The fundamentals of the industry have not changed; supply will continue to outstrip demand, and prices will be hit further

Cement stocks enjoyed a huge rally across the board yesterday mainly on reports of a 2% hike in western India - CLSA says cement dealers confirmed a 2% hike in Mumbai. Cement stocks went up anywhere between 3%-8%.

Somewhere there was an element of catch-up too - cement stocks have been underperforming the indices. So what does one make of this rally? Well, to be very honest, this looks like a one-off rally - and by the looks of it, it is already fizzling out. Nothing seems to have changed fundamentally.

Most brokerages are advising clients to not read too much into yesterday's rally. Today's CLSA report to its institutional clients states: "Over FY11-12, we expect effective supplies (17% CAGR) to outstrip demand (9% CAGR) which would take down industry utilisation rates to 20-year low of ~80%. Cement prices have already corrected by 10%-35% over the last 3-4 months and we expect pressures to continue over the next few quarters."

The report also says that while dealers have confirmed the ~2% price hike in Mumbai, they are sceptical about the market's ability to absorb it given demand-supply issues.

A channel check update for July by Anand Rathi just three days ago observes that while all-India production declined 0.2%, dispatches rose 2.2% y-o-y - they grew 16% in the west but declined 4% in the centre. The south was still leading in capacity additions. The report said 6 million tonnes have been added in March 2010, but is not yet reported by the Cement Manufacturers Association. All-India utilisation has dropped to 75%, (it was 85% same time last year, and 79% last month) - the south and north recorded lowest utilisation. Volume outperformers were JPA, Orient, Dalmia, UltraTech and India Cements (note that JPA has new capacity) while laggards were ACC and Ambuja. The report states, "prices in August slipped Rs8-12 a bag in the western and central regions; they have been stable in all other regions. In the south, price increases in certain pockets couldn't be sustained. Demand during July-August has eased, chiefly due to shrinking demand from construction at government projects and in real estate. Dealers do not expect any major price cuts in the next two to three months." So, in short, nothing much has changed in the last two months.

Religare has a different standpoint. The brokerage says, in a report dated 4th August, that it sees FY11 as the trough year for cement and expects prices to bottom out in the September quarter. The basis for this assumption is an expectation of an improvement in demand led by higher infrastructure and real estate off-take, rise in capacity utilisation as incremental additions ease off, and a firming up of cement prices. The report also talks of attractive valuations since stocks have corrected 8%-28% over the past four months limiting downside and M&A activity in the sector, fuelling a re-rating. None of these arguments feel right, at least at the moment - so in the short-to-medium term, the flat to negative trend in cement prices could continue.

Q1 earnings of the cement industry were almost universally disappointing. Companies with higher exposure to the south were more hit than others as this region saw both a supply increase and demand contraction. However, sequentially, most companies posted realisation gains of 2%-3% thanks to a price hike in March 2010. However, prices came under pressure once again towards June and right now, realisations are actually 5%-6% lower than they were in Q1. Investors, especially retail ones, will be well advised to stay away and just observe for the moment, at least for a quarter or so.