cement price freeze issue -toll of functioning democracy

7/30/2019 Cement Price Freeze Issue -Toll of Functioning Democracy

1/5

Event UpdateToll of a Functioning Democrary - Not the End of Story

March 19, 2007 Sector Update

Industry : Cement

Analyst:

Rajan Kumar

+91 22 22836307

[email protected]

Prices as on 16.03.07 Reco*

ACC ACCUCMP: 730.0 810.0

Grasim BuyCMP: 2017.0 2420.0

Ambuja Cement ACCUCMP: 106.0 120.0

India Cement BuyCMP: 160.0 200.0

Shree Cement BuyCMP: 917.0 1120.0

Ultratech BuyCMP: 764.0 920.0

Kesoram Industries BuyCMP: 330.0 450.0

* Target for FY08E

Movement in Cement Prices

0

50

100

150

200

250

2004

.04.30

2004

.07.31

2004

.10.31

2005

.01.31

2005

.04.30

2005

.07.31

2005

.10.31

2006

.01.31

2006

.04.30

2006

.07.31

2006

.10.31

2007

.01.31

Price

Price Freeze Issue

After a week of parleys with Finance and Commerce Ministry overprice issue, cement manufacturers agreed to hold the cement pricesat current level for one year even if the input cost rises. Besidesthey also agreed to pass on the benefit to the consumers in case thegovernment revokes the additional Rs 200 per/ton excise dutyannounced in the recent budget.

Before that the government has removed the import duty on cementand some other commodities in pretext of controlling inflation. Themove did not have any impact on cement prices as higher landedcost of imported cement and lack of infrastructure facility madeimport unviable. But the industry met with its worse fear when inFY08 budget, FM imposed dual excise duty on cement raising exciseduty by Rs200/ton for cement sold in retail above Rs190/bag. Themove backfired as cement manufacturers immediately passed onthe excise duty by raising prices Rs 12/bag across India. This led toserious spat between FM and Cement Industry leading to the saiddecision to freeze the prices at existing level.

The street has viewed it as a capitulation by cement manufacturers

over government dictat that would serve electoral interest of theruling coalition at the cost of the profit of the Industry.

We view the event just as a toll of a functional democracy where byagreeing to price freeze, Cement Industry was able to get out ofcurrent imbroglio in return for possibly some hard bargain. Letslook at what the industry got in return

Price cap when the cement prices are ruling at historic high. Noroll back of a kind that would impact existing realization/ margin.No adverse measures like ban on cement export or worse, harshmeasure like imposition of government levy on cement to besold at subsidisized price. True it takes away the possibilities of

immediate hike in cement price but Industry was not expectinga runaway price hike any way.

Cement companies to pass on the benefit of excise duty rollback: But dont be surprised that in case of duty reversal benefitmay be passed on partly by the cement companies as consumershave already tested the higher prices. Meanwhile the cementplayers would be in position to affect marginal increase inrealization through squeezing the dealers margin.

Room For Negotiation On Govt Controlled Input Cost: Besidesby conceding to the demand to freeze prices at current level, thecement companies have kept enough leeway to negotiate when

it comes to the issues like Coal Linkages.

All India Cement Price(Source : CMIE)


2/5

Event Update

2March 19, 2007 Sector Update

FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10

Cement Capacity 144 151 160 172 191 235 247

Add On Effective Capacity 142.2 150.1 157.2 165.7 180.6 208.5 244.0

Capacity Utilization 83 85 90 92 90 90 90

Production 117.4 127.6 141.8 152.9 162.5 187.7 219.6

Domestic Demand 114 121 136 150 163 178 194

Growth % 6.4 12.0 10.5 9.0 9.0 9.0

Export 3.4 4.1 6 6 5 5 5

Growth % 20.6 46.3 0.0 -16.7 0.0 0.0

Surplus (Deficit) 0.2 2.4 0.2 -2.9 -5.8 4.7 20.6

So what implication does this have on the earnings of cement companies. Very little in terms of profitability .. Yes prices would not rise..But on the cost front the cement companies are not expected to see anymajor cost inflation as most of the major cost component (Freight, Coal/Pet Coke) has stabilized and efficiency gains through savings in powerand logistics cost (Gujarat Ambuja, Ultratech, Grasim and JK Cementand Mangalam Cement) still leaves room for margin expansion... Goodenough to sustain an all time high margin. In fact many companieswould see robust expansion in margin on account of cost savingmeasures underway.

Besides the higher level of consolidation and maturity of the Industrywould ensure that capacity roll out would be in phases maintaining

pricing power. As far as reversal is concerned it is certainly not in sightin FY09. As per the timeline announced for the roll out of the cementcapacity expansion, the industry would still have to operate at above90% capacity to meet the annual consumption growth of 9% (Except forpossibly north region). Besides some possible delay due to landacquisition and Equipment supplies could further delay the capacityaddition. Further goal of 8-9% growth in Indian Economy and concomitantthrust on infrastructure would ensure that the cyclical reversal wouldbe short-lived and that price decline might not be as severe going ahead.

Correction a right opportunity to buy:

So does the current correction is an opportunity to buy cement stocks.We risk saying yes. The street is justifying the lower valuation on PE,EV/EBIDTA in anticipation of cycle reversal. But certainly cycle reversalis not in sight before FY10 and recent correction have made the cementcompanies a pure asset plays when most of them are trading either atslight premium or discount to replacement cost when their earning areat an all time high.

Impact on Earning NotSignificant


3/5

Event Update


What should be the right way to value the cement stock when pricehike would contain the profitability growth to the capability of cementplayers to expand volume and the possibility of cyclical reversal lurkingafter two years? Looking at asset values should help.

Take for example ACC trading at @730 means the stock would be valuedat 9.8 x CY07 earning and 6.5 x CY 07 EV/EBIDTA at a time when itsearning would show a growth of 31%. Even on asset valuation the stocktrades at $150/ton of its existing 19.91 million tons while with currentearnings the company would have Free Cash flow of INR 46 bn over

CY06-CY08 translating into an USD 51/ton premium on account of threeyears earning only. We have attempted to see the current valuation ofthe companies in terms of Asset Value adjusted for cash flow of threeyears (07 to 09) which throws up interesting facts about the companies.

The table gives the valuation of the companies post correction taking Q3FY07 cement prices as price forFY08.

Valuation CM P M-Cap Realization FY08 FY08 FY08Assumption

INR Rs.bn CY07/FY08 Y-o-Y E P S PE EBIDTA EV/EBIDTA EBIDTA/Ton EV/ton

ACC 7 3 0 1 3 7 3118 6 .1 74.6 9 . 8 897.3 6 .5 1031.7 1 2 5

Gujarat Ambuja 1 0 6 1 6 0 3200 5 .0 10.5 10.1 2295.5 6 . 4 1304.6 1 42

Ultratech 7 6 4 95 3114 6 .0 75.9 8 .5 1741.0 6. 8 969.9 1 4 6

Grasim 2017 1 8 4 2950 3 .3 239.0 8 . 4 4653.3 5 .5 926.5

Shree 9 1 7 31 2900 2 .7 134.5 6 . 8 787.7 4 .8 1258.2 96

India Cement 1 6 0 41 2800 2 .8 26.0 6 . 2 897.3 5 .4 922.4 97

Kesoram 3 3 0 23 2880 2 .4 68.7 5 . 0 5213.2 3 . 3 1060.0 63

Asset values of adjusted for cash flow of three years.

Capacity Replacement FCF per/ton 1+2 Current

Cost for FY07-09 EV/ton (FY07)(1) (2) (USD)

ACC 19.9 80.0 51.4 131.4 150.9

Gujarat Ambuja 16.3 80.0 68.2 148.2 192.9

Ultratech 17.0 80.0 45.7 125.7 146.7Shree 6.0 80.0 56.7 136.7 128.0

India Cement 11.0 80.0 43.3 123.3 110.0

Kesoram 4.5 80.0 41.7 121.7 74.2

The analysis shows that the frontline cement companies are either trading at slight premium or at discountto their replacement cost adjusted for 3 years Free Cash Flows. This valuation is at a time when theoperating profit per ton of cement sold is in range of 21 to 30 USD per ton, companies have unrevealedbalance sheet, are undergoing efficiency enhancement drive and are able to finance their expansion throughinternal accruals. Besides any delay in roll out of fresh capacity would extend the cement cycle beyond FY09which would make the Cement majors like ACC and Gujarat Ambuja trade below their asset replacementcost and that makes us see the cement space an attractive opportunity to enter in this phase of correction.

Valuation near AssetReplacement Cost

(RSM) (X)


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Event Update


CMP Capacity Replacement EBIDTA/ Fair CurrentCost TON Asset Value

Value USD/Ton

Birla Corp 200.0 5.8 80.0 1077.2 127.9 59.0

Mangalam Cement 148.9 1.5 80.0 998.9 124.4 67.2

Prism Cement 32.4 2.0 80.0 1205.4 133.6 109.4

Orient Paper 410.3 2.5 80.0 1034.0 126.0 72.3

Century Textiles 531.0 6.3 80.0 881.1 119.2 102.0

Chettinad Cement 415.0 2.2 80.0 862.1 118.3 141.1Madras Cement 2750.0 6.0 80.0 1041.9 126.3 132.8

Mysore Cement 39.1 2.1 80.0 603.2 106.8 65.3

Some more Asset Plays


5/5

Event Update


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cement price freeze issue -toll of functioning democracy

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