Investment outlook -- Watch out for sustainability

Recommendations:

Gujarat Ambuja Cements: Hold

ACC: Hold

India Cements: Sell

Madras Cements: Sell

Larsen & Toubro: Sell

Grasim Industries: Hold

WHAT LOOKED like an extremely tough year for the cement industry about a couple of months back has now turned out to be a pretty good one.

At least that is how the picture may be in the October 2000-March 2001 period. The industry players have the carefully managed uptrend in cement prices to thank for such a position.

The effect of the sharp increase in cement prices has already been felt in the October-December quarter. Virtually every company with the exception of Gujarat Ambuja Cements and Dalmia Cements has turned in an impressive earnings growth.

At the outset, any investment from a medium-to-long-term horizon cannot be based on the latest quarter performance. Though the industry has been providing indications that the price trends may be here to stay, a question mark would have to hang over the sustainability of the price trends.

And one should not lose sight of the fact that the current prices are running on the back of flat volume growth. Production cuts and enhanced and advanced maintenance shutdowns have helped choke supplies and push up prices. In this backdrop, a certain degree of scepticism may be well placed.

Any investment decision would also have to factor in the impact of lower prices on the profitability of the companies. The recent stock price trends suggest that the market has been factoring in at least one more quarter of good earnings riding on the back of high cement price levels.

*From a long-term perspective, the Gujarat Ambuja Cements' stock continues to be the more attractive option. This is despite the fact that a question mark hangs over how the group's presence in the industry would be distributed across Gujarat Ambuja Cements, Ambuja Cement India and ACC. As for the debt burden stemming from its acquisitions, the company has managed to replace a significant part through equity/quasi-equity. Existing shareholders can stay invested. But shareholders in two other group concerns -- Ambuja Cement Eastern and Ambuja Cement Rajasthan -- can consider cutting exposures and booking profits.

*As for Madras Cements, the recent price rise and any further uptrend can be used to pare down exposures. But fresh investment can be considered at declines to the current price levels of around Rs 5,400. This is on account of the usual efficiencies, the capacity expansion through new units and the strong cash flows that could minimise debt burden. The greenfield unit strategy to grow big may provide an edge in terms of operational efficiencies without having to wait for time.

*Though ACC may appear overvalued on fundamentals as well in comparison with peers, existing shareholders may stay invested. As for ACC, at least for the next 12-18 months, the prospect of a hostile takeover bid as well the improvement in its operational efficiencies under the auspices of the Gujarat Ambuja are factors that could keep the valuation of the stocks out of line with the underlying fundamentals.

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*As for the two diversified companies with a strong presence in cement -- Grasim Industries and Larsen and Toubro, it may be better to cut exposures in the latter. Shareholders can contemplate staying invested in the former as it appears to be better placed. Also the proposed de-merger of the cement business of L&T is riddled with uncertainty. In this context, the uptrend can be used to pare exposure in the L&T stock. Though both are also restructuring stories in the making, Grasim may be the better one in terms of underlying fundamentals as well as mode of distribution of ownership claims.

Many smaller companies have seen a sharp increase in stock prices. Not all of them may become a part of consolidation exercise underway in the cement industry. Investors in stocks such as Sagar Cements, Kakatiya Cements, Deccan Cements among others can capitalise on the uptrend of the last four months to book profits.