Given the current conditions of low volume growth and margin compression, we have a negative outlook on the cement sector.
We have revised our estimates and target P/E multiple downward for certain companies in our cement universe where we see a higher risk to earnings. All cement companies under our coverage are trading at a significant discount to replacement cost.
While the current replacement cost is $130/tonne, our large-cap universe is trading in the range of $60–75. We believe M&A activity could be a potential trigger to narrowing this discount.
We believe the cement sector would witness a situation of oversupply in the next two years as most companies are in the midst of large capacity expansion programmes.
Supply is projected to increase by 9% and 28% in FY09 and FY10 respectively, much ahead of demand, with the northern and southern regions experiencing the highest surplus levels. Companies from the RHH cement universe are more susceptible to a drop in cement prices than a drop in volume sales.
We expect JK Lakshmi Cement, Mangalam Cement and ACC to witness a higher impact on earnings than other companies in the event of lower-than-anticipated realizations.
Owing to their diversified lines of business, Grasim and Orient Paper’s earnings would show less volatility.
In regards to a volume drop, JK Lakshmi and Birla Corporation would witness the sharpest decline in EPS, whereas Grasim and UltraTech would take the least hit.