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Cement
India
3QFY11E: Pricing improves, volumes lag. Cement companies will likely report a
surge in profitability led by likely ~9% qoq improvement in cement prices, although the
gain in absolute earnings will likely be curtailed on account of sluggish volume growth.
We continue to maintain our cautious stance on the sector, as sustenance of current
price levels may be difficult in the face of sluggish demand growth and correspondingly
a widening demand-supply gap. Maintain SELL on Ambuja Cement and India Cement.
Demand uptick in October not sustaining
Cement despatches reported de-growth of 6% in November 2010, unable to sustain the sharp
uptick in volumes in October (+17% yoy), yielding a modest YTD growth of 5.4%. Subdued
dispatch growth could be attributed to (1) political unrest in North India on account of the Gujjar
agitation, (2) transport strike in Himachal Pradesh in October and November, and (3) retreating
monsoons in South India. Barring Jaiprakash Associates (+32% yoy), most cement companies will
likely report negligible volume growth, while regional players such as India Cement and Shree
Cement will report de-growth in cement volumes during the quarter.
Profitability likely to improve on back of price revival in South and West
Cement prices saw a healthy revival in 3QFY11 with all-India average cement prices increasing by
~Rs20/bag during 3QFY11E, contributed largely by South where cement prices increased by
Rs42/bag in October 2010 and have sustained those levels in November 2010 (with prices in West
India registering a sequential increase of Rs10-12/bag). We remained concerned on the sustenance
of current prices given the worsening demand-supply situation in the absence on consumption
growth, though factor a 48% sequential increase in profitability in 3QFY11E on the back of price
increases already taken.
Maintain SELL on expensive names – Ambuja Cements and India Cements
Cement stocks have moved in line with the Sensex in the past three months, though they are still
trading at a significant premium to replacement cost of US$120/ton. We maintain our cautious
stance on the sector and reiterate SELL on expensive names such as Ambuja Cement and India
Cement on account of rich valuations compared to peers. Ambuja is trading at 7.8X CY2011E
EBITDA and US$192/ton on CY2011E capacity, while India Cement is trading at 7.3X FY2012E
EBITDA. We continue to remain optimistic on Grasim Industries on account of reasonable
valuations and cushion from non-cement earnings.
Temporary respite from cost pressures
With stable freight rates and coal prices increasing only towards the end of the quarter, we
believe that 3QFY11E will likely witness a needed respite from inflating input costs. We
factor in a marginal 2% sequential inflation in operating cost per ton, factoring the leverage
benefits of expanded volumes post the monsoon quarter.
Power and fuel cost. We believe that with prices of imported coal remaining fairly stable
during the June-October period, power and fuel cost would reflect a limited uptrend vis-à-vis
2QFY11 and accordingly factor a marginal 2% sequential inflation in power and fuel cost.
We note that due to an average 1-2 months of coal inventory and an additional lag between
contract and delivery of imported coal, increase in coal prices affects the income statement
with a 3-6 month lag. As indicated in Exhibit 6, international coal prices have remained fairly
stable over the past six months and have started rising only over the past month, hence we
foresee limited cost inflation on power and fuel cost.
Freight cost. We factor in 3% sequential increase in freight cost per ton to account for
minor inflation in freight rate
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