Sep 4, 2006|
Cement: Nothing concrete about it!
'Given the infrastructure boom in the country, we are positive on the cement sector', this statement has become quite popular with a lot of fund managers and other prominent investors alike. Indeed, with cement prices touching record highs, most of the sector stocks have had a fantastic run in recent times. But to expect these companies to give the same magnitude of returns year after year can prove to be a risky proposition.
For one, these companies are currently trading well above their fair value and secondly, with substantial capacity being added over the next few years, cement prices might come under pressure. As per industry estimates, it does not take more than US$ 100 m to set up a 1 MT green-field cement capacity. However, as indicated in the chart below, most of the cement companies are trading well above the US$ 100 per tonne mark, thus leaving little room for further price appreciation. Although smaller players appear cheap as compared to larger players, it should be borne in mind that cement is an industry where economies of scale rules. Hence, it wont be long before these players start bleeding once prices fall. In fact, quite a few players have just come out of restructuring phase but have still attracted investors owing to the general positive sentiment towards the sector.
According to estimates, as much as 76 MT of capacity are likely to be added by 2010. The sector has never witnessed capacity addition on such a large scale before this and it is likely to put downward pressure on prices. While demand in a developing region like India follows a secular pattern, supply increase always comes in spurts and this skews the demand-supply equation. The memories of the year 2002 will still be fresh in the minds of the industry players, as this was the year when close to 20 MT were added in just one year. Even a company like Gujarat Ambuja witnessed a 450 basis points decline in operating margins. A repeat of 2002 thus cannot be ruled out (though not in the near term).
While we remain positive on the long-term demand for cement in the country, current valuations seem to have factored in the medium-term growth. Moreover, the recent capex frenzy has raised an additional alarm. Hence, we would advise investors to certainly exercise caution.
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