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Equity Research

September 13, 2011 BSE Sensex: 16502

Equity Research September 13, 2011 BSE Sensex: 16502 INDIA Cement sector Foundation for the next up-cycle

INDIA

Cement sector

Foundation for the next up-cycle

Top picks

Ambuja Cement

UltraTech Cement

Reason for report: Theme report

We believe the next 12 months would lay the foundation for the next up-cycle in the Indian cement sector. Pricing power would revert, as utilisation is expected to

bottom out at ~74% in FY12E and then gradually increase to 78% by FY14E. Our

demand-supply analysis factors ~8% CAGR in effective supply and demand over

FY11-14E (versus 17% CAGR in effective supply and 8% CAGR in demand over FY08-11). Utilisation is unlikely to fall below 74% over FY12-14E even if one assumes ~6% CAGR in demand, implying that the worst for the sector could be behind. We re-iterate our anti-consensus positive stance on cement stocks in spite of their ~20% YoY outperformance. We believe that the earnings could surprise and the sector could re-rate with the revival of pricing power. Our FY12- 13E EBITDA / EPS are 3-16% ahead of consensus and we expect upgrades in consensus estimates. We prefer pure-play cement companies with minimum exposure to South and maximum pricing leverage. Ambuja Cements (ACEM) with no presence in South and UltraTech Cement (UTCL) with ~25% exposure to South and enjoying maximum pricing leverage are our top picks.

Demand likely to improve given: i) low base effect of FY11 / H1FY12; ii) better rural housing demand; iii) forthcoming elections in few large states / the Centre over CY12-14E and iv) gradual pick-up in Government infrastructure spend. Historically, cement demand has grown ~1.2x real GDP growth except as recent as in FY11 / H1FY12. With India’s GDP still expected to maintain growth of +7-7.5% (factoring in slowdown from 8.5-9% growth), cement demand growth of +8-9% (which is also historical long-term average) over FY12-14E seems achievable.

Pace of supply to decelerate. Around 93mnte capacity got added over FY10-11. However, lesser 50mnte are expected over FY12-14E. North and West regions would witness only 6mnte and 3mnte effective incremental supply over FY12-14E resulting in 700-800bps uptick in utilisation.

Pricing power to revert as utilisations bottom out in FY12E. Utilisation in South is likely to remain at ~60% over FY12-14E. Hence, cement companies in South would be compelled to maintain production cuts and pricing discipline. We expect prices to inch up in rest of the regions (maximum uptick in North and West) on improved utilisation over FY12-14E. While we factor in ~5% CAGR in average cement realisations over FY12-14E, we build in 50-100bps increase in FY12-13E EBITDA margins, which would be achieved merely by increased cost efficiencies.

Companies better placed with strong balance sheet, healthy cashflow generation and higher regional concentration, leading to better pricing discipline. Top 5 companies enjoy ~69-86% market share in their respective regions excluding South.

Key risks are lower demand, fragile pricing in South and regulatory intervention.

Krupal Maniar, CFA

krupal.maniar@icicisecurities.com +91 22 6637 7254

Varun Sharma

varun.sharma@icicisecurities.com +91 22 6637 7180

Company

Mcap

Reco

CMP

TP

P/E (x)

EV/EBITDA (x)

P/B (x)

(US$bn)

(Rs)

(Rs)

FY12E

FY13E

FY12E

FY13E

FY12E

FY13E

ACC*

4.1

BUY

1,030

1,160

16.6

13.9

8.7

6.9

2.8

2.5

Ambuja*

4.7

BUY

145

162

16.6

14.4

9.4

7.9

2.7

2.4

Grasim

4.2

BUY

2,166

2,750

8.1

7.3

4.0

3.5

1.2

1.1

UltraTech

6.4

BUY

1,100

1,235

14.1

12.0

7.9

6.9

2.4

2.0

Jaiprakash^

2.9

BUY

65

80

17.5

14.9

9.9

8.9

1.4

1.2

Shree

1.2

BUY

1,562

2,000

20.6

12.2

5.3

4.5

2.5

2.1

* December year ending CY11E and CY12E; ^ Standalone

Please refer to important disclosures at the end of this report

Cement sector, September 13, 2011

ICICI Securities

TABLE OF CONTENTS

Investment rationale

 

3

Pace of supply to decelerate

3

Capacity utilisation to bottom at ~74% in FY12E

3

Pricing power would return by H2FY13E

5

Cement remains a regional play

7

Demand to regain strength

 

12

Likely reversion to historical correlation with GDP

12

Elections in few large states

 

13

Housing still remains the largest demand contributor

14

Gradual pick-up in Government infrastructure spend

16

Better placed than earlier down-cycle

20

High degree of concentration in most regions

20

Companies focusing on absolute higher EBITDA

21

Eye on consolidation in the industry

23

Key

risks

24

Valuation: Sector likely to get re-rated

25

Sensitivity analysis

 

27

Annexure 1: Capacity addition – Schedule

29

Annexure

2:

Regional

capacity additions

31

Annexure 3: Index of Tables and Charts

32

Companies

 

ACC Ambuja Cements (ACEM) Grasim Jaiprakash Associates (JPA) Shree Cement UltraTech Cement (UTCL)

 

33

37

43

49

53

59

Prices and Sensex as on September 12, ’11

Cement sector, September 13, 2011

ICICI Securities

Investment rationale Pace of supply to decelerate

We expect the pace of capacity addition to come down over FY12-14E. Where FY10 and FY11 witnessed capacity addition of ~93mnte, this is expected to drop to 50mnte in FY12-14E. Though many companies are gearing up for their next phase of expansion (with most expected to announce their plans over the next six-nine months), the proposed capacities are not expected to be commissioned before FY15E. Our demand-supply analysis factors in ~8% CAGR in both effective supply and demand over FY12-14E (versus 17% CAGR in effective supply and 8% CAGR in demand over FY08-11).

Capacity utilisation to bottom at ~74% in FY12E

We continue to believe that supply would be staggered over the longer period, whereas demand is expected to revive, thereby lowering the quantum of oversupply. Surplus effective capacity is expected to peak in FY12E. All-India effective utilisation in FY12E is likely to bottom out at ~74% and then gradually increase to ~78% by FY14E. None of the top 10 cements companies (except Jaiprakash Associates), constituting more than 2/3 rd of the industry capacity, would be adding any capacitiy over the next two years.

Table 1: Cement supply / demand industry outlook

(mnte)

 

FY10

FY11

FY12E

FY13E

FY14E

Year-end installed capacity Actual- effective capacity Domestic consumption Export (cement + clinker) Domestic consumption + exports Surplus / (Deficit) % surplus - wrt effective capacity Capacity utilisations Average price Change in average price (%) Capacity growth (%) Domestic growth (%) Domestic + exports growth (%)

270

305

320

342

355

239

275

306

325

346

198

209

222

242

264

5.3

5.3

4.5

4.9

5.4

203

214

227

247

269

36

62

79

78

77

15

22

26

24

22

85.0

77.7

74.1

76.0

77.7

247

244

260

273

286

2.8

(1.2)

6.4

5.0

5.0

17.5

15.3

11.1

6.3

6.5

11.1

5.5

6.5

9.0

9.0

10.2

5.4

6.0

9.0

9.0

Source: I-Sec Research

Chart 1: Utilisation to bottom out in FY12

95% Utilisation 90% Bottoming 85% 80% 75% 70% 65% 60% (Utilisation) Q1FY10 Q2FY10 Q3FY10 Q4FY10
95%
Utilisation
90%
Bottoming
85%
80%
75%
70%
65%
60%
(Utilisation)
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
Q2FY11
Q3FY11
Q4FY11
Q1FY12
Q2FY12E
Q3FY12E
Q4FY12E
Q1FY13E
Q2FY13E
Q3FY13E
Q4FY13E

Source: CMA, I-Sec Research

Cement sector, September 13, 2011

ICICI Securities

While we factor in ~5% CAGR in average cement realisations over FY12-14E, we build in a conservative 50-100bps increase in FY12-13E EBITDA margins, which would be achieved merely by increased cost efficiencies

Table 2: EBITDA margins in narrow range

   

EBITDA (%)

 

Company

FY10

FY11

FY12E

FY13E

ACC

29.0

19.5

19.6

20.1

ACEM

26.4

24.7

24.7

24.9

Grasim

29.0

22.0

22.1

22.5

UTCL

28.0

20.7

23.1

23.7

JPA

26.0

22.3

25.3

25.4

Shree

41.3

25.2

24.6

25.1

Source: I-Sec Research

Utilisations excluding South would be in excess of 82% in FY12E and would increase to 87% in FY14E, resulting in substantial return of pricing power in those regions.

Table 3: Utilisation ex-South to improve by ~500bps over FY12-14E

All India excluding South

FY10

FY11E

FY12E

FY13E

FY14E

Effective Capacity Despatches including exports Utilisation (%) YoY change (%) Surplus

153

176

197

208

223

139

150

162

178

194

90.8

85.4

82.4

85.4

87.1

14.3

7.8

8.3

9.4

9.1

14

26

35

30

29

Source: I-Sec Research

Even if demand grows at a CAGR of ~6%, pan-India utilisation is unlikely to fall below ~74% over FY12-14E, implying that the worst for the sector could be behind.

Table 4: Utilisation sensitivity assuming ~6% demand CAGR over FY12-14E

 

FY10

FY11

FY12E

FY13E

FY14E

Year-end installed capacity Actual- effective capacity Domestic consumption Export (cement + clinker) Domestic consumption + exports Surplus / (Deficit) % surplus - wrt effective capacity Capacity utilisations Average price Change in average price (%) Capacity growth (%) Domestic growth (%) Domestic + exports growth (%)

270

305

320

342

355

239

275

306

325

346

198

209

222

237

252

5.3

5.3

4.5

4.9

5.4

203

214

227

241

257

36

62

79

84

89

15

22

26

26

26

85.0

77.7

74.1

74.3

74.3

247

244

260

273

286

2.8

(1.2)

6.4

5.0

5.0

17.5

15.3

11.1

6.3

6.5

11.1

5.5

6.5

6.5

6.5

10.2

5.4

6.0

6.5

6.6

Source: I-Sec Research

Cement sector, September 13, 2011

ICICI Securities

Pricing power would return by H2FY13E

Cement prices are expected to inch up in H2FY12 as construction activities resume after monsoon and festive season. We are factoring in an average price increase of 6- 7% in FY12E, which is same as average trailing 12-month price increase YoY till date. The prices are expected to remain in a narrow band during H1FY13 and the real pricing power would revert by H2FY13E. We believe that the next 12 months would lay the foundation for the next up-cycle. We factor in an average price CAGR of ~5% over FY13-14E, which we believe to be conservative. We do not expect average utilisation to fall below 74% in FY12E.

Chart 2: Utilisation versus cement prices All India Avg Price per bag (RHS) Capacity Utilisation
Chart 2: Utilisation versus cement prices
All India Avg Price per bag (RHS)
Capacity Utilisation
120
300
110
280
100
260
90
80
240
70
220
60
200
50
40
180
Source: CMA, I-Sec Research
(%)
Feb-06
Jul-06
Dec-06
May-07
Oct-07
Mar-08
Aug-08
Jan-09
Jun-09
Nov-09
Apr-10
Sep-10
Feb-11
Jul-11

North and West regions would witness only 6mnte and 3mnte effective incremental supply over FY12-14E resulting in 700-800bps uptick in utilisation. Utilisation in South is likely to remain at ~60% over FY12-14E. Hence, cement companies in South would be compelled to maintain production cuts and pricing discipline. We expect prices to inch up in rest of the regions (maximum uptick in North and West) on improved utilisation over FY12-14E. Central and East regions would continue to operate at 90%+ and 85%+ utilisation.

Table 5: Region-wise realisation growth

(%)

 

North

East

South

West

Central

All India

FY09

3.4

2.7

7.7

1.8

0.2

3.8

FY10

6.8

7.9

(7.3)

(2.5)

13.4

2.8

FY11

1.8

(1.6)

(0.3)

0.0

(5.0)

(1.2)

FY12E

0.9

1.0

11.3

11.7

3.0

6.3

Source: I-Sec Research

Table 6: Company-wise realisation growth

 

(%)

 

ACC

ACEM

UTCL*

JPA

Shree

FY09

3.8

4.3

9.0

18.9

(2.4)

FY10

6.8

6.5

(0.6)

10.2

8.2

FY11

(2.6)

(2.5)

12.3

(10.2)

(7.6)

FY12E

7.4

9.0

10.3

7.0

8.0

FY13E

4.5

5.5

5.0

5.0

5.0

*Merger with Samruddhi Cement assumed w.e.f 1 st April’2010 Source: I-Sec Research

Cement sector, September 13, 2011

ICICI Securities

Chart 3: Cement price chart – Region-wise

North – Price movement

 

290

280

FY10 FY11 FY12E
FY10 FY11 FY12E
FY10 FY11 FY12E

FY10

FY10 FY11 FY12E

FY11

FY12E

270

(Rs/bag)

260

250

240

230

 

Apr

Oct

Jul

Nov

Jan

Jun

May

Dec

Sep

Aug

Feb

Mar

 

South – Price movement

 

300

FY10 FY11 FY12E
FY10
FY11
FY12E

280

260

(Rs/bag)

240

220

 

200

180

 

Apr

Oct

Jul

Nov

Jan

Jun

May

Dec

Sep

Aug

Feb

Mar

 

Central – Price movement

 

270

FY10 FY11 FY12E
FY10
FY11
FY12E

260

250

(Rs/bag)

240

230

 

220

210

200

 

Apr

Oct

Jul

Nov

Jan

Jun

May

Dec

Sep

Aug

Feb

Mar

Source: CMA, I-Sec Research

East – Price movement

 
FY10 FY11 FY12E

FY10

FY10 FY11 FY12E

FY11

FY10 FY11 FY12E

FY12E

 

280

270

  280 270

260

(Rs/bag)

250

240

230

220

 

Apr

May

Oct

Jul

Feb

Mar

Nov

Jan

Jun

Dec

Sep

Aug

 

West – Price movement

 

290

280

FY10 FY12E FY11

FY10

FY10 FY12E FY11

FY12E

FY10 FY12E FY11
FY10 FY12E FY11

FY11

270

260

(Rs/bag)

250

240

 

230

220

210

200

 

Apr

May

Oct

Jul

Feb

Mar

Nov

Jan

Jun

Dec

Sep

Aug

 

All India – Price movement

 
FY10 FY11 FY12E

FY10

FY10 FY11 FY12E

FY11

FY10 FY11 FY12E

FY12E

 

290

280

  290 280

270

260

(Rs/bag)

250

240

 

230

220

210

200

 

Apr

May

Oct

Jul

Feb

Mar

Nov

Jan

Jun

Dec

Sep

Aug

Cement sector, September 13, 2011

ICICI Securities

Cement remains a regional play

Pricing discipline continues in South; North and West to see maximum uptick in utilisation

Utilisation in South is likely to remain at sub-60% levels over FY12-14E even after factoring in the gradual recovery in demand. South would continue to remain an overhang, with surplus share of the region inching above 60% of the total domestic surplus. This increase in overcapacity share has been led by decline in cement growth in Andhra Pradesh (kudos to Telangana issue) and lackadaisical attitude of the state governments of the region towards infrastructure or housing projects. Hence, cement companies in the region would be compelled to maintain production cuts and pricing discipline.

At all-India level, the surplus is expected to come down to 22.0% in FY14E from 25.7% in FY12E due to improvements in utilisations across regions led by North and West. Hence, we expect prices to inch up in North and West, as utilisation improves over FY12-14E.

Table 7: South contributing >60% in the total oversupply

Surplus capacity (mnte)

FY10

FY11

FY12E

FY13E

FY14E

North

5.7

14.0

16.3

13.0

11.9

Central

0.3

1.4

3.5

4.0

4.4

East

4.7

5.3

5.6

5.8

6.3

South

23.8

37.9

46.7

49.8

50.2

West

1.5

2.9

6.8

5.2

3.6

All -India

36.0

61.5

79.0

77.7

76.5

Surplus as a % of total oversupply North Central East South West India

FY10

FY11

FY12E

FY13E

FY14E

15.7

22.7

20.6

16.7

15.5

0.8

2.3

4.5

5.1

5.8

13.1

8.6

7.1

7.4

8.3

66.1

61.7

59.2

64.1

65.6

4.2

4.7

8.6

6.7

4.8

100.0

100.0

100.0

100.0

100.0

Source: I-Sec Research

Table 8: Break-up of capacities region-wise for key companies

 

(% of capacity)

UltraTech

ACC

Ambuja

JPA

North

22.9

19.8

33.5

17.1

Central

11.5

15.2

5.6

48.0

East

13.5

20.0

15.2

16.5

South

25.8

31.5

-

-

West

26.3

13.5

45.7

18.4

Source: I-Sec Research

Cement sector, September 13, 2011

ICICI Securities

Region-wise analysis North to see ~700bps improvement in utilisation over FY12-14E

Table 9: North to see ~700bps improvement in utilisation over FY12-14E

 

North

FY10

FY11

FY12E

FY13E

FY14E

 

Effective capacity Production Utilisation (%) Despatches YoY change (%)

 

52.3

62.5

68.9

70.6

74.7

46.6

48.5

52.6

57.6

62.8

89.2

77.6

76.4

81.6

84.1

46.6

48.5

52.6

57.6

62.8

13.4

4.0

8.5

9.5

9.0

Source: I-Sec Research

 

Key demand drivers

 

Semi-urban and rural housing projects especially in Punjab and Haryana

 

Urban infrastructure projects in cities like Chandigarh and Delhi

 

Several hydro power projects in Himachal Pradesh

 

Several road projects Table 10: Key capacity additions in North region

 

Region

Company

CoD

FY11

FY12E

FY13E

FY14E

 

North

Birla Corp

- Rajasthan

Oct-10

0.9

North

Birla Corp - Rajasthan India Cements Mahi, Rajasthan Jaiprakash -Baga (HP) JK Cement Lafarge - HP Shree Cements - Jaipur, Rajasthan Wonder cement

Dec-12

1.2

North

Dec-10

1.3

North

Sep-11

2.0

North

Mar-14

3.5

North

Sep-12

2.0

North

Mar-11

1.5

North

Sep-12

2.5

 

Total

5.7

-

5.7

3.5

Source: CMA, -Sec Research

 

Central – Utilisation to remain in >90% range

 

Table 11: Central – Utilisation to remain in >90% range

 

Central

FY10

FY11

FY12E

FY13E

FY14E

 

Effective capacity Production Utilisation (%) Despatches YoY change (%)

 

29.8

33.8

38.9

42.7

46.7

29.5

32.4

35.4

38.7

42.2

99.0

95.8

90.9

90.7

90.5

29.5

32.4

35.4

38.7

42.2

14.7

9.8

9.3

9.6

9.0

Source: CMA, -Sec Research

Key demand drivers

Rural and low-cost housing

Rural infrastructure projects including roads

Several hydro power projects in Uttar Pradesh

Cement sector, September 13, 2011

ICICI Securities

Table 12: Key capacity additions in Central region

Region

Company

CoD

FY11

FY12E

FY13E

FY14E

Central

Birla Corp - MP Heidelberg Heidelberg Jaiprakash - Sidhi, Chunar, Dalla Jaiprakash - Sikandrabad Jaiprakash - Dalla KJS Cement Prism Cements

Oct-10

0.9

Central

Jun-12

1.0

Central

Dec-12

1.9

Central

Sep-09

1.0

Central

Jun-11

1.0

Central

Dec-11

2.5

Central

Sep-12

2.3

Central

Sep-10

3.6

Total

5.5

3.5

5.2

-

Source: CMA, -Sec Research

East – Utilisation to remain in 85%+ range

Table 13: East – Utilisation to remain in 85%+ range

East

FY10

FY11

FY12E

FY13E

FY14E

Effective capacity Production Utilisation (%) Despatches YoY change (%)

34.0

37.7

41.3

44.9

48.9

29.2

32.4

35.7

39.1

42.6

86.1

85.9

86.3

87.1

87.0

29.2

32.4

35.7

39.1

42.6

12.4

11.0

10.0

9.5

9.0

Source: CMA, -Sec Research

Key demand drivers

Semi-urban and rural housing projects especially in Bihar and Paschim Banga (West Bengal)

Various Industrial projects being implemented in Chhattisgarh, Jharkhand and Orissa

Several roads and power projects

Table 14: Key capacity additions in East region

Region

Company

CoD

FY11

FY12E

FY13E

FY14E

East

Ambuja - Bhatapara Birla Corp - West Bengal Jaiprakash- SAIL JV Bhilai Jaiprakash- SAIL JV Bokaro JK Lakshmi Cement -Durg Lafarge - Jharkhand Others Others Ultratech - Raipur, Chhatisgarh

Jun-11

1.1

East

Dec-12

0.6

East

Apr-11

2.2

East

Jun-11

2.1

East

Dec-12

2.7

East

Dec-11

1.0

East

Mar-11

1.0

East

Mar-12

1.0

East

Sep-14

4.8

Total

3.2

5.2

3.3

4.8

Source: CMA, -Sec Research

 

West to see ~700bps improvement in utilisation over FY12-14E

Table 15: West to see ~700bps improvement in utilisation over FY12-14E

West

FY10

FY11

FY12E

FY13E

FY14E

Effective capacity Production Utilisation (%) Despatches YoY change (%)

37.2

41.6

47.7

49.8

52.3

30.4

33.4

36.4

39.7

43.3

81.7

80.4

76.3

79.7

82.8

30.4

33.4

36.4

39.7

43.3

6.8

10.0

9.0

9.0

9.0

Source: CMA, I-Sec Research

Cement sector, September 13, 2011

ICICI Securities

Key demand drivers

Urban housing in key cities like Pune, Ahmedabad and Mumbai

Urban infrastructure projects, roads and metro rail

Commercial real estate / construction in key cities like Pune, Ahmedabad and Mumbai

Table 16: Key capacity additions in West region

Region

Company

CoD

FY11

FY12E

FY13E

FY14E

West

ACC - Chanda Ambuja - Maratha ABG Cements Jaiprakash- GACL SP-2 Kutch Jaiprakash -Wanakbori 2

Mar-11

3.0

West

Jun-11

0.9

West

Dec-12

3.0

West

Mar-11

1.2

West

Mar-11

1.2

Total

5.4

0.9

3.0

-

Source: CMA, -Sec Research

 

South – utilisation to remain in ~60% range

 

Table 17: South – utilisation to remain in ~60% range

South

FY10

FY11

FY12E

 

FY13E

FY14E

Effective capacity Production Utilisation (%) Despatches YoY change (%)

87.7

101.8

110.9

119.1

125.7

63.9

63.9

64.2

69.3

75.6

72.9

62.7

57.9

58.2

60.1

63.9

63.9

64.2

69.3

75.6

6.9

-

0.5

8.0

9.0

Source: CMA, -Sec Research

 

Key demand drivers

Low-cost housing schemes like Indira Awas Yojna

 

Roads, irrigation and urban infrastructure projects by government

 

Urban housing especially in Bengaluru

 

Table 18: Key capacity additions in South region

 

Region

Company

CoD

FY11

FY12E

FY13E

FY14E

South

ACC - Wadi Bhavya Cement Chettinad - Karikalli Jayajyothi Jaiprakash - Balaji JSW KCP Cements My Home Indus Madras Cement Madras Cement NCL - Nalgonda Raghuram Cement (Bharathi) Sagar-Vicat Cement Ultratech - Gulbarga, Karnataka Zuari (Italicementi)

Nov-10

3.0

South

Nov-10

1.0

South

Mar-11

2.3

South

Jun-10

1.0

South

Mar-12

3.5

South

Sep-12

2.0

South

Dec-10

1.0

South

Nov-10

1.3

South

Mar-11

1.3

South

Sep-11

2.0

South

Nov-10

1.0

South

Dec-10

2.0

South

Dec-12

2.5

South

Sep-14

4.4

South

Nov-10

1.5

Total

15.4

5.5

4.5

4.4

Source: CMA, -Sec Research

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Inter-regional dynamics

Historically, inter-regional movement of cement has been from South to West and that within North, Central and East. And we expect this trend to continue.

Though inter-regional movement could increase due to substantial price differential, it would not have meaningful impact on regional prices. We do not expect sizeable movement from extended South to extended North and vice-versa on following counts:

It being uneconomical due to freight expenses

Lack of proper dealer network / channel distribution

Lack of brand recognition (localisation of brands)

Lack of adequate infrastructure i.e. shortage of wagons, improper road condition

Higher consolidation

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Demand to regain strength

Cement demand in FY11 grew at a lower ~5.5% pace hit by: a) low demand from South due to political issues and b) slowdown in infrastructure spend by the Government. The analysis of region-wise demand trend shows that in FY11, growth in East, Central and West was strong at 8-11% whereas that in North was reasonable at ~4% owing to high base effect (13.5% growth in FY10). And that the hit came from South (1/3rd of the industry), which remained almost flat YoY due to political turmoil in Andhra Pradesh (which de-grew 14% in FY11). In Q1FY12 also, the cement demand remained subdued at ~1-1.5% on similar grounds. However, despatch growth in July’11 and Aug’11 was ~9% and ~6% YoY respectively owing to low base effect of

FY11.

We believe that the demand will improve given: i) low base effect of FY11; ii) better rural housing demand; iii) forthcoming elections in few large states / centre over next two-three years and iv) gradual pick-up in Government infrastructure spend. Though housing continues to be the main driver, constituting +60% of overall cement demand, the positive demand delta is expected to come from significant increase in infrastructure spending. Given the policy thrust by the Government, the share of infrastructure in cement demand would go up to 25%+ in FY12-16E from ~20% in FY07-11.Our recent interaction with cement companies and other channel checks shows that over the next three to five years, the industry could post low double digit growth as medium-to-long term structural demand drivers still remain intact.

Likely reversion to historical correlation with GDP

Cement demand shares a strong correlation with economic growth – directly as well as indirectly. Directly, because infrastructure investment and construction activity, the main drivers of cement demand, are the key components of gross domestic product (GDP). Indirectly, because housing (both rural and urban), again a key determinant for cement demand, depends on agricultural productivity and income levels, which in turn are the key components of GDP. Historically, Cement-to-GDP ratio has remained ~1.2x except in FY11. With India’s GDP expected to maintain growth of +7-7.5%, cement demand growth of +8-9% seems achievable during the next two-three years.

Chart 4: GDP versus cement demand growth 20 Cement consumption grow th GDP grow th
Chart 4: GDP versus cement demand growth
20
Cement consumption grow th
GDP grow th
16
12
8
4
0
(4)
(%)
FY00
FY01
FY02
FY03
FY04
FY05
FY06
FY07
FY08
FY09
FY10
FY11

Source: Cement Manufacturers’ Association (CMA), Bloomberg, I-Sec Research

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Elections in few large states

Demand for cement picks up during the election time, as incumbent Government tries to meet some of the infrastructure-related commitments. Over the next two to three years, besides general election at the Centre, many of the key cement consuming states like Uttar Pradesh, Gujarat, Punjab, Madhya Pradesh, Maharashtra and Rajasthan are scheduled for elections. And this would spur demand for cement. Bihar, which went for assembly elections in FY11, posted a 42% YoY consumption growth during FY10 and a 14% growth during FY11. Similarly, West Bengal, which went for hustings in May’11, posted 24% YoY consumption growth in FY10 and 18% growth in

FY11.

Table 19: Forthcoming elections in few large states

Year

State

2012

Uttar Pradesh, Gujarat, Punjab, Uttrakhand

2013

Chhattisgarh, Madhya Pradesh, Delhi, Rajasthan, J&K, Karnataka,

2014

Centre, Haryana, Maharashtra, Andhra Pradesh, Orissa,

Source: Election Commission of India, I-Sec Research

Table 20: Cement demand growth (%)

State

Last election

1 year prior to election (%)

2 years prior to election (%)

WB

2011

18

24

Bihar

2011

14

42

AP

2009

13

13

Rajasthan

2008

16

9

Gujarat

2007

13

16

Source: I-Sec Research

Bihar and Gujarat are the recent examples of how strong political leadership and better policy implementation could lead to a solid overall growth of a state. The policy thrust on infrastructure and housing in these states has resulted in a strong demand for cement.

Bihar has witnessed a flush of FDI in both residential and commercial real estate. Where growth in tier II towns of the state are supported by residential projects, that in Patna, the capital, is propelled by commercial development – the planned software IT parks. The commercial real estate in Patna has already been overtaken by mall and multiplex culture, which is now being taken to the next level – old shopping hubs are being re-designed and turned into new-age shopping malls and supermarkets. This has led to an all-round growth in the state. This phase of investment in Bihar has come after a period of standstill in and around ‘05. Around election time, Bihar witnessed a splurge in real estate investment (‘08-09), which is getting manifested now.

Among all states, Gujarat has seen the maximum number of PPP projects focused on infrastructure across housing, roads, bridges, ports and developing SEZs. In the past five years, the state government’s outlay for urban development has increased tenfold. In the real estate sector, which includes development by private builders as well as PPP projects by the government, Gujarat has the second largest number of projects among all states. We expect the state to continue this momentum and remain undeterred in following the policies that support infrastructure and housing demand, and hence demand for cement.

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Housing still remains the largest demand contributor

Housing has been the largest contributor (+60%) to cement demand. According to various industry sources, rural and urban housing stock is expected to grow at a faster pace of 2.3% and 2.6% CAGR respectively over ‘10-15 vis-à-vis ‘08-10.

Chart 5: Rural housing stock to grow at a higher CAGR over ‘10-15

Housing Stock Habitable Stock 210 2.3% CAGR 190 1.6% CAGR 2.5% CAGR 170 2.7% CAGR
Housing Stock
Habitable Stock
210
2.3% CAGR
190
1.6% CAGR
2.5% CAGR
170
2.7% CAGR
201
150
179
174
130
161
121
145
103
110
96
86
90
74
70
2001
2005
2008
2010
2015
mn units

Source: Industry Sources, I-Sec Research

Good monsoon to propel rural housing demand

A good monsoon has a strong bearing on construction activity especially rural housing, which forms a significant part of overall housing. Water availability as well as good agricultural productivity and the resultant improved incomes of rural households after a good monsoon lead to improved cement demand in rural India. Rural housing also benefits from various Government programmes and schemes. The ‘inclusive growth’ agenda (a broader policy envisioning development of all sections of Indian society), loan waiver scheme, employment generating programmes such as National Rural Employment Guarantee Scheme (NREGS), rural housing initiatives like Indira Awas Yojana (IAY) and infrastructure development schemes such as Pradhan Mantri Gram Sadak Yojana (PMGSY) and Bharat Nirman would boost rural housing both through increased rural incomes and improved rural infrastructure.

Chart 6: Urban housing stock also to grow at a higher CAGR over ‘10-15

90 Housing Stock Habitable Stock 80 2.6% CAGR 1.9% CAGR 2.9% CAGR 70 82 2.2%
90
Housing Stock
Habitable Stock
80
2.6% CAGR
1.9% CAGR
2.9% CAGR
70
82
2.2% CAGR
58
60
72
70
50
64
50
59
46
42
39
40
30
2001
2005
2008
2010
2015
mn units

Source: Industry Sources, I-Sec Research

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In urban areas, project launches by realty players, both regional as well as pan-India (Unitech and DLF), has led to significant increase in housing launches especially in metros like NCR (Noida taking the lead), Mumbai (Navi Mumbai airport leading to increased development) and Bengaluru (led by growth in IT/ITeS). Project launches / sales volume by top 5 urban builders has almost doubled in the last two years. These projects with construction horizon ranging from 3-5 years are expected to fuel cement demand. Further, in FY12, we expect another 40mnte worth of project launches by the top 5 urban builders.

Chart 7: High number of project launches in FY10-11

DLF Unitech Sobha HDIL JPA 20 18 16 49mn sqft 14 12 35mn sqft 40mn
DLF
Unitech
Sobha
HDIL
JPA
20
18
16
49mn sqft
14
12
35mn sqft
40mn sqft
10
8
25mn sqft
6
4
2
FY09
FY10
FY11
FY12E
mn sqft

Source: Industry sources, I-Sec Research

Chart 8: Credit growth in housing sector increasing consistently

800,000 ICICI Bank 750,000 HDFC Upsw ing in home loans disbursement 700,000 650,000 600,000 550,000
800,000
ICICI Bank
750,000
HDFC
Upsw ing in home
loans disbursement
700,000
650,000
600,000
550,000
500,000
450,000
400,000
(Rs mn)
Q1FY10
Q2FY10
Q3FY10
Q4FY10
Q1FY11
Q2FY11
Q3FY11
Q4FY11
Q1FY12

Source: Company data, I-Sec Research

Credit growth in housing sector has also been increasing consistently. HDFC’s housing loan has grown at a CQGR of ~4.5% for the past eight quarters. The benefit of such credit growth will be staggered over the construction horizon of real estate and will therefore flow in over the next 3-4 years, thereby benefiting cement demand. While housing loan growth could be impacted given the recent interest rate hikes, most of the top banks are confident of 18-20% growth in housing loan in FY12E.

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Gradual pick-up in Government infrastructure spend

Sharp increase in infrastructure spending expected in XII FYP

Policy thrust on improving the infrastructure across the country and the consequent investment in roads and highways through programmes such as National Highways Development Project (NHDP) and Bharat Nirman is expected to push up the share of infrastructure spending as a percentage of GDP from 6.0% in FY08 to 10.7% in FY17E (~10% average during the XII Five-Year Plan). And this spurt in infrastructure spending is expected to fuel cement demand over the next decade and increase the share of infrastructure in cement demand – from ~20% in FY07-11 to 25%+ in FY12-

16E.

Chart 9: Infrastructure spending during XI FYP and XII FYP

Infrastructure investment Infrastructure investment as % of GDP (RHS) XI FYP XII FYP 14,000 14
Infrastructure investment
Infrastructure investment as % of GDP (RHS)
XI FYP
XII FYP
14,000
14
12,000
12
10.7
10.3
9.9
10,000
9.5
10
9.0
8.1
8.4
10,395
7.2
8,000
9,180
8
6.0
6.5
8,095
6,000
7,127
6
4,000
6,194
4
5,283
4,601
2,000
2
4,028
3,038
3,592
0
0
(Rs bn)
FY08
FY09
FY10
FY11E
FY12E
FY13E
FY14E
FY15E
FY16E
FY17E
(%)

Source: Ministry of Finance, Planning Commission, I-Sec Research

Significant slowdown in road infrastructure impacted FY11 growth

FY11 disappointed with just 5-6% growth in cement demand. Roads, which form a significant (one-third) portion of overall cement demand from infrastructure, remained under strain, especially those under NHDP. NHDP – Phase 1-6 saw muted growth given the poor implementations during FY11.

Chart 10: NHDP implementations under strain in FY11

Phase II-4/6 laning, SEW corridorPhase III-Upgradation, 4/6 laning Phase I-GQ, NSEW, Ports Phase V-6 laning of GQ 1,800 1,600

Phase III-Upgradation, 4/6 laningPhase II-4/6 laning, SEW corridor Phase I-GQ, NSEW, Ports Phase V-6 laning of GQ 1,800 1,600

Phase I-GQ, NSEW, Portslaning, SEW corridor Phase III-Upgradation, 4/6 laning Phase V-6 laning of GQ 1,800 1,600 1,400 poor

Phase V-6 laning of GQPhase III-Upgradation, 4/6 laning Phase I-GQ, NSEW, Ports 1,800 1,600 1,400 poor 1,200 performance 1,000 in

1,800 1,600 1,400 poor 1,200 performance 1,000 in FY11 800 600 400 200 - FY09
1,800
1,600
1,400
poor
1,200
performance
1,000
in FY11
800
600
400
200
-
FY09
FY10
FY11
(km)

Source: Industry sources, I-Sec Research

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In FY10, where NHDP met 85% of its implementation targets, in FY11, it could meet only 55% of its targets. This is lower than even ~60-65% targets it met in FY08 and FY09. The drop in FY11 is further exacerbated by the fact that the target for FY11 was 21% lower than that for FY10.

As against our expectation of 65% achievement of road targets in FY11, actual achievement came in at 55%, which could have led to lower than expected cement demand in FY11.

Chart 11: NHDP targets (85% achievement in FY10)

2009-10 Target2009-10 Achievement 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 - Phase I

2009-10 Achievement2009-10 Target 2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 - Phase I Phase

2,000 1,800 1,600 1,400 1,200 1,000 800 600 400 200 - Phase I Phase II
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
-
Phase I
Phase II
Phase III
Phase IV
(km)

Source: Ministry of Road, Transport and Highways (MoRTH)

Chart 12: NHDP targets (55% achievement in

FY11)

2010-11 Target1,400 2010-11 Achievement* 1,200 1,000 800 600 400 200 - Phase I Phase II Phase

1,400 2010-11 Achievement* 1,200 1,000 800 600 400 200 - Phase I Phase II Phase
1,400
2010-11 Achievement*
1,200
1,000
800
600
400
200
-
Phase I
Phase II
Phase III
Phase IV
(km)

*annualised Source: MoRTH, I-Sec Research

Only NHDP Phase-I&II have shown traction over years. Special Accelerated Road Development Programme for North Eastern Region (SARDP-NE), Left Wing Extremist (LWE) and other special programmes are relatively new additions to road projects.

Table 21: Projects under NHDP

 

Length

Completion

Incomplete

Cement to be consumed

Programme

Details

km

%

km

(mn te)

NHDP-I & II

Balance work of GQ and EW- NS corridors

14,145

87

1,827

4

NHDP-III

4-laning

12,109

16

10,141

20

NHDP-IV

2-laning

20,000

-

20,000

40

NHDP-V

6-laning of selected stretches

6,500

7

6,057

12

NHDP-VI

Development of expressways

1,000

-

1,000

2

NHDP-VII

Ring roads, bypasses, service roads etc.

700

-

700

1

SARDP-NE

Special Accelerated Road Devpt Prog. - North East

10,141

-

10,141

20

LWE Areas

Left-Wing Extremism Areas

5,477

-

5,477

11

Special

Minimum 2-lane

6,700

-

6,700

13

Programme

Total

76,772

19

62,043

124

*Cement demand, assuming 25% of roads made of concrete and 500kms requiring 1mnte cement Source: NHAI, Committee on Infrastructure, I-Sec Research

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Gradual pick-up likely soon

Given the fact that overall completion level of projects stands at just 19%, we expect implementations to ramp up. Therefore, roads are likely to contribute meaningfully to overall growth in cement in the near to medium term. For FY12, National Highways Authority of India (NHAI) has set a steep target of awarding ~8,000km of projects under NHDP between Apr’11 and Jan’12.

Table 22: Projects to be awarded during FY12 – Initial yearly plan

 

to be awarded (km)

Projects

Estimated cost

Cement requirement

Month

(#)

(Rs bn)

(mnte)

April’11

481

4

55.3

3.3

May’11

570

5

46.6

2.8

June’11

756

5

82.8

4.9

July’11

1,269

7

109.8

6.5

August’11

1,357

12

49.5

2.9

September’11

928

7

66.2

3.9

October’11

1,373

8

31.1

1.9

November’11

905

7

91.0

5.4

December’11

135

3

14.2

0.8

January’12

220

1

23.1

1.4

Total

7,994

59

569.4

33.9

*Cement demand, assuming 25% of roads made of concrete Source: NHAI, I-Sec Research

In aggregate, Rs488bn worth of expenditure is targeted in FY12 for various phases of NHDP, which will help generate 29mnte of cement demand over the year. In FY11, the expenditure achievement was 80% of the total targeted expenditure and that was skewed across programmes. Even if we assume similar target achievement in FY12, NHDP programme will help generate 23mnte of cement demand in FY12 as against 16mnte in FY11.

Table 23: Expenditure target for NHDP and SARDP-NE

 

FY11 (target)

FY11 (actual)

FY12 (target)

Cement

NHDP Phase

(Rsbn)

(Rsbn)

(Rsbn)

requirement (mnte)

I

6.21

16.4

8.5

0.5

II

75.41

98.9

37.1

2.2

III

150.97

103.4

274.7

16.4

IV

13.23

0.0

56.7

3.4

V

84.32

49.0

91.0

5.4

VI

9.72

-

-

-

VII

1.15

-

4.6

0.3

SARDP-NE

4

7.9

15.2

0.9

Total

345.0

275.7

487.7

29.0

*Cement demand, assuming 25% of roads made of concrete Source: Government of India, I-Sec Research

In addition to aforementioned projects under NHDP, additional projects will be awarded to speed up the pace of road development in India. The good news on this front is the thrust on SARDP-NE – the programme has been languishing for a couple of years now despite all sanctions being in place.

These additional projects to be awarded will add another 2,000km to the total target awards and another 3-4mnte to the total cement demand in the near term.

Cement sector, September 13, 2011

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Table 24: Additional projects to be awarded during FY12

No

NH No

Project Name

State

Length (km)

NHDP Phase

1

1A

Ramban-Banihal

Jammu & Kashmir Jammu & Kashmir West Bengal Madhya Pradesh Haryana Himachal Pradesh Uttar Pradesh Madhya Pradesh Uttar Pradesh Uttar Pradesh Rajasthan Rajasthan Rajasthan Uttar Pradesh Uttar Pradesh Uttar Pradesh Rajasthan Assam Assam Assam

36

II

2

1A

Udhampur-Ramban

40

II

3

31&31D

Ghoshpukur-Salsalabari

163

II

4

12

Bhopal-Jabalpur

290

III

5

65

Ambala-Kaithal

86

III

6

22

Parwanoo-Solan

41

III

7

233

Ghagra Bridge-Varanasi

177

IV

8

69

Obedulganj-Betul

108

IV

9

231

Raibareilly-Jaunpur

169

IV

10

231

Lucknow - Raibareilly

70

IV

11

24B

Padhi-Dahod

86

IV

12

113

Jhalawar-Rajasthan/Madhya

62

IV

13

12

Karauli-Dhaulpur

72

IV

14

11B

Ambedkar Nagar-Raibareilly

150

IV

15

232

Raibareilly-Banda

140

IV

16

232A

Unnao-Lalganj

68

IV

17

65

Rajasthan Border-Fatehpur

135

IV

18

37

Demow-Dibrugarh

46

SARDP-NE

19

37

Numaligarh-Jorhat

51

SARDP-NE

20

37

Jorhat-Demow Total

82

SARDP-NE

   

2,072

Source: NHAI, I-Sec Research

Commercial construction

Commercial construction includes construction of malls, multiplexes, office space, hotels and hospitals. As real estate / housing sector picks pace, we expect demand in commercial / office space to also pick up. Demand for office space is largely driven by the IT / ITES industry, which comprises 75-80% of commercial demand. Besides, SEZs will aid the investments made in the industrial sector directly and / or indirectly through development in and around these zones.

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Better placed than earlier down-cycle

Most of the cement companies made bumper profits over FY05-08 and generated huge operating cashflow. Hence in FY11-14E, they are financially stronger vis-à-vis that in the earlier down-cycle (FY00-04).

For cement companies, FY11-14E is better than FY00-04 on account of:

Better profitability – EBITDA margins at ~23-25% (FY11-14E) compared to ~13%

(FY00-04)

Low gearing of 0.5x (FY11-14E) compared with ~2.5x (FY00-04)

Strong balance sheet and free cashflow generation

Improved working capital cycle of 10 days from ~35 days

Better efficiency (higher share of captive power plant) and cost control

Higher consolidation (top five companies control ~55% compared to 48% and top ten players control 72% compared to 66% in FY01)

The companies are even geared up for the next expansion phase, indicating that the demand-supply mismatch, if any, would not result in disrupting the prices.

High degree of concentration in most regions

High concentration and cost escalations may result in better pricing discipline

The cement industry is highly