Macquarie Research:: Associated Cements -Cost shock

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Associated Cements
Cost shock
Event
 CY10 results below estimates: ACC reported CY10 results which were 15%
below our estimates at the operating level. Writebacks of provisions helped
make net profit look reasonable. We have marginally (2-4%) cut our numbers
to reflect lower volume and higher cost assumptions but have raised
realisations due to sharp recovery in the South. We have rolled forward our
DCF and our new target price is Rs837 (from Rs771). Maintain Underperform.

Impact
 Q4CY10 results a shocker: ACC reported an EBITDA per ton of Rs373/t
only, even as realization grew 5% QoQ. Freight costs increased by 40%,
while raw material costs increased by 10% QoQ. It seems unbelievable, and
we believe that this may include a previous quarter’s adjustment. In any case,
things can worsen further for ACC, as it is highest exposed to subsidized
domestic coal and highest share of transport via railways.
 Aggressive margin expansion built in: Cement prices have seen an
increase since January, but we expect unrelenting cost pressures due to an
increase in rail freight, higher thermal coal prices, as well as impact of higher
transport costs from the HP plant strike. We are building in a recovery to
margin at Rs716/t against the current quarter’s margin of Rs373/t; however,
risks remain to the downside due to oversupply concerns.
 We remain 6% below consensus estimates for CY11: In spite of building in
aggressive estimates, we are 6% and 2% below consensus for CY11 and
CY12, respectively. Had it not been sharp recovery in South India, this could
have been even worse.
 Capacity expansion now complete: ACC has commissioned two new kilns
and have increased capacity by 5mtpa to 30mtpa. Stil,l we believe that given
the oversupplied market, ACC will have to contend with 10-12% volume
growth for CY11.
Earnings and target price revision
 We are reducing our estimates by 2%, and 4% for CY11 and CY12 to Rs57.2
and Rs69.8 per share, respectively.
Price catalyst
 12-month price target: Rs837.00 based on a DCF methodology.
 Catalyst: Continued weak demand and volume
Action and recommendation
 Maintain Underperform: ACC has rallied and held on very well since the
stake increase by Holcim. There are still expectations of a merger with ACEM
IN, which we believe is still some time away. Given the higher risk factors on
the cost side, the current PER of 17-18x looks highly stretched. Maintain
Underperform.