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Cement
India
3QFY12E—seasonal improvement not reflective of underlying risks. Cement
companies under our coverage are likely to report improved profitability, supported by
higher realizations. However, the quarterly earnings do not fully reflect potential risks to
pricing discipline from (1) regulatory intervention, (2) potentially weak demand and
(3) continued capacity overhang, besides cost pressure from domestic and imported
fuel. We maintain a cautious stance with ACC and Ambuja being our top Sell ideas.
Strong 3QFY12 likely to be driven by sharp revival in prices after the monsoon.
We estimate strong 40% sequential (36% yoy) jump in profitability for our coverage universe,
driven by (1) a 7% sequential increase in realizations as average cement prices increased by
~Rs15/bag sequentially, (2) strong volume growth driven by a sharp spurt in November and
(3) moderate input cost inflation (1% qoq). Cement prices revived sharply after the monsoon,
before showing signs of moderation in December. Prices in South India continue to be robust
despite a seasonally lean quarter.
Politics of pricing—the demon raises its head again
According to media reports, Government of Himachal Pradesh, in the wake of high cement prices,
has asked the Central Government to bring cement under the purview of the Essential
Commodities Act to better control prices. This follows a recommendation by a Serious Fraud
Investigation Office (SFIO) probe to initiate action against the top-three cement manufacturers
(UltraTech Cement, Ambuja Cement and ACC) for price collusion in September 2011.
As cement prices remain firm despite sluggish demand and depressed utilization rates, the risk of
potential regulatory intervention has resurfaced. We note that though cement manufacturers were
given a clean chit by the Ministry of Corporate Affairs, the risk of a potential regulatory
intervention continues to loom large for the sector.
Coal could become dearer—domestic as well as imported
A shift in the pricing structure from UHV-based pricing to a GCV-based pricing by Coal India Ltd.
(CIL) will impact fuel bills of cement manufacturers, especially those with higher dependence on
domestic coal (both linkage and e-auction). Although the exact impact is difficult to assess— a
10% hike in price could potentially impact FY2013 EPS by 4-6% while the impact on Shree
Cement and India Cement is expected to be negligible. We note that despite moderation in global
coal prices, importers will continue to face cost pressure due to significant currency depreciation
(see Exhibit 9).
Valuations do not reflect underlying risk, we maintain our cautious stance
Cement stocks have outperformed the benchmark BSE Sensex by 38% over the six three months.
In our view, the current multiples do not factor in potential earnings pitfalls from (1) a prolonged
slump in demand, which could hurt the pricing discipline and (2) impending hike in diesel prices
and depreciating currency. We remain cautious on ACC and Ambuja, which are trading at their
peak-cycle multiples. ACC trades at 8.6X CY2012E EBITDA and US$156/ton on CY2012E
production and Ambuja Cement trades at 8.3X CY2012E EBITDA and US$192/ton on CY2012E
production.
Spurt in volumes not indicative of a revival in demand
Our coverage universe is likely to register 7% yoy growth in volumes in 3QFY12, driven
mainly by a sharp spurt in November (industry volumes grew 20% yoy). We however note
that this was likely due to the impact of post-monsoon pent-up demand, magnified by a low
base in November 2010. We note that cement consumption grew by 4.7% YTD (as of
November 2011) with key indicators such housing launch activity and order booking by
construction companies not showing signs of recovery (see Exhibit 10, 11 and 12). Although
reported dispatches in December indicate mixed numbers (10.5% for UTCEM, 8.5% for
ACC and more sedate 6% for Ambuja), we remain watchful of the demand environment
and do not construe this as a structural shift in the demand pattern.
Hike in duty on captive power by Maharashtra—impact likely to be muted
A recent decision by the Maharashtra Government to raise the electricity duty on captive
power from Rs0.4/kwh to Rs1.5/kwh will directly impact ACC, Ambuja and UltraTech, which
have captive capacities of 40 MW, 40 MW and 46 MW respectively in Maharashtra.
However, these captive units account for a marginal 12%, 10% and 9% of overall captive
capacities, respectively. Hence an incremental electricity duty of Rs1.1/kwh will impact
power and fuel cost by 1%, 0.8% and 0.5% respectively for ACC, Ambuja and UltraTech.
Moderate cost inflation driven by currency depreciation, profitability revives
3QFY12 is likely to see a 7% sequential increase in realizations (Rs13-14/bag) and 7.6%
sequential increase in volumes. We discuss below our key assumptions for 3QFY12.
Volumes – We estimate volumes will increase 7% yoy driven by (1) strong volume
growth of Ambuja and Jaiprakash and (2) sharp volume spurt in November. Volume
growth for ACC will however be muted as the base effect catches up. South India
markets are likely to witness seasonal weakness with a slump in demand and India
Cement volumes are likely to decline 7% yoy and 19% qoq.
Realization – We factor a 7% sequential decline (Rs13-14/bag) in average realization,
driven by a sharp revival in prices after the monsoons. Cement prices in South India
remained stable as reflected in a 4% sequential increase in India Cement’s estimated
realizations.
Power and fuel costs – We estimate 6% sequential increase in power and fuel costs. As
highlighted in Exhibit 8, although prices of imported coal have come off significantly from
their highs of US$130/ton, the benefits of moderation in coal prices are likely to be lost to
a weaker Rupee, yielding marginal inflation in power and fuel costs.
Freight costs – We build 5% sequential increase in freight costs. We note that truck
freight rates have remained fairly stable during the quarter.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Cement
India
3QFY12E—seasonal improvement not reflective of underlying risks. Cement
companies under our coverage are likely to report improved profitability, supported by
higher realizations. However, the quarterly earnings do not fully reflect potential risks to
pricing discipline from (1) regulatory intervention, (2) potentially weak demand and
(3) continued capacity overhang, besides cost pressure from domestic and imported
fuel. We maintain a cautious stance with ACC and Ambuja being our top Sell ideas.
Strong 3QFY12 likely to be driven by sharp revival in prices after the monsoon.
We estimate strong 40% sequential (36% yoy) jump in profitability for our coverage universe,
driven by (1) a 7% sequential increase in realizations as average cement prices increased by
~Rs15/bag sequentially, (2) strong volume growth driven by a sharp spurt in November and
(3) moderate input cost inflation (1% qoq). Cement prices revived sharply after the monsoon,
before showing signs of moderation in December. Prices in South India continue to be robust
despite a seasonally lean quarter.
Politics of pricing—the demon raises its head again
According to media reports, Government of Himachal Pradesh, in the wake of high cement prices,
has asked the Central Government to bring cement under the purview of the Essential
Commodities Act to better control prices. This follows a recommendation by a Serious Fraud
Investigation Office (SFIO) probe to initiate action against the top-three cement manufacturers
(UltraTech Cement, Ambuja Cement and ACC) for price collusion in September 2011.
As cement prices remain firm despite sluggish demand and depressed utilization rates, the risk of
potential regulatory intervention has resurfaced. We note that though cement manufacturers were
given a clean chit by the Ministry of Corporate Affairs, the risk of a potential regulatory
intervention continues to loom large for the sector.
Coal could become dearer—domestic as well as imported
A shift in the pricing structure from UHV-based pricing to a GCV-based pricing by Coal India Ltd.
(CIL) will impact fuel bills of cement manufacturers, especially those with higher dependence on
domestic coal (both linkage and e-auction). Although the exact impact is difficult to assess— a
10% hike in price could potentially impact FY2013 EPS by 4-6% while the impact on Shree
Cement and India Cement is expected to be negligible. We note that despite moderation in global
coal prices, importers will continue to face cost pressure due to significant currency depreciation
(see Exhibit 9).
Valuations do not reflect underlying risk, we maintain our cautious stance
Cement stocks have outperformed the benchmark BSE Sensex by 38% over the six three months.
In our view, the current multiples do not factor in potential earnings pitfalls from (1) a prolonged
slump in demand, which could hurt the pricing discipline and (2) impending hike in diesel prices
and depreciating currency. We remain cautious on ACC and Ambuja, which are trading at their
peak-cycle multiples. ACC trades at 8.6X CY2012E EBITDA and US$156/ton on CY2012E
production and Ambuja Cement trades at 8.3X CY2012E EBITDA and US$192/ton on CY2012E
production.
Spurt in volumes not indicative of a revival in demand
Our coverage universe is likely to register 7% yoy growth in volumes in 3QFY12, driven
mainly by a sharp spurt in November (industry volumes grew 20% yoy). We however note
that this was likely due to the impact of post-monsoon pent-up demand, magnified by a low
base in November 2010. We note that cement consumption grew by 4.7% YTD (as of
November 2011) with key indicators such housing launch activity and order booking by
construction companies not showing signs of recovery (see Exhibit 10, 11 and 12). Although
reported dispatches in December indicate mixed numbers (10.5% for UTCEM, 8.5% for
ACC and more sedate 6% for Ambuja), we remain watchful of the demand environment
and do not construe this as a structural shift in the demand pattern.
Hike in duty on captive power by Maharashtra—impact likely to be muted
A recent decision by the Maharashtra Government to raise the electricity duty on captive
power from Rs0.4/kwh to Rs1.5/kwh will directly impact ACC, Ambuja and UltraTech, which
have captive capacities of 40 MW, 40 MW and 46 MW respectively in Maharashtra.
However, these captive units account for a marginal 12%, 10% and 9% of overall captive
capacities, respectively. Hence an incremental electricity duty of Rs1.1/kwh will impact
power and fuel cost by 1%, 0.8% and 0.5% respectively for ACC, Ambuja and UltraTech.
Moderate cost inflation driven by currency depreciation, profitability revives
3QFY12 is likely to see a 7% sequential increase in realizations (Rs13-14/bag) and 7.6%
sequential increase in volumes. We discuss below our key assumptions for 3QFY12.
Volumes – We estimate volumes will increase 7% yoy driven by (1) strong volume
growth of Ambuja and Jaiprakash and (2) sharp volume spurt in November. Volume
growth for ACC will however be muted as the base effect catches up. South India
markets are likely to witness seasonal weakness with a slump in demand and India
Cement volumes are likely to decline 7% yoy and 19% qoq.
Realization – We factor a 7% sequential decline (Rs13-14/bag) in average realization,
driven by a sharp revival in prices after the monsoons. Cement prices in South India
remained stable as reflected in a 4% sequential increase in India Cement’s estimated
realizations.
Power and fuel costs – We estimate 6% sequential increase in power and fuel costs. As
highlighted in Exhibit 8, although prices of imported coal have come off significantly from
their highs of US$130/ton, the benefits of moderation in coal prices are likely to be lost to
a weaker Rupee, yielding marginal inflation in power and fuel costs.
Freight costs – We build 5% sequential increase in freight costs. We note that truck
freight rates have remained fairly stable during the quarter.
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