Two beaten-down sectors to pick winners from INSIGHT
The cement industry has suffered overcapacity for years. This led to low margins for every company and, despite consolidations, the situation has persisted for long. The Q1 of 2016-17 might indicate the industry is turning a corner. However, it may be noted that in some cases, the sequential performance compared to Q4 of FY16 is not so strong though that could be due to seasonal factors.
Most of the listed cement majors have registered decent profits even though revenues did not grow a great deal. In year-on-year terms, ACC’s profit after tax (PAT) is up by 79 per cent in Q1, FY2017, while Ambuja Cement has seen a 76 per cent rise in PAT and UltraTech has profits up 29 per cent. Shree Cement has seen PAT rise by 316 per cent and Prism Cement is among several turnarounds, with the losses of a year ago transformed into profits.
Cement shares have been outperformers on the stock market as well, in the past month. Share prices of most of these companies have beaten the index. ACC for example, has risen by over five per cent in the past month, while the Nifty is up only by about 1.5 per cent. Ambuja is also up five per cent, Shree Cement is up by six per cent. UltraTech is up 11 per cent, though the scenario here is complicated by the Grasim merger with Aditya Birla Nuvo (since Grasim holds substantial stake in UltraTech).
The industry saw a lot of consolidation in 2016. Nirma bought Lafarge, paying ~9,400 crore. UltraTech bought out Jaiprakash for ~16,200 crore and Birla Corp bought out ADAG’s Reliance Cement for ~4,800 crore.
The industry has a lot of big players and customers are price-focused and convenience-focussed (fast delivery, etc), rather than brand-conscious. The reasons cited for better sector performance are centred on cost reductions. Power costs have come down substantially and so have freight costs for much the same reasons — lower fuel prices. As power is a huge input cost and freight is also a substantial input, margins are up. On the demand side, affordable and rural housing is one thrust area while infra projects are also supposedly looking up. The volumes of despatches did grow about five-six per cent in Q1, FY17 compared to the corresponding quarter of 2015-16.
Since most cement companies have delivered improved financials, the market has discounted at least some of the positives. But, if cement demand is indeed sustained, this also implies the construction industry should be doing well in the next phase.
That would be interesting since construction contains a large number of medium-sized players with messy balance sheets. Many construction companies had tried to move up the chain and become operator/developers of infrastructure projects. Most suffered reverses with projects stalled and the companies being stuck with large debts. There have been desperate attempts to deleverage by selling off assets. A pickup in construction activity could lead to a sector-specific bull run.
If construction does recover, it should also mean a pick-up in steel consumption, since construction activity creates demand for both steel and cement. The steel industry has also been in bad shape and there may be a sector specific bull run there if there is an uptick in demand. Going forward, the chances of picking up big winners in those two beaten-down industries is perhaps even higher than the chances of picking up big winners in the cement industry.