estimates and 13% for FY24 estimates. Thus, the sector has seen a de-rating in the last 6 months, given concerns over lower profitability due to elevated costs and increasing competition.
Valuations are down 30-35% from the peak of the last 6 months and stocks are now trading marginally below the long-term average.
Analysts at IIFL Securities note that 1 year-forward EV/EBITDA for large cap cement players is around 13.4x versus the long-term average of 14.3x (6-month peak of 19.6x); while on EV/t, the sector is down at US$143/MT versus long-term average of US$157/MT and the recent peak of US$217/MT.
Analysts at IIFL Securities have cut their sector EBITDA estimates for FY23 by 7% (ranging from +4% to -16%) and by 4% for FY24 (ranging from +6% to -13%). In the last 6 months, they have cut EBITDA by 16-21% versus a 13-19% cut by consensus. On revised estimates, they are lower by 7-11% versus consensus. Sustained cost pressure and inability of the companies to entirely pass-on the same has impacted profitability.