India’s Cement Stocks On The Cusp Of A New Cycle, Says Morgan Stanley

India’s cement industry is on the “verge of beginning a new cycle” and will be in a “sweet spot” over the next two-three years, according to Morgan Stanley, on account of a strong demand outlook and their ability to regain margin.

“Over the last several years, the cement industry has not gone through any full-blown business cycle owing to events that affected growth. Over 2015-2020, there were multiple events that affected the business cycle and demand growth in the cement industry,” the global investment bank said in a note. “Assuming no exogenous events, we believe cement demand will show a strong and broad-based recovery, led by a pickup in public capital expenditure along with improving fundamentals in the housing industry.”

Morgan Stanley sees a broad-based and above average demand growth of 9% annually over FY21-23 and margins holding up on a two-year basis, despite a dip in FY22. “We will use the share price volatility to accumulate select stocks,” it said, advising investors to “play the cycle rather than focusing on near-term cement price movements”.

Morgan Stanley on cement stocks

• UltraTech Cement: Maintains ‘overweight’ rating; hikes price target to Rs 8,000 apiece from Rs 6,300.
• Ambuja Cements: Maintains ‘overweight’ rating; raises price target to Rs 360 apiece from Rs 325.
• Dalmia Bharat: Maintains ‘underweight’ rating but hikes price target to Rs 1,300 apiece from Rs 1,050.
• Grasim Industries: Upgrades to ‘overweight’ from ‘equal-weight’; increases price target to Rs 1,700 apiece from Rs 966.
• Shree Cement: Downgrades to ‘equal-weight’ from ‘overweight’ but hikes price target to Rs 32,100 apiece from Rs 26,000.
• ACC: Downgrades to ‘underweight’ from ‘equal-weight’; cuts price target to Rs 1,950 apiece from Rs 2,000.

Morgan Stanley has raised its FY23 earnings estimates for the cement sector up to 13%, owing to better realisations, margin assumptions. “We believe the street is underestimating margin potential for cement stocks in FY23. We expect margins to surprise positively during the March 2022 and June 2022 quarters and drive earnings upgrades for FY23 over time.”

Besides, the financial services provider sees room for valuation premium to expand for stronger cement firms.

“Cement stocks have done well and one-year forward EV/Ebitda multiples have rerated in the last 12 months. Current multiples are higher than the long-term average (since 2010) for the top four stocks on an aggregate basis,” Morgan Stanley said. “With improving growth visibility, valuation multiples tend to overshoot long-term averages and valuation premiums should expand for the stronger players.” Investors’ focus, it said, should shift to two-year forward EV/Ebitda and free cash flow yield, which are still attractive.

Why Morgan Stanley thinks the current cement cycle is different from previous ones…

• Capacity addition is much slower.
• Market share is more concentrated among the top five companies.
• New capacity additions are led by the top five players, which have gained good volume market share.

“We see limited room for irrational competitive behaviour in most regions, although we are more constructive on the north, central and Gujarat markets compared to the south and east,” it said, recommending Ambuja, UltraTech and Grasim as its top picks among cement makers.

Morgan Stanley’s rationale behind the upgrades and downgrades...