Following Adani’s foray into the cement business, the opportunity for mergers and acquisitions (M&A) is far and few, believes foreign brokerage house UBS. For a sector that is seen as a proxy to play the India infrastructure story, analysts are playing it by the ear on cement stocks. Competition is likely to intensify with about 110 million tonnes per annum (MTPA) of capacity coming onstream in the next 2.5 years versus incremental demand of 70 MTPA.
Following the $6.5 billion acquisition of Ambuja Cements and ACC, Adani has emerged as the second largest cement manufacturer of cement with a capacity of 67.5 MTPA compared with market leader Ultratech which has a capacity of 131 MTPA.
Analysts Nikunj Mandowara and Pramod Kumar believe cement companies will have to resort to defending market share in the face of increasing overcapacity. While Ultratech is adding 4 MT capacity (primarily grinding units) in FY24 through debottlenecking and another 22.6 MT capacity by FY25/26, Adani plans to double its consolidated capacity to 140 MT in five years. “Unlike consensus, we see little scope for value-accretive M&A for the top-five firms,” state the analysts.
An analysis of the next 23 largest firms --- which account for 44% of FY23 capacity in the industry --- reveal they also have good performances and capacity expansion plans. UBS feels that there is limited incentive for the top 6-28 companies as the balance sheet strengths provide a buffer to absorb margin hits from weak pricing. “We believe notable market share gains from the top 6-28 companies remain difficult for the top-five firms – organically or inorganically. This raises the threat of overcapacity or expansion lagging guidance,” states the report. The top-five firms (47% of the sector's FY23 capacity) guide for aggressive capacity expansion at 8-14% CAGRs in the next 5-7 years, in comparison cement volumes have grown at 5-6% CAGR or 1-1.2x GDP over the past three decades, creating excess capacity risks.
While cement stocks have seen a mixed performance over the past one year, UBS believes there is a de-rating risk as cement stocks are trading at 15x one-year forward EV/EBITDA and 30x FY25E PE. For a sector tracking close to GDP growth rate, rising competition, low entry barriers and return profile of low double digits, UBS sees little room for potential upside. With demand likely to slow after the general elections in May 2024, and fresh capacity is rising fast, UBS feels any rally in cement stocks should be used as an opportunity to sell the stocks. While cement companies will remain operationally robust in FY24, weakening prices and profits amid moderating volume growth will kick in from FY25.
While the material price hikes have failed to sustain, a fall in fuel prices is likely to support margin in the upcoming quarters but not enough to keep stock prices on the boil. Despite robust demand and high-capacity utilisation levels, pricing in seasonally strong Q1 FY24 was under pressure, being flattish to negative versus the 3-4% QoQ average growth over the past 10-years. The pressure will persist as an additional capacity of roughly 110 mt over the next 2.5 years will negate incremental demand of about 70 mt expected over the same period. As a result, the top-five companies are trading at significant premiums to the mid and small caps.
A report by Nomura too sounded sceptical about the sector’s prospects in the interim with the brokerage stating that in the absence of pricing power and low utilisation levels, return on capital employed for the industry will be depressed amid rising capital deployment.
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