We are reiterating our positive view on the Russian cement market and see Sibirsky Cement's recent sell-off as overdone on excessive fears of a market downturn and corporate governance concerns. In our view, the stock is likely to re-rate once these fears start to abate.
Positive market to create a supportive environment. In our view, the worst fears regarding the Russian cement market's downturn are unlikely to materialise and Russia's cement demand is to increase 6% in 2012 to reach the pre-crisis peak of 61mnt. We also project that cement consumption will rise at a CAGR of 5% in 2011-21F, driven by construction activity and infrastructure challenges. We believe this will create a supportive environment for Russian cement producers.
Sibirsky Cement appears oversold. We believe that Sibirsky Cement has been badly oversold recently, as the general market worries were exacerbated by corporate governance concerns. While the company's involvement in regional M&A activities might have increased the already elevated risks, we believe that the scope of the recent sell-off was incommensurate with the changes in the risk profile.
Hefty upside in Sibirsky Cement despite the TP downgrade. Factoring in the additional risks accounts for most of our 24% downgrade of Sibirsky Cement's 12-month Target Price to USD 25.8. However, this price still offers 73% upside to the current level and the stock remains our top pick in the Russian cement universe. The company also trades at 42-50% discounts to international peers at 2012-13F EV/EBITDA multiples of 4.1x and 3.5x, respectively.
Hold on Gornozavodskcement, coverage of Iskitimcement is discontinued. We remain holders of Gornozavodskcement (TP raised 10% to USD 270, 3% upside) and are discontinuing coverage of Iskitimcement due to its acquisition by Russian Cement Company.
Key risks. The state of the Russian economy and the resulting cement market environment pose key upside and downside risks. Corporate actions could also result in both positive and negative surprises.
Russian Cement Market: Little Reason for Pessimism In our view, the latest trends on the Russian cement market provide little reason to be overly cautious about its near-term prospects, which appeared to be the key investor concern in 2H11. For example, Russia's total cement production in December 2011 and January 2012 increased more than 20% YoY and was equal to the volumes produced in December 2007 and January 2008, when cement markets were clearly overheated. We expect the growth in Russia's cement consumption, which rose 15% YoY to 57mnt in 2011, to slow down to 6% in 2012. Nevertheless, this implies a recovery of cement consumption to the precrisis peak of 61mnt that was registered in 2007. We also remain fairly bullish on Russia's cement market in the coming years and project that consumption will increase at a 5% CAGR in 2011-21F to reach 90mnt in 2021F on the back of expanding construction activity and infrastructure development. At the same time, we believe that the market will remain balanced in terms of demand and supply. This sets a good foundation for the continued improvement of the cement producers' capacity utilisation and financial performance.
Sibirsky Cement: Unjustified Victim of Two Phantoms?
Sibirsky Cement remains our top pick in the Russian cement universe. The stock has lost 37% since its latest peak of USD 26.65/share that was registered in mid-July 2011. Meanwhile, the decline of the RTS index over the period was just 11%. In our view, this was the result of a confluence of exaggerated fears of the cement market's downturn on the back of external headwinds and increased concerns about corporate governance at Sibirsky Cement due to its involvement in quite non-transparent M&A activities in Siberia.
Our current view on the Russian cement market implies that the fears of its significant downturn in the coming months are likely to be unjustified. We believe that the beginning of a seasonal pick-up in construction activity in the spring will further confirm this thesis. Sibirsky Cement is well positioned to capture the future growth of cement demand in Siberia. This underlies our forecasts of the company's revenues and EBITDA showing a 2011-21F CAGR of 8% and 10%, respectively.
Thus, the investment case for Sibirsky Cement boils down to corporate governance, i.e. whether any recent changes in this area justify the recent selloff.
First, we note that even before the recent decline, high corporate governance risks had always been built into Sibirsky Cement's valuation due to the company's poor track record on this front. Second, while the latest developments have clearly increased the risk of abusing minority shareholders, this has not resulted in any clear cases of this so far. Third, we believe that the extent of the recent sell-off implies that massive abuses, such as the sale of Sibirsky Cement's key assets to obscure entities at discounted prices or value destruction through transfer pricing, are unlikely to materialise. Fourth, we believe that the market is still overlooking the potential benefits of the Siberian cement market's consolidation and the end of a bitter corporate conflict between its two major players. These considerations lead us to believe that the stock's current price factors in excessive corporate governance risk.
For the time being, we have refrained from incorporating any benefits into our model. Moreover, we have increased our corporate governance risk premium to the maximum level of 5% to address concerns in this area. Along with the delay of some value accretive projects, this resulted in a 24% decrease of our 12- month Target Price for Sibirsky Cement to USD 25.8. This new target price nevertheless implies 73% upside to the current level, and we are thus reiterating our Buy recommendation for Sibirsky Cement.
Recovery on Track The Russian cement market has seen a notable recovery in 2011, with cement consumption rising 15% YoY to 57mnt, just 4mnt below the pre-crisis peak of 61mnt registered in 2007. Had it not been for the logistics constraints, mostly related to shortages of rail cars during the peak seasonal demand in the summer, the annual result could have been even higher. The positive trend was also supported by rising cement prices, which increased 22% YoY in rouble terms to RUB 2,607/tonne (USD 89/tonne), though they remained some 23% (35% in USD terms) below the pre-crisis peak of 2008.
We note that 2012 also started on a positive note. In particular, Russia's January cement production increased 24% YoY to 2.7mnt. Russia's average cement price went down 5% MoM in January to RUB 2,658 per tonne (USD 84/tonne), but it remained 22% above the January 2010 level. We believe that this decline hardly sends any worrisome signal as January is traditionally the weakest month for cement producers, while the trend in volumes was encouraging. Overall, we believe that a scenario of a market downturn on the back of external headwinds is unlikely to materialise this year, and we forecast cement consumption in Russia to grow 6% to 61mnt. This should set the stage for further improvement of the financial results of Russian cement producers.
Demand Forecasts Overall, we remain bullish on Russia's cement consumption in the coming years that is likely to be driven by residential construction and infrastructure development while being further supported by non-residential construction. In particular, according to our estimates residential completions are to increase at a 6% CAGR in 2011-16F, while Russia's spending on infrastructure would grow at a 13% CAGR in USD terms, with the bulk of this investment being spent on roads and railroads.
We note that the government has set much more ambitious targets in these areas. For example, it plans to commission some 100mn sqm of residential area in 2016 vs. our forecast of 82mn sqm. Meanwhile, the Transportation Federal Target Programme envisages total spending on infrastructure reaching USD 258bn in 2015F, or 10x our forecast for the year of USD 26mn. However, given the past implementation track record and the government's ambitious spending plans in other areas, we prefer to stick to our more cautious projections.
Nonetheless, even our more conservative assumptions imply the continuation of an uptrend in cement demand in Russia. Moreover, given Russia's international commitments, such as the World Cup in 2018, we believe that large-scale infrastructure projects will be given priority even in the event of any potential adverse economic developments (this actually happened in 2008-09, when the government continued to fully finance the preparations for the 2012 APEC summit in Vladivostok and the 2014 Winter Olympics in Sochi). Overall, we believe that the catch-up with peers will continue to drive Russia's ascent along the per capita consumption curve in the years to come on the back of economic expansion.
According to our estimates, Russia's cement consumption is to grow at a 5% CAGR in 2011-21F to 90mnt. We also project that on a per capita basis it will stabilise by the end of our forecast period at over 600kg. While this per capita demand roughly coincides with the upper end of the curve in Figure 6, we note that it still falls far below the current levels of such nations as Turkey (669kg), Iran (743kg) and Korea (984kg), not to mention the world's largest cement market, China (1,377kg). This leads us to believe that our consumption forecasts could prove conservative and be exceeded at a certain point, given Russia's vast territory and development challenges.
Supply Projections Russia's cement production increased 11% YoY to 56mnt in 2011. Given the country's cement capacity of 79mnt, this implies capacity utilisation of 71%. We also continue to believe that due to the local nature of cement markets, logistics and raw material bottlenecks, high wear and tear as well as other factors, the available capacity is in fact lower. Specifically, we estimate that the available capacity utilisation stood at some 81% in 2011.
In 2010-11, Russia saw its first notable cement capacity additions since the disintegration of the USSR. We believe that the process of capacity upgrades and expansions will continue. While the number of announced new projects remains significant, we included into our model only those projects that we believe have a fair chance of being implemented. Overall, we see net capacity additions in 2011-16F at 24.5mnt (of this, over 5mnt of net capacity was launched in 2011), which would bring the total capacity to almost 100mnt.
Overall, we believe that these capacity additions suffice to meet our projected growth in cement demand. We also envisage a certain increase in cement imports in the coming years that are likely to balance the market if either demand exceeds our projections or we see a delay in capacity additions. Our current forecasts do not imply any significant tightness of the Russian cement market in the coming years with available capacity utilisation hovering around 80%, which is a normal utilisation level for the industry.