In this article we shall take a look at how the industry has fared in the past two years when India's GDP was growing at a robust pace and the slowdown witnessed during 1QFY09 led by rising inflation.
In the past two years, the cement industry witnessed one of the best times since inception. As cement tracks GDP growth, the sector is impacted by ups and downs of the economic cycles. On an average the cement demand in the past two years grew at the rate of over 10% annually led by strong growth in GDP. The cement producers in order to cater to the rising demand hurried to ramp up capacity and hence production in order to meet demand from various regions in the country. Meanwhile, cement manufacturers had a field day on account of firm realisations (supply barely matched demand), which was boosted by the real estate and housing boom witnessed within the economy. Not only cement but also major commodities that constitute the wholesale and consumer price index witnessed a similar situation. This led to a general rise in price level. Inflationary situation witnessed in the economy of late, coupled with slowdown in housing loan disbursement on account of tight scrutiny by banks has cooled off the demand for the commodity. The same is reflected by the adjacent chart. The average rate of growth in demand in FY07 that hovered in the range of 12% to 15% has moderated to around 7% both in FY08 and 1QFY09.
EBITDA margins (%)
In FY08, while production and consumption stood at nearly 167 MT the industry capacity was scaled up by 14 MT to nearly 190 MTPA. On one hand the growth in despatches has decelerated, on the other hand capacities have started coming on stream. The impact of the same was reflected in 1QFY09. In quarter, few of the companies witnessed a fall in realisations on a per tonne basis as compared to the same period last year as the government had imposed a ban on cement price hike to curtail inflation and the planned capacities that commenced operations exerted downward pressure on realisations. The table indicates the performance of the cement companies under our coverage namely ACC, Ambuja Cements, Shree Cement, Madras Cements and Ultratech Cement. The topline growth of 11% has been the result of subdued growth in volumes (4% YoY) and realisations (6.6% YoY). One must also note that the growth in volumes came in lower on account of companies catering to the western region having been impacted by the sociopolitical issues during the quarter, which restricted the movement of goods. The operating costs grew at a much faster rate as compared to growth in topline resulting in a nearly 6% contraction in EBITDA margins.
However, the bulk of the planned capacities are expected to commence operations during CY09 as against earlier expectations of FY09, which has provided temporary relief to cement manufacturers. Further, the second half of the fiscal year is generally considered as the peak period as construction activity is in full swing. Moreover, as the temporary ban on cement price hike imposed in the recent past came to an end last week, cement companies have indicated an increase in prices as they have been witnessing pressure on the input front. The price hike planned by the companies will enable them to off set hike cost pressures to some extent and help sustain margins. While in the short term the companies might be able to sustain margins, from a medium perspective the upcoming capacities will result in supply outstripping demand putting downward pressure on margins.
We value cement companies based on enterprise value per tonne basis as we believe that commodity stocks should be valued at their replacement cost. It is the likely price at which one would be interested in acquiring the cement company. To set up a cement plant of 1 MT an investment of Rs 3,500 per tonne is required. On this premise we feel cement companies should not trade at a high premium to their replacement costs.
Out of the cement companies under our coverage, we value the major players with well established distribution reach and ability to face the downside pressures (reflected by the past performance during the times of boom and slowdown) in the range of Rs 3,500 to 4,200 per tonne. On the other hand, regional players who are more likely to be hurt by the cyclical trough have been valued to at a discount to the replacement cost. Thus, we have valued such companies in a band of Rs 3,080 to Rs 3,850 per tonne.
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