5 stocks you should prefer from cement space: Motilal Oswal
Motilal Oswal has come out with its report on cement industry. The research firm, has preferd ACC, Shree Cement in large caps and Madras Cement, Dalmia Bharat and Birla Corp in mid caps, in its research report dated November 27, 2013.
November 28, 2013 / 15:35 IST
Motilal Oswal's report on cement industry
Weak demand + Aggressive Tier II = Sub-optimal pricing
Cement demand witnessed 6.6 QoQ decline (+3.6 percent YoY) in 2QFY14. Aggregate utilization was down to 65 percent (-6pp QoQ, -3pp YoY), with lowest utilization belonging to Tier II players at ~60 percent (-4pp QoQ, flat YoY). This led to aggressive pricing undertaken by Tier II players (~INR12/bag QoQ v/s ~INR7/bag for Tier-1 v/s ~INR8/bag for aggregate), resulting in disturbance in price rationality and increase in Tier II market share (by 180bp QoQ) at the cost of Tier I and ISM.Sub-optimal pricing, cost push leads to severe pressure on profitability
Unusual cost push on various aspects led to a fall in profitability. But the impact was severe on ISM, as EBITDA/ton turned negative in 7 companies. 10 of the 23 companies posted net loss and 6 posted cash loss. ISM’s net loss stood at a three-year low of -INR289/ton. While Tier II players’ EBITDA/ton was at par with Tier I, the segment had much inferior interest coverage and net profitability on account of sharp rise in leverage (ex-SRCM net DER of 0.9x).ISM players in precarious position, interest servicing further weakens
The impact on profitability deterioration has been severe on ISM, with select players posting loss at EBITDA level during 2QFY14. Almost 18 percent of analyzed capacity posted PAT loss, while 6 percent posted loss at EBITDA and cash PAT level. Interest servicing position has further weakened for ISM and tier II players, with interest coverage ratio of 0.5x and 2x respectively – one of the weakest in last 10 years. Further, on-going capex by tier-II (~INR32b) and ISM (~INR80b) players would further add to interest burden on them, which is being currently capitalized.Pricing recovery dependent on rationality of tier II players
Given that Tier I players are accommodative and ISM players are not in position to be price makers, rationality of Tier II would be the key to price recovery along with demand recovery. Thus, while the level of inflexion point is away (theoretically should be the price point where Tier II section starts making cash loss like ISM), we expect a gradual return to rationality. We expect 2HFY14E to post a better profitability trend YoY/QoQ on low base of 2HFY13 (delayed monsoon impacted volume and pricing), led by price recovery.Valuation and view: "While cement demand continues remain weak, after strong growth in September 2103, cement prices have witnessed recovery in Oct-Nov’13. Sustainability of price recovery, improvement in operating and stock performance is critically dependent on sustained demand recovery. In large caps, we prefer ACC and Shree Cement, while in mid caps we prefer Madras Cement (The Ramco Cements) , Dalmia Bharat and Birla Corp," says Motilal Oswal research eport.Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions. 
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