Trend

Concrete love

While investors are enamoured, analysts feel valuations are looking stretched

Cement stocks are on a roll. If last year large caps such as Ambuja Cement, ACC and Ultratech Cement did well, year-till-date the entire cement universe  has, on average, gained 40% compared with 16% gain for the benchmark Sensex.

What then is driving this outperformance? Quite simply, demand has been robust for sometime now. For the first nine months of FY12, demand grew 7% on a year on year (y-o-y) basis, led chiefly by a consumption spike in western and northern India. During April-December 2011, consumption grew by 17%, 10% and 8% in the north, central and eastern regions, respectively. The southern region, which had been posting a decline in demand over the past six quarters, too showed signs of recovery with 3.2% y-o-y growth, aided by easing of the Telangana agitation.

Demand in the western region was boosted by improved offtake from state-sponsored infrastructure projects and individual housing segment. Not surprisingly, the cement industry’s capacity utilisation during the same period rose to 82%, up from 80% during the same period last year. Going ahead, the rate of capacity addition is expected to moderate, with only 31 mtpa of capacity expected to be added by FY13, much lower than the 55 mtpa added till FY11.

Varun Sharma, analyst at ICICI Securities, believes investors are bullish on the sector because the worst is over. “As an investor, you would want to invest in the upcycle and not in a downcycle. Price action seems to indicate that we are past the inflection point.”

In fact, for the just concluded third quarter, cement companies’ operating profit margin (OPM) rose by 267 basis points y-o-y to 21.6%, with all companies seeing an OPM expansion in the range of 100 to 1,350 basis points on a y-o-y basis. This is despite power and fuel costs rising by 11% and freight costs rising by 12.5%, on average.

But for now, analysts believe the stocks have run ahead of fundamentals. Analysts point out that the cement sector’s valuations in terms of EV/sales and EV/tonne are trading ahead of the cycle compared with utilisation levels. Stocks are 40% more expensive than historical valuations during periods of similar utilisation levels, they point out. Sharma, too, believes that stocks could be subdued for a few months. “Over the next two quarters, returns will be in line with the Sensex as in the monsoon quarter demand will be lower.”