Cost relief leads to improved sentiment in Cement Sector: Sharekhan
Cement stocks can witness renewed investor interest on the back of an improvement in the business dynamics.
Though the macro-headwinds remain, in terms of a slowdown in key user industries (real estate and construction) and the overall economy, cement prices are holding up steady. In fact cement companies have only partially passed on the benefit of Rs9-10 per bag accrued from the recent reduction in excise duty on cement.
The growth in dispatches has also revived strongly in November after a rather-muted growth in October. The cumulative growth for two months—October and November 2008—stood at 7.2% as compared to that in the corresponding period of the previous year, inspite of a severe liquidity crunch.
But the key positive change is significant easing of cost pressures. Cement companies can witness saving of Rs18-20 per bag due to correction in coal prices (falling by around 60% from their peak levels), reduction in diesel prices (that will translate into saving in freight cost) and cut in packaging cost. The positive impact of lower cost of production should begin to get reflected in the financial performance from Q4FY2009.
The combined positive impact of the three factors—a better than expected realisation, a surge in dispatches in November (indicating resilience in demand environment) and significant easing of cost pressures can boost the earnings before interest, tax, depreciation and amortisation (EBITDA) estimates by 8-15% in FY2010. This essentially means that the consensus earnings estimates of cement companies can potentially see an upward revision. Moreover, as mentioned in our previous note, the valuations are already attractive with most companies trading at 30-60% discount to their replacement cost. Consequently, we expect a near-term re-rating led rally in cement stocks. We prefer UltraTech Cement among frontline stocks. In mid-cap space, we prefer Shree Cement and Madras Cement.
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