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Indian Cement Sector
Investigations, oversupply - significant
risks
Investigation intensifies, downside risk
Competition Commission of India (CCI) has been enquiring into sharp cement
price increases given low demand for quite some time. Now the government has
broadened the investigation by getting Securities Fraud Investigation Officer
(SFIO), Department of Corporate Affairs in the ring. Global experience suggests
that penalties, whenever imposed, have led to underperformance of stocks. In
recent cases (2009), we saw penalties being imposed in our neighbouring
country Pakistan. CCI can levy penalty up to 10% of revenue or 3x profits for
years under consideration. Stocks have corrected from peaks, but we still
recommend reducing exposure.
Structural bull cycle at least 2yrs away
Cement prices have hit an all time high driven by supply discipline, supported by
rising costs and at times helped by constraints on logistic infrastructure.
However, industry fundamentals remain weak with capacity utilisation below
75%, clinker inventory at 8yr high and demand subdued at 5-6% down from 3yr
average of 10%. We believe that cement price has held up stronger than
anticipated, but now have peaked out.
Cost rise is structural, margins dependent on cement price
For the first time cement companies are seeing all round inflation across all cost
centres. Energy costs which account for 30% of the costs are increasing due to
rising imported coal prices as well as due to recent hike by Coal India. Transport
costs have been on the rise, though their full impact has not yet been felt as
diesel prices are still subsidised. Staff costs have been rising in double digits,
much higher than volume growth of 9-10% and eating into the margins. Raw
material costs have also risen sharply, as most companies are now forced to pay
for fly-ash. To add to the misery, we see no major easy cost saving potentials, as
captive power plants and blending ratios, which were the main source of cost
reduction in last decade, have been exhausted. The next big potential to reduce
costs is captive coal mines, and we believe this is at least 3yrs away.
Valuations to see de-rating
We do think that it might be too early to buy for structural tightness, as
oversupply issues will not be resolved at least till 2013. While profits look
reasonable, the risks are very high given the investigation and also due to
increased volatility in cement prices. We think market will assign lower multiple
to account for increased risk. We have introduced a 15% discount to our NPV
and cut our target prices for all stocks.
ACEM and ACC: Fully priced in, merger delayed, likely to grow slower.
UTCEM: Fully valued, but one to own for medium term due to superior growth.
Grasim: Cheaper way to own UTCEM.
India Cement: Best play as it looks to reduce costs by Rs300/t.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Indian Cement Sector
Investigations, oversupply - significant
risks
Investigation intensifies, downside risk
Competition Commission of India (CCI) has been enquiring into sharp cement
price increases given low demand for quite some time. Now the government has
broadened the investigation by getting Securities Fraud Investigation Officer
(SFIO), Department of Corporate Affairs in the ring. Global experience suggests
that penalties, whenever imposed, have led to underperformance of stocks. In
recent cases (2009), we saw penalties being imposed in our neighbouring
country Pakistan. CCI can levy penalty up to 10% of revenue or 3x profits for
years under consideration. Stocks have corrected from peaks, but we still
recommend reducing exposure.
Structural bull cycle at least 2yrs away
Cement prices have hit an all time high driven by supply discipline, supported by
rising costs and at times helped by constraints on logistic infrastructure.
However, industry fundamentals remain weak with capacity utilisation below
75%, clinker inventory at 8yr high and demand subdued at 5-6% down from 3yr
average of 10%. We believe that cement price has held up stronger than
anticipated, but now have peaked out.
Cost rise is structural, margins dependent on cement price
For the first time cement companies are seeing all round inflation across all cost
centres. Energy costs which account for 30% of the costs are increasing due to
rising imported coal prices as well as due to recent hike by Coal India. Transport
costs have been on the rise, though their full impact has not yet been felt as
diesel prices are still subsidised. Staff costs have been rising in double digits,
much higher than volume growth of 9-10% and eating into the margins. Raw
material costs have also risen sharply, as most companies are now forced to pay
for fly-ash. To add to the misery, we see no major easy cost saving potentials, as
captive power plants and blending ratios, which were the main source of cost
reduction in last decade, have been exhausted. The next big potential to reduce
costs is captive coal mines, and we believe this is at least 3yrs away.
Valuations to see de-rating
We do think that it might be too early to buy for structural tightness, as
oversupply issues will not be resolved at least till 2013. While profits look
reasonable, the risks are very high given the investigation and also due to
increased volatility in cement prices. We think market will assign lower multiple
to account for increased risk. We have introduced a 15% discount to our NPV
and cut our target prices for all stocks.
ACEM and ACC: Fully priced in, merger delayed, likely to grow slower.
UTCEM: Fully valued, but one to own for medium term due to superior growth.
Grasim: Cheaper way to own UTCEM.
India Cement: Best play as it looks to reduce costs by Rs300/t.
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