UBS assumes negative view on cement sector amid rising competition, expensive valuations; downgrades UltraTech, Ambuja

Cement stocks such as Ultratech Cement, ACC, Ambuja Cement and Dalmia Bharat declined on Wednesday after foreign brokerage firm UBS assumed coverage of India’s cement sector with a negative outlook.

Going against the consensus view, UBS has this contrarian negative outlook of cement stocks on the back of rising competition and expensive valuations.

Shares of Ultratech Cement fell over 2%, Damia Bharat declined 1.5%, while ACC and Ambuja Cement decreased over 1% each. 

UBS analysts Nikunj Mandowara and Pramod Kumar expect strong earnings for cement companies in the next two quarters to be driven by robust demand and margin tailwinds. However, they cautioned that any sharp uptick in stock prices could offer a good opportunity for booking profits. 

“Strong demand is likely to slow after the general elections in May 2024, and fresh capacity is rising fast and likely to exceed medium-term demand, in our view. We expect players to resort to pricing to grow or defend market share, as Adani’s entry to the sector significantly intensifies competition,” UBS said in a report.

Also, contrary to consensus, the brokerage sees limited room for value-accretive M&A.

“With valuations of 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, we see little room for potential upside. Structurally, we would sell any rally, not buy the dip,” UBS said.

UBS has a ‘Buy’ rating on ACC, while it downgraded Ultratech Cement to Neutral and Dalmia Bharat and Ambuja Cement to ‘Sell’.

The brokerage house has a target price of ₹2,200 per share on ACC, ₹8,900 on UltraTech Cement, ₹440 for Ambuja Cements and ₹2,190 for Dalmia Bharat. 

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The brokerage firm noted that despite strong demand and high utilisation, cement prices were flat in Q1FY24, in what is normally a strong quarter for price hikes. 

Pricing is where it sees the big negative delta in the medium term: competition is likely to intensify with about 110 mtpa of capacity coming onstream in the next 2.5 years versus incremental demand of 70 m. 

“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, whereas cement volumes in India have grown at 5- 6% CAGRs or 1-1.2x GDP over the past three decades, creating excess capacity risks,” it said.

Moreover, facing overcapacity, it expects companies to defend their market share. It believes 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. Both are de-rating risks for an expensive sector in the 90th percentile of its five-year valuation range,” UBS said.

Large cement companies are trading far above replacement costs and high return midcap firms, implying expectations of strong share gains, it added.

At 12:35 pm, shares of UltraTech Cement were trading 1.42% lower at ₹8,208.25, ACC was trading 0.10% higher at ₹1,785.00, Ambuja Cements was down 0.29% at ₹418.40, while Dalmia Bharat was trading 0.29% higher at ₹2,073.65 on the BSE.

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