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Sector at cross roads; competitive intensity to rise going forward 

The Indian cement sector is at the cross roads. With the entry of large conglomerate Adani Group in this space, market participants are divided about the way forward on the sector dynamics. Based on our industry interactions, we simulate two scenarios which are likely to pan out as a result of the Adani’s entry – i) Aggressive capacity addition to increase competitive intensity and keep sector profitability muted and ii) Profitability to be prioritised over volumes, thus keeping realisations steady or better. While industry participants favour scenario 2, we believe scenario 1 is the most likely one to pan out. The larger players are expected to experience a tug of war for the market share and the push on volumes will drive a demand CAGR of 9% over FY22-24E. However, volume growth will be accompanied by decline in the profitability as the players undercut each other. The smaller players are expected to witness a deterioration in the fundamentals – cash flows and return ratios, thereby derailing their capacity expansion plans. Further, with the deterioration in the fundamentals, smaller players could become acquisition with strong regional presence. In terms of valuations, current trading multiple of the sector is higher than the long term median multiple. We continue to remain positive on large caps – Ultratech and Shree continue to be preferred picks. We also prefer ACC owing to the benign valuations.

Scenario 1 – Volume push by the players will lead to higher competitive intensity:

With the entry of Adani, we believe the competitive intensity will rise and the larger players will continue to struggle for market and capacity share. The large players will push volumes at the cost of pricing thereby impacting profitability of the sector. As a result, the volumes are expected to report strong volume growth at 9% CAGR over FY22-24E on the back of demand from infrastructure and housing segments. Additionally, infrastructure spending in FY24 (pre-election year) will drive the volume growth during the period. While EBITDA/t is expected to decline by INR 300//t over the same period driving the deterioration in the fundamentals of the sector – return ratio profile and cash flow to deteriorate. While larger players will keep adding capacity to the tune of 25-30MTPA annually, deterioration in the cash flows of smaller players will impact their capacity addition plans. Current trading multiples are at or higher than the long term median multiples for the sector. Additionally, deteriorating fundamentals will also lead to smaller players being target for the acquisition by the larger players. Our preference in this scenario is towards large cap players. Our top pick for the sector will be Ultratech (market leader) and Shree cement (cost leader with market leadership in North). Further, ACC is also a preferred pick on the back of benign valuations.

Scenario 2 – Profitability takes precedence over volumes:

Given the high price paid by Adani to buy the stakes in ACC and Ambuja, few participants believe that sector will prioritise profitability and return ratios over volumes. As a result, the volumes are estimated to remain stable over FY22-24E accompanied by the strong price uptick driving the improvement in the EBITDA/t by INR 100/t over the same period. Despite the rising profitability, RoEs and RoICs are expected to decline marginally over FY22-24E from 14.5% to 14.7% to 11.6% and 13.5% respectively. Additionally, the capacity addition speed is expected to moderate and the current capacity pipeline will be delayed as the players focus on improving utilisation at operational plants. We believe, the smaller players will benefit more in this scenario driving the improvement in return ratio profile, cash flows and capacity addition pipeline. The trading multiples are below the long term median multiples for the sector. Our preference in this scenario will be towards small and mid sized players – JK Cement, Orient Cement and Sagar Cement, which may re-rate.

Scenario 1 is most likely – Ultratech, Shree and ACC are the top picks:

We believe with the entry of Adani Cement in the Indian cement sector, the competitive intensity will rise. The struggle for the market share will lead to deterioration in the profitability and fundamentals of the sector. As a result, we continue to remain positive on the large caps. Our top picks for the sector remains Ultratech and Shree owing to their leadership position in the market. We also prefer ACC owing to the benign valuations.

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