Will it crack?

 

Share prices of cement companies have slumped over the past few days, especially between January 19 and February 27, 2007 and much faster than the fall in the BSE Sensex. Against a decline of 4.96% in the Sensex, cement stocks (big and small) have fallen between 8% and 28% during this period.

 

After the cut in import duty last month (from 12.5% to nil on January 22), the general market sentiment towards cement stocks turned negative. Further, the CRR hike earlier this month has led to a further rise in the interest rates and hence, has made housing loans more expensive. This along with firm real-estate prices, the market believes, seems to have the potential to slow down demand for housing and commercial real estate, which in turn could impact demand for cement.

 

The industry is also anxious about the changes that may take place post budget and there is a general sentiment of uncertainty. In order to keep inflation in check, it is expected that the government might take measures, including banning cement exports, if prices continue to rise unabated. What these changes will be and when will they be implemented is anybody’s guess.

 

The government seems determined to keep cement prices under control in order to curb inflation. In light of this, the government’s action of cutting the import duty rates to keep cement prices in check seems to be showing results as most cement players remain reluctant to raise prices following the cut in the import duty rate. This in turn means that at least for the near-term, the upside for cement companies may remain capped.

 

Analysts though say that the recent cut in the import duty for Portland cement has not really affected the situation greatly. In fact, in select regions, there has been a price hike of up to Rs 7-8 per bag. Looking at the demand scenario one can only expect prices to remain firm. Cement prices in the Mumbai stood unchanged at Rs 224 per 50 kg bag compared to the previous month. And, as compared to the same month last year, prices registered a 36.6% jump.

 

On the demand front, demand continues to outpace supply, thanks to factors like booming retail sector, rising construction activities (led by housing, manufacturing and services viz., IT, ITES, etc) and increasing infrastructure projects including in tier II and tier III cities. A strong construction demand has led to a growth in the production even on a high base.

 

Explains a recent cement sector report by Prabhudas Lilladher, “Cement demand grew at the rate of 7.7% in January 2007 while, for the first time, operating rates crossed 100%. Strong demand and higher operating rates continued to ensure robust cement prices, which were 27% higher y-o-y.” It further adds, “Since demand growth is likely to outpace likely supply additions, we expect prices to remain strong in FY08.”

 

Analysts maintain that fundamentals of the industry are strong and that demand for cement will continue to be robust. Exports will continue to grow till 2008. The problem may start when capacity additions start coming in a big way in Middle East; exports are expected to slow down post 2008. The domestic industry too will witness major capacity additions during 2008, about 15 months from now. The capacity will get streamlined to the extent of 19-20 million tonnes during 2007-08. Analysts expect prices to come under pressure with such capacity addition in 2008. Until then prices will most probably see a hike of Rs 5-10 per 50 kg. Domestic demand is expected to cross 200 million tonne mark by 2010 (current demand is 140 million tonnes per annum). For the next five years, demand is likely to grow in the range of 8%-10%.

 

To sum up, how cement stocks perform in the near-to-medium term will be determined by factors like further measures by the government towards controlling inflation (and cement prices) and demand growth, which in turn have a direct fallout on cement prices. Lastly, PE (valuations) of most cement stocks are neither cheap at over 11 times their estimated 2007-08 earnings.