cement sector earnings change centrum 170709

7/30/2019 Cement Sector Earnings Change Centrum 170709

1/8

Please refer to important disclosures/disclaimers inside

Underweight

Rajan [email protected]+91 22 4215 9640

Oversupply fear stays

Demand concerns waning, but oversupply fearsremain: The formation of a stable government isexpected to boost infrastructure spending and reduceconcerns on the demand front. However, oversupplyfears still persist and all-India capacity utilization isexpected to fall to 83% in FY10 and 76% in FY11.

Fall in cement realizations on a higher base:The fallin utilization would lead to a correction in prices fromQ2FY10 onwards starting from the southern region.However, due to price hikes effected in central, easternand northern regions during Q4FY09 and Q1FY10,price fall would be on a higher base.

Numbers revised; Earnings upgraded: We haverevised our all-India cement price assumptions toRs239/bag for FY10E and Rs223/bag for FY11E, fromRs215/bag and Rs200/bag earlier. We have upgradedaggregate earnings for FY10E and FY11E by 22.4% and27.5%, respectively, for companies under our coverage.

Valuation drivers missing; Reiterate Underweight:Frontline cement companies trade at EV/ton of US$77-US$135 on FY10E capacity vs replacement cost ofUS$75-90. With oversupply concerns expected topersist over FY10-12E and M&A triggers missing, we donot see valuation drivers that would value the sectorabove asset replacement cost. Reiterate Underweight.

Grasim is our top pick: Inline with earnings revisionand expected stability in earnings, we have revised ourtarget prices by valuing the companies on PEmultiples. Grasim (Hold) is our top pick, given itsexpansion in the northern region.

Shree Cements downgraded to Hold, maintain Holdon UltraTech: We have downgraded Shree Cementsto Hold (from Buy) as the stock looks fairly valued atcurrent levels. OPIL has been downgraded to Hold dueto oversupply concerns in its key markets. We reiterateSell on ACC, Ambuja Cements and India Cements.

Centrum cement universe underperforms Niftyuntil Budget: Since our initiation (Nadir? Not Yetdated

19 March 2009), our cement universe hasunderperformed the Nifty by 12%, as projected.However, post Budget we saw overall 18%outperformance due to status quo on excise duty anddemand generating measures.

Company NameCMP(Rs)

TargetPrice (Rs)

ACC 795 684

Ambuja Cements 98 83Grasim Industries 2,608 2,590

Ultratech Cement 741 688

India Cements 142 114

Shree Cement 1304 1,358

Orient Paper & Industries 49.5 56

Source: Centrum Research

Centrum cement index vs. Nifty

Centrum Cement Index Outperformance over Nifty

(25)

(20)

(15)

(10)

(5)

0

5

10

15

17-Mar-09

24-Mar-09

31-Mar-09

7-Apr-09

14-Apr-09

21-Apr-09

28-Apr-09

5-May-09

12-May-09

19-May-09

26-May-09

2-Jun-09

9-Jun-09

16-Jun-09

23-Jun-09

30-Jun-09

7-Jul-09

14-Jul-09

(%)

Status quo on excise duty and

increase in infraspend led to recent

outperformance of cement

Source: Bloomberg, Centrum Research

Summary valuations

M Cap CMP EPS (Rs) PE (x) EV/E (x) EV/Ton ($) P/BV (x) ROE (%)

Company Rating (Rsbn) (Rs)

TP(Rs)

Upside(%) FY10E FY11E FY10E FY11E FY10E FY11E FY10E FY10E FY10E FY11E

ACC Sell 149 795 684 (13.9) 76.3 54.1 10.4 14.7 5.8 7.7 110 2.6 27.7 18.5

Ambuja Cem Sell 149 98 83 (15.5) 8.3 7.6 11.8 12.8 6.8 6.6 134 2.3 20.6 16.8

Grasim Hold 239 2,608 2,590 (0.7) 259 217 10.1 12 5.1 5.5 94 1.7 18.7 13.6

Ultratech Hold 92 741 688 (7.2) 85.8 69.0 8.6 10.7 5.1 5.5 93 2 26.1 17.3India Cem Sell 40 142 114 (19.3) 17.6 12.8 8.1 11.1 4.7 5.2 77 1.2 15.6 10.1

Shree Cem Hold 45 1,304 1,358 4.1 181.3 165.0 7.2 7.9 5.2 5 91 1.9 29.4 21.5

OPIL Hold 9.5 49.5 56 13.1 11.2 10.6 4.4 4.7 3 2.8 41 1.2 29.4 22.4

Source: Company, Centrum Research Estimates

17 July 2009

Earnings change

INDIA

Cement Sector


2/8

2Cement Sector

Demand concerns abating, but oversupply fears remain

Post the formation of a stable government, we believe concerns over demand have eased. However,we believe the industry would still feel the impact of oversupply in FY10 and FY11 as per ourdemand-supply model. The northern, central and eastern regions look better-placed to sustainprice discipline over a longer period due to higher utilization levels. However, our all-India demand-supply model would remain almost same with utilization levels at 83% and 76 % in FY10 and FY11,

respectively.

Capacity utilization in the northern and central regions combined is estimated at around 89% and82% in FY10 and FY11, respectively, which would aid sustainability of prices. However, in thesouthern region, we expect utilization levels to drop to 76% and 68% levels in FY10 and FY11,respectively, leading to fall in prices. The oversupply in the southern region is also expected todisrupt the demand-supply dynamics and pricing in the western region.

Exhibit 1: Our all-India demand-supply scenario indicate surplus scenario

(mt) FY06 FY07 FY08 FY09A FY10E FY11E

Capacity at Beginning of year 155 161 168 198 222 274

Operative Capacity 152 158 162 188 213 268

Capacity Addition During the Year 6 7 30 22 50 19

Add On Capacity 2 4 8 8 24 11

Effective Capacity 155 162 170 196 237 279

Cement Production 142 155 168 181 197 213

Production 145 158 170 184 198 213

Consumption 136 149 164 178 193 210

Growth assumption (%) 12.0 10.2 9.8 8.4 8.7 8.7

Exports 9.2 9.0 6.0 6.1 6.0 5.0

Capacity Utilization (%) 92 96 99 92 83 76

Source: CMA, Centrum Research Estimates

Exhibit 2: Regional demand-supply scenario (north-south divide accentuated)

Zone wise demand-supply dynamics

Zone North* West East South

(mt) FY08 FY09E FY10E FY11E FY08 FY09E FY10E FY11E FY08 FY09E FY10E FY11E FY08 FY09E FY10E FY11E

Capacity at Beginning of year 59.4 74.1 79.1 96.7 28.9 31.8 32.4 39.4 25.4 29.0 31.3 36.1 53.9 62.6 78.8 102.0

Operative Capacity 57.4 68.7 75.4 94.5 28.9 31.4 31.4 38.4 23.5 26.9 29.9 34.7 52.4 60.6 76.8 100.5

Capacity Addition During the Year 14.7 5.0 17.6 1.5 2.9 0.0 7.0 9.1 3.6 0.9 5.5 3.0 8.7 16.2 2 0.0 5.5

Add On Capacity 4.4 2.3 8.8 4.0 0.0 0.0 2.9 4.0 1.0 0.8 3.3 2.4 2.6 5.2 8.9 0.5

Effective Capacity 61.8 71.1 84.2 98.5 28.9 31.4 34.2 42.4 24.5 27.6 33.2 37.1 54.9 65.9 85.7 101.0

Production 61.5 67.4 75.0 80.8 30.7 30.7 31.1 33.2 23.8 26.0 28.3 31.0 54.2 59.7 64.8 70.0

Consumption 57.3 61.4 68.5 74.3 32.2 34.0 36.3 39.4 25.3 28.2 30.5 33.2 49.2 54.3 58.1 63.3

Growth assumption (%) 9.5 7.1 11.6 8.5 14.0 5.4 7.0 8.5 5.6 11.3 8.0 9.0 9.7 10.4 7.0 9.0

Exports 0.8 1.0 1.0 1.0 5.1 5.0 5.0 4.0 0.0 0.1 0.0 0.0 0.1 0.0 0.0 0.0

Net Transfer From other Zone (3.4) (5.1) (5.6) (5.6) 6.9 8.3 10.3 10.3 1.5 2.2 2.2 2.2 (5.0) (5.5) (6.7) (6.7)

Capacity Utilization (%) 99.6 94.9 89.1 82.1 106.0 97.6 90.8 78.3 97.4 94.3 85.1 83.4 98.6 90.7 75.6 69.3

Source: CMA, Centrum Research Estimates

The northern and central regions are expected to have a relatively balanced demand-supplysituation on account of high demand, lower capacity addition and high level of consolidation whichwould translate into price discipline for a longer period. The southern region faces an adversedemand-supply-pricing scenario on account of lower growth in demand due to the high base,massive capacity addition and fragmentation.

The massive election-related spending in UP as well as profligate expenditure on monuments by theMayawati government caused cement prices to rise in Uttar Pradesh. Additional demand due to the2010 Commonwealth Games in New Delhi and the freight corridor in North is expected to sustainhigh growth in the northern region.


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3Cement Sector

Exhibit 3: Kanshiram memorial in Lucknow (a Rs3.7bnmonument spread over 43 acres)

Exhibit 4: Work in progress for the 2010 New DelhiCommonwealth Games

Source: Centrum Research Source: Centrum Research

Price assumptions revised

We have raised our cement price assumptions for FY10E and FY11E to Rs239/bag (earlier Rs215/bag)

and Rs223/bag (Rs200/bag).Our new demand-supply pricing model assumes a staggered decline of 9% in prices from Q1FY10levels in the eastern, western, northern and central regions and 12% aggregate fall by March 2010.However, our price decline assumptions are modest compared to the steep 20% price fall duringFY02-03.

Exhibit 5: Revised all-India and regional price assumptions

(Rs/bag) Old Revised

Region FY10E FY11E FY10E FY11E

North/Central 207 192 239 224

East 207 192 242 227

West 207 192 230 215

South 234 219 243 226

All India 215 200 239 223

Source: Centrum Research Estimates

Exhibit 6: Our price decline assumptions are modest compared to historical precedent

Average Cement Prices All India

100

120

140

160

180

200

220

240

260

May-92

May-93

May-94

May-95

May-96

May-97

May-98

May-99

May-00

May-01

May-02

May-03

May-04

May-05

May-06

May-07

May-08

May-09

(Rs/50 Kg Bag)


20% decline


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4Cement Sector

Exhibit 7: Revised realization assumptions

Company Net Realization (New) (Rs/ton) YoY Growth (%) Revised By (%)

Y/E March FY10E FY11E FY10E FY11E FY10E FY11E

ACC # 3,609 3,334 6.0 (7.6) 5.2 6.9

Gujarat Ambuja# 3,694 3,414 3.9 (7.6) 6.1 6.2

Ultratech 3,427 3,146 (1.2) (8.2) 4.6 2.6

Grasim 3,415 3,139 (0.0) (8.1) 6.6 5.2

Shree 3,150 2,879 1.3 (8.6) 7.6 6.3

India Cements 3,509 3,173 (1.1) (9.6) 10.7 7.5

OPIL 2,806 2,534 (5.7) (9.7) 9.8 4.9

Note: # Dec. Ending


Earnings estimates upgraded

We have raised aggregate earnings (sum of net profit of companies under coverage) estimates by22.4% and 27.5% in FY10E and FY11E to factor in the hike in cement prices in the central, easternand northern region during Q4FY09 and Q1FY10. Average cement prices were hiked by 10% in thenorthern region between Jan 2009 and June 2009. Over the same time, they were hiked by 13% and19% to Rs249/bag and Rs254 /bag, respectively, in the eastern and central regions. The hikes startedin UP where prices went up by over Rs60/bag as additional demand created by election-ledexpenditure and the huge expenses on building statues and memorials by the Mayawatigovernment created a shortage. With higher demand expected in the northern and central regions,prices are likely to stay firm for longer period due to the high level of consolidation in these regions.

Exhibit 8: Revised estimates (EPS)

Growth (YoY) (%) Estimate change (%)

Y/E March (Rs) FY10E FY11E FY10E FY11E FY10E FY11E

ACC # 76.3 54.1 30.3 (29.0) 22.5 50.0

Ambuja Cements # 8.3 7.6 15.1 (7.6) 19.3 25.0

Ultratech Cement 85.8 69.0 9.2 (19.6) 8.0 (1.4)

Grasim Industries 259.0 217.0 8.6 (16.2) 28.5 27.8Shree Cement 181.3 165.0 3.1 (9.0) 17.1 21.0

India Cements 17.6 12.8 6.4 (27.5) 24.1 28.2

OPIL 11.2 10.6 (5.9) (5.6) 22.5 12.0

Note: # Dec. Ending


Valuation triggers missing; reiterate Underweight

The outlook in terms of profit growth for Q1 and Q2 looks robust on account of cement pricessustaining at high levels till date and lower energy costs. However, we believe the sector would seean oversupply scenario during FY10-11 and utilization levels would come down to 83% and 76%,respectively, from 92% in FY09. Further, a hike in excise duty still remains a high probability event.

As the sector is already valued above replacement cost and there is perceptible lack of M&Aactivities, we do not see any valuation drivers that would value the sector above asset replacementcost. Hence, we maintain our Underweight stance on the sector.


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5Cement Sector

Target prices revised

Given the relatively high visibility of earnings post easing of demand-side concerns, we have revisedour target prices by valuing Grasim at 10x FY10E, Ambuja Cements at 10x CY09E, and ACC at 9xCY09E. We have valued UltraTech at 8x FY10E, Shree Cements at 7.5x FY10E, India Cements at 6.5xFY10E and OPIL at 5x FY10E, giving appropriate discount on account of their regional presence. Ourcurrent valuations criteria results in higher implied P/BV multiple and EV/tonne, inline with our

earnings and RoE revisions. Grasim Industries (Hold) is our top pick as we believe it would benefitdue to the expansion in the structurally robust northern region. We maintain Hold on UltraTech. Wehave downgraded Shree Cements to Hold (from Buy) as the stock looks fairly valued at currentlevels. OPIL has been downgraded to Hold due to oversupply concerns in its key markets. Wemaintain our Sell rating on ACC and Ambuja Cements due to expensive valuations. India Cement is aSell for its exposure to challenging southern market.

Exhibit 9: Revised target prices and implied multiples

Company Target price (Rs) Implied multiple at revised target price

Revised Earlier P/BV (x) EV/ton ($) PE (x) EV/EBIDTA (x)

ACC # 684 503 2.2 94 9.0 4.9

Ambuja Cements # 83 65 1.9 113 10.0 5.7

Grasim Industries 2590 1,474 1.7 93 10.0 5.1Ultratech Cement 688 542 1.9 87 8.0 4.8

India Cements 114 83 0.9 65 6.5 4.0

Shree Cement 1358 1,004 2.0 95 7.5 5.4

OPIL 56 41 1.3 46 5.0 3.3

Note: # Dec. Ending


Centrum cement universe underperformed till Budget

The Centrum Cement Index underperformed the Nifty by 12% until 6 July 2009 (the day the Budgetwas presented) since our initiation with underweight rating on 19 March 2009. However proposalsin the Budget like increased thrust on the Bharat Nirman andJNNURM schemes and maintaining the

8% excise duty on cement against street expectation of 4% hike led to the Centrum Cement Indexoutperforming the Nifty by 18% post budget.

Exhibit 10: Centrum cement index vs. Nifty

Centrum Cement Index Outperformance over Nifty

(25)

(20)(15)

(10)

(5)

0

5

10

15

17-Mar-09

24-Mar-09

31-Mar-09

7-Apr-09

14-Apr-09

21-Apr-09

28-Apr-09

5-May-09

12-May-09

19-May-09

26-May-09

2-Jun-09

9-Jun-09

16-Jun-09

23-Jun-09

30-Jun-09

7-Jul-09

14-Jul-09

(%)

Status quo on excise duty and

increase in infraspend led to recent

outperformance of cement



6/8

6Cement Sector

Shree Cements, which was the top pick at the time of our initiation, outperformed the Nifty by 62%and peer India Cements by 71 %

Exhibit 11: Shree Cements vs. India Cement

Shree Cement Vs India Cements (since initiation)

116.0

45.0

53.5

59.3

0 20 40 60 80 100 120 140

Shree Cements

India Cements

Nifty

Centrum Index

Return (%)


Our positive stance on AV Birla Group is substantiated by significant outperformance of Grasim andUltraTech (both AV Birla Group companies) over Ambuja Cements and ACC of the Holcim group.

Exhibit 12: AV Birla group companies vs Holcim group companies

AV Birla Vs Holcim (since initiation)

43.0

46.0

79.0

54.0

53.5

59.3

0 10 20 30 40 50 60 70 80 90

ACC

Ambuja

Grasim

Ultratech

Nifty

Centrum Index

Return (%)



7/8

7Cement Sector

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8/8

8C t S t

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cement sector earnings change centrum 170709

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