Rating: Underweight - Ultratecht, Ambuja Cement; neutral - ACC, Overweight - Grasim
We are more constructive on the outlook for cement demand and raise our FY16/17 demand estimates to 10%, but highlight that it is not going to be an easy climb from here as we reduce FY15 estimates. We now build in strong demand and pricing for the companies and give a higher multiple, but even then struggle to justify current valuations of 11x FY17 EV/Ebitda (enterprise value/earnings before interest, taxes, depreciation, and amortisation) for Ultratech Cement (UTCEM) and Ambuja Cement (ACEM).
Outlook improves, but..: Our cement stock calls have been wrong even as we got the earnings call right, as we underestimated the multiples investors were willing to pay for an industry where returns declined, overcapacity rose, and earnings were consistently cut. Indian cement stocks are now among the most expensive in the world on two-year forward earnings, even as the RoE (return on equity) profile is relatively weak compared to SE Asian companies. Even on FY17e (estimated) earnings, which are the highest in each company’s history, stocks are near peak multiples. We downgrade UTCEM to UW (underweight) with a revised PT (price target) of R2,300 (R1,750 earlier) and maintain UW on ACEM with a revised PT of R190 (R155 earlier). Our top OW (overweight) remains Grasim with a revised PT of R4,680, as we expect the holding company discount to narrow (currently at 50%). We maintain N (neutral) on ACC as we increase our target multiple closer to ACEM.
Industry unlikely to cross 75% utilisation in FY17e: Even after building in strong 10% demand estimates for FY16-17, industry utilisation would remain <80%. On the margin, we expect South India demand growth to pick up after a multi-year slowdown and benefit from new state creation. While we are building in declining capacity additions, we would not be surprised to see this pick up if demand actually grows at 10%.
We would revisit our calls: Our current estimates build in near lifetime high earnings for FY16e. We would revisit the sector on corrections. While investors are currently willing to discount FY17/18, given ongoing weakness in FY15e, we would not be surprised to see a meaningful correction from current levels. As we enter a demand upcycle, our view is that holding company discounts should narrow; hence, we remain Overweight on Grasim.
What are the risks from here? Downside risk is clearly a