Macquarie Raises Earnings Forecast For Cement Firms; Lists Top Stock Bets

Macquarie sees “solid demand growth with stable margin” for India’s cement makers in the upcoming financial year while it raises earnings estimates and price targets.

“Demand has held up better-than-expected, and we estimate only a modest 3% decline in FY21 (10 percentage points above our May 2020 forecast). We expect this to be followed by a solid 13% FY22 growth helped by the government’s focus on infrastructure, healthy rural demand and a potential recovery in urban housing, apart from a low base,” the investment banking company said in a report. “Against this backdrop, we expect our covered companies to deliver superior 14-24% growth.”

Macquarie bets on companies with potential savings from cost efficiency initiatives and deleveraging potential. It listed UltraTech Cement Ltd. as its top pick from the sector, followed by Ambuja Cements Ltd., Dalmia Bharat Ltd. and ACC Ltd. It has maintained its ‘neutral’ rating on Ramco Cements Ltd. on rich valuations.

“We raise FY22 and FY23 Ebitda estimates by 0-6% and 2-6% (ex-ACC) and our residual income-based target prices by 0-25% on the back of earnings,” it said.

The Margin Factor

Margin for cement makers expanded in FY21, driven by a focus on cost reduction and price hikes to support cash flow. According to Macquarie, the street is factoring in a margin contraction on a year-on-year basis for FY22 and remains concerned about the downside risk from input cost inflation.

The financial services provider, however, said the cement price will be resilient amid rising demand and an inflationary cost environment, which is reflected in the 3-6% price hike in March 2021. “Historical analysis confirms that in a rising cost scenario, the industry has largely defended margins through price hikes,” Macquarie said.

Pricing Outlook

Macquarie factors in a 0-1% price hike in FY22E for its coverage universe compared to FY21, and 1-2% increase in FY23 as the industry looks to offset cost pressures owing to higher input costs. “FY23 price hike is supported by continued uptick in capacity utilisation as capacity growth continues to lag demand growth,” it said.

Region-wise, Macquarie expects cement prices in south to decline year-on-year in FY22, but sees this trend to reverse as demand improves. Ramco Cement’s FY22 realisation is likely to decline 3-4% year-on-year, given the highest exposure in this region. “In addition, Ramco’s blended realisation and Ebitda per tonne will reflect rising share of east in its overall volume on the back of ongoing capacity expansion.”

Concerns Over New Capacity

According to Macquarie, investors have highlighted new capacity addition announcements as an earning risk. The research firm, however, don’t see these as a risk to FY21-23 earnings, given their commissioning timelines.

Even after FY23, Macquarie views the capacity addition pipeline in the context of:

• About 70% pipeline is from the top six players compared to their share at nearly 40% in capacity added over FY11-20.
• Close to 50% of the pipeline is driven by over 85% utilisation for the company in a region where capacity is added.
• Clinker capacity addition continues to lag cement capacity.

“We estimate the share of the top six players to increase further, which bodes well for cement prices,” the note said.

Top Picks

• UltraTech Cement: Maintains ‘outperform’ rating and hikes price target to Rs 7,848 apiece from Rs 6,633. Top pick given strong volume growth, deleveraging and focus on cost efficiency.
• Shree Cement: Downgrades to ‘neutral’ from ‘outperform’, but hikes price target to Rs 29,835 apiece from Rs 27,331. Superior RoE versus peers, high growth profile and strong balance sheet. Await better entry point as upside is priced in.
• Ambuja Cement: Maintains ‘outperform’ rating and hikes price target to Rs 336 apiece from Rs 325. Likes Ambuja due to expansion-led volume growth and cost focus through optimisation programme and master supply agreement with ACC.
• ACC: Maintains ‘outperform’ rating and cuts price target to Rs 2,080 apiece from Rs 2,088. Cost focus and trades at a valuation discount to peers.
• Ramco Cement: Maintains ‘neutral’ rating and hikes price target to Rs 1,019 apiece from Rs 911. Reflects a rich valuation at 13.2x FY23 estimated EV/Ebitda. “While we acknowledge its cost efficiency, its predominant exposure to south (about 90% of total capacity) will lendEbitda volatility.”
• Dalmia Bharat: Maintains ‘outperform’ rating and hikes price target to Rs 1,802 apiece from Rs 1,436. Rating reflects expansion and valuation upside from a favourable court judgment.

Key Risks

• Weaker-than-expected volume growth led by slower macro recovery and / or increased risk of Covid-19 cases leading to slower growth.
• Lower-than-expected cement prices with large players focusing on volume growth relative to margins.
• Higher-than-expected cost rise and inability of the industry to pass it on in a weak demand scenario.
• Weaker-than-expected earnings momentum to lead to stock de-rating.