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Ambuja Cements
Action
We maintain our REDUCE rating and price target of INR113, based on an EV/IC
multiple-based methodology. The stock’s recent outperformance puts it at trading
premiums of 23% and 22% over peers ACC and Ultratech, respectively. We believe
such gaps are unjustified and expect a correction, as most of the earnings upside
appears to be priced in.
Catalysts
Pressure on earnings from a correction in realisations in the company’s core
markets could dampen share price performance.
Anchor themes
Profitability of the Indian cement sector looks set to decline considerably over the
next two to three years and valuations are yet to reflect the lower profitability levels.
We expect Ambuja Cement to deliver an average ROCE of 26% during FY10-12F,
compared with the 33% that the company delivered during FY06-09.
Premium valuations look unjustified
Earnings outperformance to end
We believe Ambuja Cements’ earnings have been the most resilient in
the sector in the recent past, as the company benefitted from its lack
of exposure to Southern markets and because it replaced clinker
purchases with its own clinker capacity. However, we believe that
earnings catalysts for the company are now near an end, and issues
such as higher fuel costs will result in the company mirroring the
overall earnings performance of the sector.
Too much premium for quality
Ambuja Cements has been successful in generating best-in-sector
ROCEs over a cycle, resulting in the stock being awarded a valuation
premium over its peers. However, we believe the recent
outperformance of the stock has made the premium too high, with the
stock now trading at premiums of 23% and 22% to peers ACC and
Ultratech on an EV/tonne basis, on our estimates.
Consolidation with ACC/Holcim may take time
We believe there have been expectations in the market that Holcim
might consolidate its two cement companies in India (ACC and
Ambuja Cements) into one entity. But our interaction with
management suggests this will be a long-drawn process, and that
parent Holcim is in no hurry to undertake this consolidation.
Valuation
We value Ambuja Cements on an EV/IC-based methodology, in which
the multiple is derived using an average ROCE of 26% for the FY10-
12F period and a WACC of 12.7%. We retain our REDUCE rating and
price target of INR113, which implies 18% potential downside and
implies an EV/EBITDA of 6.7x and an EV/tonne of US$137 on Ambuja
Cements’ FY11F financials.
Drilling down
Returns to deteriorate going forward
We expect Ambuja Cements to deliver an average ROCE of 26% during FY10-12F,
compared with the 33% average ROCE generated by the company during FY06-09.
However, we think valuations do not reflect this decline in profitability, and imply an
average ROCE of 32% for the company during this period.
Valuation methodology
We value Ambuja Cements using an EV/IC (Enterprise Value/Invested Capital)
multiple method. The EV/IC multiple is derived as follows:
EV / IC = (ROCE – g) / (WACC – g)
(EV = Enterprise Value, IC = Invested Capital, ROCE = Average ROCE for the current
and following 2 years and g = long-term growth)
Our price target values Ambuja Cements at an EV/EBITDA multiple of 6.6x on FY11F
estimated EBITDA. We find the stock is currently trading at an FY11F EV/ EBITDA
multiple of 8.5x.
On an EV/tonne basis, our price target implies a valuation of US$137 for Ambuja
Cements’ end-FY11F capacity, while the stock is currently trading at an EV/ tonne
valuation of US$170.
Key risks
Better-than-expected volume growth in CY11F on the back of an overall pick-up in
demand in the sector would put our earnings estimates at risk.
Stronger-than-expected realisations in the company’s core markets (North India)
would result in better profitability for Ambuja Cements.
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