On a comeback trail

Post demonetisation, mid-cap cement stocks look poised to recover lost ground

As the cement demand shows signs of recovery post demonetisation, analysts feel that mid-cap cement stocks offer a good investment opportunity.

The valuations of mid-cap stocks have perennially been under the overhang of their debt burden, but if analysts are to be believed, this could be changing. The likes of JK Cement, JK Lakshmi Cement, Heidelberg Cement, The India Cements and Mangalam Cement together have a combined debt of Rs.10,311 crore. Debt repayment for most mid-caps is likely to accelerate in Q1FY18 as the sector sees improved cash generation. This will be the key driver behind re-rating. For instance, analysts expect the gearing levels of JK Cement to improve from 2x in FY17 to 1.7x in FY19 and the Ebitda margin to improve from 18% in FY17 to 20% in FY19.

Vaibhav Agarwal, analyst at Phillip Capital, in a client note states that cement stocks are likely to deliver a positive earnings surprise in Q1FY18 driven by price hikes. “The sector Ebitda/tonne is likely to improve by 15-20% YoY in Q1FY17,” he says. Cement prices have been raised across regions by about 10%.

Some of the cement players are also seeing improvement in volumes. For instance, the Kolkata-based Mangalam Cement reported a better than expected volume growth of 15.3% in Q4FY17. Analysts expect an average growth of 11% every year in volumes over FY17-FY19 driven by further ramp-up in its newly commissioned Aligarh plant. Capacity additions have pushed up JK Lakshmi Cement’s capacity to 13 million tonne from 10.2 million tonne, which will result in higher volumes in the coming quarters.

Despite the recent run-up (see: Concrete gains), the stocks are still available at attractive valuations. The pack of mid-cap stocks are trading in the range of 10.5x to 15x EV/Ebitda on a one-year forward basis. Meanwhile, large-cap cement names (ACC, Ambuja, Shree Cement, Ultratech) are trading 20x-24x.

According to Ravi Sodah, cement analyst at Elara Securities, the companies catering to demand in northern and central part of India (Heidelberg, JK Lakshmi, JK Cements and Mangalam) are likely to do better as pricing and demand in these regions are seeing an improvement. The cement demand growth is expected to increase from 2% in FY17, to 7% in FY18, to 8% in FY19.

Agarwal of Phillip Capital says that the largest player in the cement sector trades at per tonne valuation of about $200 while most mid-caps trade at $70-$120. He adds that as the scenario turns favourable and as mid-caps get rid of debt faster than expected, this valuation gap could narrow, to say about 25% discount to large-caps.