Planning to invest in cement sector? Take a look 2 stocks with 20-30% 1-year upside

Over the last month, we have seen a 5-37% rise in cement stocks. Rising hopes of a higher consolidation in the Indian cement industry are behind the recent run-up in the stock prices.

Most of the bigger players are eyeing inorganic growth opportunities, which have gathered pace after the foray of the Adani group into the Cement business.

For instance, Shree Cement, as per media articles, is exploring inorganic growth plans in central and south India.

Consolidation in the industry, if it occurs, will boost: 1) pricing power, 2) synergies in the form of cost reduction and operational efficiency; and 3) cross-branding, which will help expand market reach.

Given the aggression shown by larger players in expanding capacity and the changing industry dynamics, there can be a capacity acquisition of 45-50 mtpa over the next two-to-three years.

M&A activity in the sector has led to increased consolidation in north, central, and east India over the last few years. While west India saw a de-consolidation due to the entry of new players (such as Dalmia Bharat, Birla Corp, and Shree Cement, with combined capacity addition of 10mtpa), the South remains the most fragmented market with a capacity share of ~43% for the top five players in FY23E.

The acquisitions (JP Group’s cement plants, Binani Cement, and the cement business of Century Textiles), as well as organic expansions (including the ongoing phase I expansion of 19.9 mtpa), have helped Ultra tech emerge as the largest player in terms of installed grinding capacity across regions.

Based on capacity expansion announcements (organically) by cement players till date, the top five players will continue to register a higher installed capacity CAGR of ~8% over FY22-25E v/s ~3% for the rest of the industry.

The installed cement capacity of the top five players clocked 7% CAGR over FY17-23E v/s a CAGR of 2% for the rest of the industry. As per the Herfindahl–Hirschman index, the consolidation in the Indian cement industry improves over FY20-23E.

We expect consolidation in the cement industry to increase further through the organic and/or inorganic routes.

Given the aggression shown by large players to expand capacity and changing industry dynamics, there may be an acquisition of 45-50mtpa Cement capacities over the next two-to-three years.

The replacement cost of cement plants is in the USD 100-120/t range, with the acquisition of good assets historically at USD 106- 151/t. Many mid/small-sized companies are trading at an EV/t of USD 45-87.

However, the actual valuation will depend on asset quality, the strategic needs of the buyer, and the bargaining power of the seller.

The anticipation of bigger acquisitions in the industry is driving the valuation rerating of regional and smaller players, which are trading at a discount to replacement cost.

Historically, a valuation premium is assigned to assets based on their ability to generate cash flows and/or their market presence or operational efficiency.

Ultratech Cement: Buy | LTP Rs 6,198 | Target Rs 7,515 | Upside 21%
Ultratech’s capacity expansion plans, along with scope for an improvement in utilisation of existing capacities, offer strong growth visibility.

We expect a growth of ~9% in sales volumes in FY23-24. An increase in WHRS/solar capacities in green power usage to increase to 36% by FY25, along with the scope for reducing lead distance with better capacity planning, will help it to structurally improve its cost structure.

We expect it to trade at higher-than-historical multiples, given its leadership position and strong growth opportunities.

Birla Corp: Buy | LTP Rs 996 | Target Rs 1,275 | Upside 28%
Birla Corp has been consistent with its capacity addition plans through both organic and inorganic routes. The management aims to expand the installed capacity to 30mtpa by CY27E (current capacity: 19.5mtpa).

We expect leverage to improve going forward as management’s continued focus on capacity expansion should drive a re-rating in its valuation multiples.

(The author is Head – Retail Research, Motilal Oswal Financial Services)