ndian Cement Sector - Is this the first sign of a pickup in real demand?

Deutsche Bank - Equity Research

* Sharp pickup in December 2008 demand - first signs of a revival?

Our channel checks with major cement producers suggest that cement dispatches in December 2008 were +12-14% yoy and +12-14% mom. More importantly, inventory levels for plants/dealers fell sharply and are close to zero for many plants.

What is likely pre-election spending by state governments (such as for a few big infrastructure projects and the renewal of many stalled projects) helped to boost demand. Shree Cements and Grasim are our top picks, though pure plays such as ACC and Ambuja Cement could do better near term.

* Restart of several big ticket projects; could be pre-election demand

Our talks with cement marketing companies and dealers suggest that demand has been boosted by state government project restarts including (a) the sewerage line project in Punjab; (b) the national irrigation project in Haryana and Andhra Pradesh; (c) roads, bridges and other infrastructure projects in Gujarat; (d) the concretization of roads in Delhi; and (e) offtake for the Bangalore Metro in Karnataka. This seems to be pre-election demand and is likely to sustain at least until May 2009. A few dealers remarked that a lot of infrastructure projects have restarted as current commodity prices make these projects look profitable for developers.


* Operating profits for cement companies could sustain over next few quarters

A 10-15% correction of average retail prices impacted ex-factory realization by only 5-7% as government had cut down excise duties. Our earnings estimates, assuming a further 5% drop in cement realisations and virtually constant energy costs, are 14-33% below consensus except for ACC and India Cements.

* Reiterate Buy on Grasim, Hold on ACC; Shree Cement is our top mid-cap
pick.

We have used a combination of bottom of cycle PE and DCF for valuations. Our cost of equity ranging from 13.1 for ACC to 13.8 for Ambuja ( risk free rate of 8.7%and beta of 0.8 to 1) with a terminal growth of 1-2%%. Our target price implies that cement stocks are at a discount to replacement value by 17 to 66% Our preferred picks are Grasim (TP Rs1,340 +9% upside potential) and Shree cement (TP Rs560 +15%upside potential).

We maintain Hold on ACC, Ultratech, India Cement and Ambuja.

Key downside risks are a collapse in demand and the bunching up of new capacities. Upside risk stems clearly from low fuel prices and delay in new capacities.