cement midcaps now

In an interview with CNBC-TV18, Jaspreet Singh Arora, Sr Analyst - Cement & Construction - Institution Equity at Anand Rathi Financial Services gave his readings and outlook on the cement sector.

He said that from a valuation perspective, the large caps are no longer as attractive as they were eight days back.

"Our view is pretty positive on the entire sector and the way largecaps have behaved in the last one week. We would prefer midcaps as on date," he added.

Citing his top picks from the mid caps in the cement sector he said, "Amongst the midcaps we prefer Birla Corp and Orient Paper. They are available at 1/3rd the valuation of a top player likeACC and Ambuja."

Below is the verbatim transcript of Arora's interview with Latha Venkatesh and Gautam Broker of CNBC-TV18. Also watch the accompanying video.

Q: That’s the issue. Had cement shares fallen low enough to become attractive we also heard about cement price hikes after the budget and even for that matter before the budget in the month of February. Is this indication of any improvement in fundamentals or is it just a cartelising that cannot carry on?

A: If you divide the seven stocks between largecap and midcap, the largecaps are actually instead of becoming cheap they are more expensive. So, from a valuation perspective they no longer as attractive as they were eight days back.

But, on the other side the midcaps having gone beaten down in the last three-four months and not having risen as much as some of the largecaps in the last eight days, definitely, offer some real value over there. So, basically, the valuation discount between the two has definitely widen and there is a scope of that getting narrowed.

The cement prices improved across regions barring a few pockets in central. Whether it’s a case of cartelisation or so-called corporation or understanding is something that one has to take with a pinch of salt. Surprisingly, this is one industry where when the prices rise all the players will have to giver reasons for why the prices are rising and in cases of cartelisation comes into picture.

But, when there is a freefall nobody is there to help the industry or even ask them any question on this. So coming to the bottomline our view is pretty positive on the entire sector and the way largecaps have behaved in the last one week. We would prefer midcaps as on date.

Q: The sceptic argument would be that cement prices have gone up quite substantially over the past two-three months and going forward, the demand may not catch up some much. The supply is increasing a lot, the industry is definitely going into expansion mode rather than contracting mode, their capacity utilisations have been rationalised which is perhaps helping prices at this point. What do you think, in hindsight could cement stocks begin to correct, at least the large ones, of course you are saying midcaps may have value in them still but would the largecaps correct having run up so much in the last one-two weeks?

A: Yes definitely, that’s what I said. We don’t see too much value left in the largecaps maybe our top pick in the sector is, in the pure cement play is Ambuja. We saw value between price of Rs 120-130 where it started about a month back or fortnight back. But, at Rs 150 definitely it doesn’t leave too much upside. So, is the case with ACC and Ultratech but one thing is clear.

We are the few brokerage houses who have a non consensus call. But, our call stands more from a double digit demand coming back to the system in the next fiscal year based on ways, assumptions and house calls that we have on industrial capex, infrastructure growth and the housing sector.

So that’s a broad call and the underlying assumption is also that the kinds of prices that we are seeing in the industry are there to hold. They probably may go up in the short-term slightly and then correct during monsoons. But, it should more or less stabilise in the second half.

So, for the year as a whole you might end up having between 10-15% higher prices which would be more than sufficient to cover up for the increase in cost. Therefore, there would be a case of expansions and margins.

Q: Which of the midcap cement companies do you still see value?

A: Amongst the midcaps that we track on active basis, we prefer is Birla Corp and Orient Paper. This is just based on two simple reasons; one, on cost parameter as both of them are cost affective and the other is the obvious thing on the valuation.

They are available at 1/3rd the valuation of a top player like ACC and Ambuja. This kind of valuation has never been sustained for too longer period of time. So, if one is looking at slightly more investment horizon, let’s say 9-12 months we would definitely recommend some of the midcaps at this point of time.

Q: Aren’t there more expansions that will bear fruit or that will come into play in the rest of 2011?

A: The kind of expansion that were there in the last two years is more or less what the industry was anticipating till now. To give you a figure, close to 290 million tonne and we have added about 70 million tonne in the last two year.

But, going forward we will at maximum have 20 million tonne coming in FY12 and another 10 million in FY13 that is where we stop. The next big expansion will come in FY15 and FY16.

So, what we are trying to say is even though the current utilisation rates are low there will only be a case of that going up in FY12 and FY13. Simply, because the pace of supply will not be as much as the pace of demand.

Demand will be a minimum of 25 million tonne to 30 million tonne on an annualised basis between FY12 as well as FY13.

Q: Any views on Grasim, it got into the Nifty, the VSF business is doing well. What is your view on the cement business of Grasim?

A: On the cement side, amongst the largecaps where we still hold value Grasim is the only pick left which offers reasonable upside. Beyond the cement regions which is through UltraTech Holding we are also positive on the VSF story.

The way prices have moved up in the last quarter or so and the company is more or less backward integrated for its raw material requirements. We are very positive on the VSF story and we believe this is one will offer real value in the times to come.