HDFC Securities’ report on Indian cement sector

HDFC Securities’ report on Indian cement sector
Published: 18 November 2008

We remain negative on the Cement Industry due to
a) addition of new capacities which will result in under-utilisation of new as well as existing capacities
b) addition of new capacities which will weaken the pricing power of manufacturers
c) government’s negative attitude towards the industry from the beginning of the year 2007
d) increase in operating costs resulting in lower margins in a scenario where it will be difficult for the manufacturers to pass on the cost hikes
e) slowdown in real estate and construction activities resulting in lower demand growth. Cement demand grew by 7.7 per cent for the period April–Sep 08 against a 10 per cent growth during the same period last year. We expect the demand to grow in the region of 8-8.5 per cent during FY09E and FY10E, which will bring down the effective capacity utilization of the industry to 80 and 74 per cent during FY09E and FY10E respectively. We expect retail prices of cement to fall by the end of FY09 due to the addition of new capacities.

During the quarter under review, operating profit of the companies under our coverage was under pressure due to
a) increase in raw material costs
b) increase in power & fuel costs mainly because of increase in International coal prices
c) increase in freight costs because of increase in diesel prices in the month of June 2008 and
d) increase in other expenses. We don’t expect the companies dependent on imported coal to benefit from the correction in International coal prices in next two quarters, as the correction in coal prices has partially been offset by rupee depreciation.

Our top pick in the sector is Shree Cement, followed by Ultratech and India Cements. We like Shree Cement due to
a) its timely capacity addition in FY08 as the company increased its production capacity by 2Mta. It is enjoying the benefits in this year itself
b) It will enjoy the benefits of correction in Pet Coke prices, which has corrected by 12 per cent to INR7000/t from its peak level
c) the company has one of the best operating efficiencies in the industry
d) It is the only company under our coverage where we expect a positive Earnings CAGR (12.9 per cent) over the period FY08-FY10E.