Materials - Cement:: Top Sell Recommendation- Ambuja Cement :Macquarie Research

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Materials - Cement --Sector Outlook

Cement demand has been strong in the past few years. However, increased supply in the
market have put pressure on prices in the past few months with producers trying to ration
supply by cutting production and giving support to prices. This, in combination with rising
costs will keep margins muted.

􀂃 Demand has been strong but is slacking: Cement demand in India is a proxy to
domestic growth, and has almost 1:1 correlation with GDP growth. Demand so far has
been holding strong, though has reduced this year so far at 7.3%, below long term average
of 10%.
􀂃 Supply is the concern: Capacity in the cement market has started to hit and prices have
come under pressure. We expect flat prices in FY11 and 5% decline in FY3/12, hit by this
increase in capacity. We expect capacity addition of 50mnt in FY3/10 and FY3/11 each,
oversupply of ~10% expected in FY3/11 and FY3/12.
􀂃 Costs have been increasing: Rising coal and energy prices would be another headwind.
Prices are down 6% since April, though recently there has been some modest recovery.
Combined with falling cement prices, companies could see compression in margins.
􀂃 Prefer exposure in diversified companies: We expect oversupply to remain a key
issue for cement companies next few quarters and prefer exposure in diversified
companies and would be sellers of expensive cement companies. Top sells – ACEM
IN

Top Sell Recommendation/s
Ambuja Cement (ACEM IN, UP; TP: Rs117; Potential upside: -11%)
􀂃 Merger with sister concern is away: Market has been speculating on merger with its
sister concern ACC which will help get synergies. However, any advantage from this
merger is still at least a year away.
􀂃 Most expensive in the coverage: Ambuja Cement is one of the most expensive cement
stock in the coverage. Though historically, its expensive valuations have been justified by
its sales tax exemptions in some of its facilities, these will also be expiring soon.
􀂃 No earnings growth in the next 2 years: We expect Ambuja’s production to increase by
10% in CY10 and VY11, however, we expect earnings to grow by only 3% in CY10 and fall
by 13% in CY11. We believe the company will not be able to reap much benefits due to
pressure on prices.
Key Near-Term Catalyst
􀂃 Continued pressure on margins because of increasing freight and coal costs and decline in
cement prices
Valuation
􀂃 Ambuja is currently one of the most expensive stock in our coverage, trading at 16x and
18.5x PER CY11 and CY12E earnings estimate, and it doesn’t reflect the no-earnings
growth scenario over the next two years.