RBS cautious on cement space in near-term

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Cement stock prices witnessed a slight improvement over the last six weeks. However, Mohan Krishnaswamy, RBS Equities (India) says he would be cautious on the cement space in the near-term.

In an interview to CNBC-TV18, he says, "We are fairly cautious. The sector has done better than our expectations. Ambuja Cement , ACC , Grasim and India Cements are his top picks from the sector.

Meanwhile, the cement capacity utilisation rate dropped to 75% on a year-on-year basis in October 2011 versus 83% in October 2010. Sanjay Ladiwala, President, Cement Stockists & Dealers Association of Mumbai informed CNBC-TV18 that the current cement capacity utilisation stands roughly at 75%.

"The northern regions are seeing a much higher utilisation while the south is seeing unfortunately because of far overcapacity as compared to the demand, a much lower utilisation of capacity," added.

He expects the cement industry to grow roughly at 4.5% in FY12.

Below is the edited transcript of their interview with CNBC-TV18. Also watch the accompanying video.

Q: What is the sense you are getting? Is there a fall in the amount of under capacity utilization? Is capacity utilization improving? What went at all right in the last few months for the cement sector?

Ladiwala: Well, traditionally we are expecting that post-monsoon there has to be an upward slope in the demand. That is what we are seeing at the moment. However, it is not appropriate to compare month-on-month figures because there are too many variables.

It is a much longer base period to be coming to any sort of a conclusion. There is not that much on an average uptake in the demand as is being seen in the monthly figures. Appropriately, if one could take the six monthly figures it would show a trend which is not as healthy as is seen in the short-term.

Q: Can you give us an idea of what sort of utilisation rate the entire cement business is working with? We learn that it fell to 75% on a year-on-year basis in October 2011 versus 83% in October 2010.

Ladiwala: The figures are mostly correct. They are working at around 75% utilisation on an average though it differs from region-to-region. The northern regions are seeing a much higher utilisation while the south is seeing unfortunately because of far overcapacity as compared to the demand, a much lower utilisation of capacity. On an average, 75% would be an appropriate figure to go by. Going forth of course it will depend on the demand.

Q: What's your sense about what could have propelled that slight improvement in cement stock prices that we saw in the last six weeks or so? It was a relative outperformer in an otherwise dreary market?

Krishnaswamy: If one looks at the sector there is an element of disconnect between the larger companies and smaller companies. So, it is the cash rich companies and the top three or four companies which have actually done well like Ambuja, ACC and Ultratech. To an extent people are viewing the stability in earnings as a big positive trigger.

The last quarter was weak and prices have improved since then and there is a hope that demand will improve eventually in the next second half which is what the companies were expecting. So it's more of that which people are seeing and even with 70-75% utilisation the pricing seems to be fairly robust.  That is also giving confidence to the market.

Q: But will it hold out? Look at the kind of IIP numbers that we have got. Not that we needed those numbers to tell us about the slowdown but there is continued paralysis in terms of giving out orders and if those orders are given allowing people to acquire necessary land or any other kind of raw material, one knows of the supply side constraints. So are you going to see any improvement in off take or prices in the next quarter? What would you pencil in?

Krishnaswamy: The demand conditions remain fairly dim right now and while the improvement was on a month-on-month basis, there is no improvement year-on-year mainly because of the lower base. So, I don't think there is going to be a dramatic improvement in the growth rates on the demand side. Best case we are looking at 4-5% levels of demand growth for the year. Pricing has been beating expectations.

The industry has been able to raise prices to pass on cost increases and fairly effectively. So it's a question of holding this disciplined approach for the next at least two years because utilisation rates is not going to significantly going up in the next 12-18 months given there is some more capacities coming up. So that's obviously anybody's guess, but I suspect if the industry does manage to hold pricing then it will be a good business because eventually one will see demand-supply balance coming up beyond FY14.

Q: There is a lot of weakness in the cement space in particular for today. Just give us a sense of what your top picks are in the sector and what your top sales are also?

Krishnaswamy: We have been cautious on the sector for a while. Some of the stocks have done better than our expectations. So we think there is value in Grasim at these levels and something like an India Cement because its valuations are at significant discount to replacement cost. Elsewhere, we think stocks are rich in terms of valuation be it Ambuja Cement or ACC. We are fairly cautious and the sector has done better than our expectations.

Q: What is the sense you are getting in terms of how demand might pan out? The thumb rule used to be that cement demand is what the GDP number is. I mean if it's 8% you have an 8% growth in demand. But what we understand from sources is that FY11 itself it was lower than what the GDP also threw up. 4.5% was what we understood. Are you getting a sense that things are going to be as bleak as that in FY12 and FY13 as well not even making up to an already declining GDP?

Ladiwala: That's right. The thumb rule no longer holds valid now. The equation between the GDP and the demand growth rate is no longer a formula that we can depend upon. The 4.5% expected growth rate during FY12 is accurate. Going forward, I don't see much more coming on as far as the growth rate is concerned until and unless there is a sharp trigger in the infrastructure segment which is not yet foreseen. So, that would be guesswork for FY13.

But as of now it is true, it does not correspond with the growth rate. Going forward also in the very short-term also I don't think there is much growth except maybe the usual trigger which is in January end and February when the rural demand kicks in, there are logistical bottlenecks and we see slight increase in prices. But I don't see any grass root level demand coming forth except in the rural segment. Unfortunately, it's the infrastructure and the real estate which is pulling the total demand down.