ACC (ACC.BO) Sell: Good Market Spread; But Valuations Not Cheap Enough  citi

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ACC (ACC.BO)
Sell: Good Market Spread; But Valuations Not Cheap Enough
 Raising TP to Rs996 — We raise our target price to Rs996 from Rs975 based
on Sep12 (vs. Dec11 earlier) EV/tonne of US$120. At our revised target price,
ACC would trade at EV/EBITDA of 8x and P/E of 17.2x. ACC has risen 13% in
the past three months and outperformed the Sensex by 24% on the back of price
hikes by cement companies despite surplus capacity. ACC trades at US$132/t,
not too expensive relative to current replacement costs (US$120/t); however, we
would recommend waiting for a correction before entering the stock.
 Cement prices have downside risk — Cement producers have cut volumes
and artificially boosted prices citing various factors (slower demand/transport
bottlenecks/shortage of rail capacity). This volume cut has helped producers
raise prices over the last few months by 9-27% since the lows of Jul11 (except
south India where prices remained steady since May11) to compensate for lower
volumes/rising costs. However the Indian cement industry remains oversupplied
(with at least 10% surplus until FY14) and fragmented (~30 companies; top 5
control 51% of capacity) – and hence cement prices have downside risk.
 Revising estimates — We cut PAT estimates by 5% for CY11 and 16% for
CY12. This change incorporates: 1) lower volumes based on trends so far
(although ACC’s volume growth exceeds its peers); 2) higher costs to reflect
current trends; and 3) higher prices by 13/12% in CY11 and CY12. We now
assume realizations will rise 9% yoy in CY11 (vs -5% earlier) and rise 1% in
CY12 (vs +2% earlier).
 Expansion update — ACC’s total capacity as of Dec 2009 was 26mtpa and has
been hiked to a current level of ~30mtpa due to expansions at Wadi, Karnataka
(world’s largest kiln of 12,500tpd) and Chanda, Maharashtra. Based on trends so
far, we expect volumes to rise by 11% in CY11 and 10% in CY12. While ACC has
yet to make a final decision, there is potential for setting up an additional 3-5mtpa
of brownfield capacity in the next 2-3 years. ACC’s captive power capacity is
361MW and meets ~75% of its requirements. ACC continues to focus on use of
alternative fuels and raw materials (tyres, industrial waste, plastic waste),
however overall usage is still quite small.
 Upside risks — (1) Continued price strength, (2) Delays in capacity, and (3)
Higher-than-expected demand growth.
ACC
Company description
ACC is India’s second largest cement company with a capacity of ~30m tpa. ACC is
located in all the major domestic markets and hardly exports any cement. ACC’s
market breakdown is as follows: south+west 45%, north+central 35% and east 20%.
Holcim holds a 50.3% stake in ACC. Adding the market presence of Holcim's other
group company in India (Ambuja Cements) takes Holcim’s total capacity to 57m tpa
in India and gives it an 18% overall market share and a significant presence in
several key markets. In the past few years, ACC has focused on cost-cutting, selling
unviable cement capacity and exiting non-cement businesses. ACC has been
allocated coal blocks in Madhya Pradesh, which are likely to be operational by
2013. ACC generated ~75% of its captive power requirements in CY10 which will
rise further as new capacities are being set up with captive power plants. Captive
power capacity has risen to 360MW. While ACC has yet to take a final decision,
there is a potential for setting up an additional 3-5mtpa of brownfield cement
capacity in the next 2-3 years. Based on trends so far, we expect cement sales
volumes to rise by 11% in CY11 and 10% in CY12. ACC continues to focus on use
of alternative fuels and raw materials (tyres, industrial waste, plastic waste) however
overall usage is still quite small.
Investment strategy
Our recommendation on ACC is Sell/Low Risk (3L), with a target price of Rs996.
Producers have reportedly cut back on volumes, using the ensuing scarcity to hike
prices. While we expect prices to remain firm in the near term, there is downside
risk given adequate supply and a long tail (~30) of companies (despite the Top 5
majors accounting for 51% of capacity). ACC trades at an EV/t of US$132/t, which
does not appear overly expensive relative to current replacement costs, but, all
other things being equal, we would have to see a correction below the benchmark
before becoming more constructive, given our cautious view on the sector. Maintain
Sell as valuations appear to price in the positives but not the weak near-term
pricing/earnings outlook and cost pressures.
Valuation
We use EV/tonne to value ACC, a common metric used to value cement
companies. We set our target price at Rs996, in line with current trends in
replacement cost of US$120/t. We value ACC in line with replacement costs (rather
than at a discount to replacement costs) as long term demand growth is expected to
be robust and new capacity creation is slowing down. Our target price of Rs996
equates to an EV/EBITDA valuation of 8x and a PE of 17.2x.
Risks
We rate ACC as Low Risk, in line with our quantitative risk-rating system, which
tracks 260-day historical share price volatility. We view this as appropriate based on
ACC's relatively healthy balance sheet (it has a net cash position) and focus on cost
cutting. The main upside risks to our target price include: (1) Continued price
strength; (2) Delays in industry capacity; and (3) Higher-than-expected domestic
demand growth.