UltraTech Cement — Fundamentals still weak; Underperform:: BofA ML

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UltraTech Cement Ltd. — Fundamentals still weak; Underperform

Coverage Resumed: Weak cement price outlook, rich valuation; PO of Rs750
We resume coverage of UltraTech at Underperform with a PO of Rs.750 for three
key reasons: 1) we expect cement prices to fall from current levels and stay weak
in FY12E, 2) the firm’s earnings are forecast to decline in FY11-12E due to high
sensitivity (about 5-7%) to cement prices, and 3) EV/capacity valuation at around
US$140/ton is already 15-20% above replacement cost despite declining RoE.
Our PO values the company at 20% discount to replacement cost, i.e. US$95/ton
vs trough discount of 40-45% during the previous downcycle. Still falling capacity
utilization in the industry makes it early to value on par vs replacement cost.


Prefer Grasim on steeper-than-expected holdco discount
Our SOTP analysis indicates that Grasim’s cement business (listed parentco) is
trading at 52% discount to the market price of UltraTech & 29% discount to our
PO for UltraTech. We think the valuation gap makes Grasim more attractive vs
UltraTech. Near-term outlook for Grasim’s viscose business also seems stronger.

Cement prices to fall; rational pricing difficult to sustain
Despite 18-20% growth in industry capacity over the past two years, average
cement prices across India are nearly flat vs FY10 levels. Based on earlier cycles,
we believe cement prices could fall about 5-7%. Recently, cement prices rose
sharply from their lows in Aug ’10, likely led by the industry’s rational pricing
efforts. We think the hikes are not sustainable given fragmented industry structure

Supply-demand balance unlikely to improve soon
We expect industry overcapacity to persist and forecast the industry’s capacity
utilization at 77% in FY12 vs 78% in FY11, assuming demand recovery in FY12