India Cements -Cheap but for a reason ::Macquarie Research

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India Cements
Cheap but for a reason
Event
 Downgrading to Neutral: Taking stock post the recent excise duty hike and
building in higher cement prices and costs, we believe that ICEM now looks
fairly valued. We have adjusted our earnings and TP marginally (by less than
5%). Our new TP is Rs112 (previous Rs109) as we roll forward. We expect
penalties by the Competition Commission of India (CCI) and cement price
decline during the monsoon season to be key negative triggers ahead.
Downgrade to Neutral.
Impact
 Valuations – building in perpetual margin expansion by 5%+: Our DCF
analysis shows that at a 9% volume growth assumption, ICEM’s current stock
price is factoring in EBITDA/t improvement of around 5%+ pa. We think this is
a very aggressive assumption given the oversupply in the market.
 Our assumptions remain optimistic: We are building in 10% YoY volume
growth for CY12 as well as flat EBITDA per ton of Rs953. This is based on the
assumption that the current pricing discipline in the industry will continue.
 Consensus is not building in cost savings: Consensus forecasts are 2%
and 12% below our estimates for FY13 and FY14, respectively. Consensus
has yet to recognize the 9% reduction in taxes for import of coal. Also,
consensus is probably not building in any benefit of the upcoming ramp-up of
captive power plants and development of its coal mine in Indonesia.
 Penalty by Competition Commission could take away 80% of net profit:
We believe that CCI is in the last stages of completing its enquiry against the
cement companies and will probably announce penalties in the next month or
so. Based on recent trends, we think it is likely to be 6-7% of total revenue, or
around 80% of net profit.
Earnings and target price revision
 We have increased earnings for FY13 by 5% and fine-tuned FY14.
Price catalyst
 12-month price target: Rs112.00 based on a DCF methodology.
 Catalyst: Penalty by CCI possibly in April and cement price declines by June.
Action and recommendation
 Downgrading to Neutral: While India Cement doesn’t look expensive vs
historical EV/EBITDA, this is no bull market either. Given the risk factors
related to the cartel’s continued existence, prolonged periods of oversupply,
and impending penalties, we advise booking some profit after the 50-60%
rally from the Jan1, 2012 bottom. We believe that the stock has reached its
fair value and would be more comfortable when fundamentals recover.