Sluggish demand due to weak economic conditions and pricing pressures have bogged down stocks in the cement sector over the last six months. But, things might improve from here.

With an above normal rainfall this year, harvests are likely to be good and rural housing demand may see a pick-up. Also, the pre-election spending on infrastructure by the government will help.

There are reports of the government fast-tracking project clearances to push economic growth.

Cement stocks at the current beaten down valuation will be a good addition to an investor’s portfolio. UltraTech Cement, a Birla group company, is our preferred exposure in the large-cap cement space. One, its all-India exposure helps negate fluctuations in offtake and prices in regional markets.

Two, the company is growing sales by expanding its market reach. Three, the company controls its costs well — a key advantage in the current scenario of high input costs and drop in realisation for cement players.

Also, the UltraTech stock is now at a discounted valuation compared with peers. At the current price of Rs 1,682, the stock discounts its trailing one-year earnings by 17 times. In the last three years, the stock has traded in the PE band of 13-20 times.

Holcim group companies, ACC and Ambuja Cements, are trading at a trailing price-earnings multiple of 19-20 times.

Growing market reach

In the recent June quarter, the cement sector reported weak numbers with sharp fall in sales and profits. UltraTech Cement did better than peers with sales decline capped at two per cent over last year and net profit sliding 13 per cent.

In the first six months of 2013, even as cement demand dropped and ACC and Ambuja Cements saw their despatches fall by around four per cent, UltraTech held its volumes — the company recorded a sales volume of 21.01 million tonnes versus 21.07 million tonnes in the same period last year. This is thanks to the company’s expanding dealer network and penetration into new smaller markets in Tier-II/III towns.

UltraTech commissioned a 1.55-million tonnes per annum (mtpa) grinding unit at Hotgi, Maharashtra and increased the capacity of its grinding unit in Gujarat by 0.6 mtpa last year. These pushed up the company’s total capacity to 53.9 mtpa.

Over the next year, UltraTech will add another 4.4 mtpa grinding capacity and, by FY-15, the company’s total capacity will increase to 61.45 mtpa.

UltraTech appears well-poised to address growth in cement demand in the coming years. Cement demand in the country is expected to grow 7 per cent in FY14, compared with 5-6 per cent last year.

There are signs of demand recovery already in the southern pockets of the country. Cement prices have recovered mildly in Hyderabad and Bangalore. The split of Telangana from Andhra Pradesh is expected to kick off some infrastructure activities in the region.

Cost efficiencies

Increase in prices of domestically sourced fly ash, lime stone, iron ore, and higher cost of packaging materials have hit cement producers. Coal India too, increased prices by 11 per cent in May driving up prices of those sourcing coal from the company. Consequently, cement producers suffered an average 5-8 percentage points dip in operating margins in the recent June quarter. UltraTech managed with a four percentage point contraction in margin to 21.6 per cent.

This follows the company’s use of a cheaper fuel — pet coke — for 34 per cent of its fuel requirement. As a result, Ultratech’s power cost is the lowest among the top players in the sector. In the June quarter, power costs as a percentage of sales for UltraTech stood at 20 per cent, compared with 22-23 per cent for the Holcim group companies.

The company also economises on freight costs by setting up split grinding units and packaging terminals at strategic locations and reducing lead distances. In the June quarter, the company’s freight costs, as a percentage of sales, stood at 22 per cent, lower than the 26 per cent of Ambuja Cements.

Light on debt

UltraTech has planned a capital expenditure of Rs 2,000 crore over the next one-and-a-half years. This will be funded by internal accruals and borrowings. As of March 2013, the company had an outstanding debt of Rs 3,894 crore under long-term borrowings. The company has a debt-to-equity ratio of 0.35 times and interest cover of comfortable 15 times in FY13.

Cartel charges

In June 2012, the Competition Commission of India (CCI) accused 11 players, including UltraTech Cement, of forming a cartel and directed them to pay 50 per cent of profits of FY10 and FY11 as penalty.

UltraTech was fined Rs 1,175 crore. Cement companies challenged this order at the Competition Appellate Tribunal, which ordered a stay against the CCI order in May this year, but directed the cement companies to pay 10 per cent of the penalty amount as an interim settlement. The hearing on the appeal of cement companies is due this month. Market observers feel that it may be difficult to prove the charges.

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