‘Replacement cost’ theory leg-up for cement shares

MUMBAI: The bloodbath witnessed on the cement counter due to the Centre hiking the excise duty (on retail prices exceeding Rs 190) and the subsequent move by the industry to go in for a price freeze has begun to attract value hunters, though the broad sentiment about the sector remains negative.

In its report, Macquarie Research has said the huge value erosion witnessed after the government’s decision to regulate prices has provided a buying opportunity since the prices are near their replacement cost.

Prices of frontline cement stocks have slipped by as high as 15-17% since the beginning of the month on government’s attempt at reining in inflation by controlling cement prices. The sector has seen almost across-the-board downgrading. “While others (brokerage houses) are concentrating on cost, we are not.

Our bottomline estimates are higher than the Street’s. We see current valuation of the cement stocks as attractive,” said Rakesh Arora, who co-authored the Macquarie report. For FY08, Macquarie expects ACC’s net profit at Rs 1,886 crore. In contrast, brokerage Edelweiss’ estimate is Rs 1,336 crore. Macquarie says Gujarat Ambuja and ACC derive 18-19% of their production from excise-exempt units and, hence, less affected by the excise duty hike.

Another brokerage having a contrarian view on the sector is Religare, which feels the price freeze for a year will not affect profitability as feared since the current prices are 5% to 7% lower than the landed cost for imported cement. “So there was scope to raise cement prices further by only 3-5% whether industry announced price ceiling or not,” says Religare.

The naysayers don’t expect demand to be impacted. “Pricing is our main concern. There is no doubt on robust demand but our call is due to the negative sentiment on government’s attempt to regulate prices,” says Manish Balwani of Emkay Share. However, according to Rakesh Valecha of Fitch Ratings, the negative view on the sector has less to do with price freeze and more to do with additional capacity.

“From the credit perspective, we are more concerned about capacity (addition). By the second half of the year, fresh capacity would come up, which anyway would bring prices down. Excise hike and prize freeze are temporary blips,” he said.

Analysts believe the sector heading for a supply surplus situation in FY09, by when close to 80 million tonnes of additional capacity would come on stream.