The average 15% y-o-y rise in October dispatches is a positive surprise. However, a lot of brokerages still maintain that there is more pain ahead for cement

•  ACC reported a 14% rise in sales for October to 1.92 million tonnes (MT). During January-October, both ACC's sales and production were down 2% at 17.51MT and 17.55MT, respectively.
   
• Ambuja Cement reported a 17% rise in production and 20% rise in dispatches for October at 1.75MT. For January-October 2010, its production was up 8% and dispatches by 9% to 16.9MT.

• UltraTech's October production was up 18% at 3.5MT and sales were up 21% at 3.4MT while April-October production was up 6% at 22.1MT and sales were up 6.5% at 22MT.

Even after the strong October performance, brokerages continue to be bearish by and large. In a note to its clients, Macquarie Research said, "Cement stocks have done well on the back of a sharp rise in cement prices and have even absorbed the substantially below-estimate results, also in hopes of things bottoming out. We think that today's news of cement dispatch growth in excess of 15% for October is the last of the positive news for some time. We are already hearing of price declines and think this is a good opportunity to book profits."

The note points out that cement companies have been forced to cut prices in the North as demand has failed to take off after the Commonwealth Games. Eastern India and MP have also been struggling for the past two weeks to enforce the last price increases and are likely to see discounts being offered. It said that its channel checks in the south indicated that some companies are offering cement at a 10% discount to market prices. "It is only a matter of time before these artificially-raised prices collapse, in our view."

October dispatches could have been surprisingly high because of stockists and dealers hoarding inventory in light of potential price increases, believes Macquarie. It points out that year-to-date, the demand growth remains a paltry 5.5% against full-year expectation of 9%-10% and capacity utilisation has remained around 73%-74%.



Emkay says the October sales are higher because of pent-up demand since the rainy season disrupted construction work across the country and also a favourable base effect.

"Can the industry cut production and match the lower demand?" the Macquarie note asks and concludes that producer discipline has historically never lasted beyond three months - so, no. Emkay points out that close to 65MT of new capacity has been added over the past six quarters (Q1FY10-Q2FY11), i.e., an average addition of close to 11MT every quarter. More capacity is being commissioned. "We estimate close to 33MT of new capacity additions over the next six quarters, resulting in an average addition of 5.5MT per quarter," says a note to its clients.

Macquarie does not expect costs to come down even if cement prices were to sustain and therefore, it is more likely than not that margins would continue to decline. Cost increases were the key surprise in the September quarter cement results and the biggest disappointment.

Valuations, too, are expensive, opines Macquarie - at 15-19x price-to-earnings with no expected earnings growth for two years, stocks seem expensive. Emkay also says that valuations are expensive for Ambuja Cement and UltraTech.



Of course, not all brokerages are as negative. Religare believes that, "H2FY11 and FY12 are likely to have strong dispatch numbers given the low base, pick-up in construction activity, new launches in real estate, and rising rural incomes. This in conjunction with the recent price hikes is likely to support strong profitability for cement majors in the coming quarters. Although cement prices could decline going forward, they are likely to remain stronger compared to Q2FY11."

(This article is based on secondary research. The report is for information only. None of the stock information, data and company information presented herein constitutes a recommendation or solicitation of any offer to buy or sell any securities. Investors must do their own research and due diligence before acting on any security. Some of the opinions expressed in this article are the author's own and may not necessarily represent those of Moneylife).