India Cement Sector 60% 50% 40% 30% 20% 10% 0% -10% Financial Leverage. Shree Cement

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1 Financial Leverage Asia Pacific/India Equity Research Cement (Building Materials & Construction IN (Asia)) Research Analysts Anubhav Aggarwal Badrinath Srinivasan India Cement Sector INITIATION Mid-caps closing gap with large-caps, should re-rate Figure 1: Mid-caps better placed with higher leverage and volume growth Dalmia 60% 50% 40% 30% 20% 10% 0% -10% Shree Cement JK Lakshmi Ultratech Ambuja JK Cement Ramco Cements ACC India Cements 5% 7% 9% 11% 13% 15% 17% Operating Leverage *Bubble Size = FY14-17E EBITDA CAGR. Source: Credit Suisse estimates, IBES Mid-caps attractively placed vs large caps. We stay positive on cement demand recovery with demand growth expected to be 8% in FY15 and 11% in FY16 vs a supply CAGR of 7%. However, large-caps are already pricing in the recovery and trading 40-50% above replacement cost. We find risk-reward attractive for mid-caps, which are trading at 40% discount to large-caps on earnings multiples and 40% discount to replacement cost. We initiate coverage on Dalmia, JK Cement (JKCE) and JK Lakshmi (JKLC), and prefer them for higher capacity growth near term, and higher operating leverage. Midcaps should rerate with increasing scale, regional diversification, and higher growth. In the past, during an upcycle, mid-caps traded at replacement cost and the discount to large caps also narrowed. In this upcycle, mid-caps are better prepared with: (1) more diversified regional exposure; (2) scale-wise being closer to large-caps, and (3) capacity expansions scheduled in the near term. As an upcycle transpires, cash flows at mid-caps should reduce leverage (next three-year EBITDA CAGR of 40-50%), whereas free cash at large-caps should either be invested in new capacity (benefits after a few years) or accumulated on balance sheet. Initiate on Dalmia, JKLC, JKCE with OUTPERFORM. The investment phase is nearing completion for these mid-caps, and returns should more than double over FY14-17E. We initiate coverage on Dalmia (with Rs585 TP), JKCE (TP: Rs540), and JKLC (TP: Rs300). The key catalyst for Dalmia is simplification of its group structure; for JKCE, restoration of coal linkages; and for JKLC, the start of East plant in Oct-14. We upgrade Ultratech to NEUTRAL with a TP Rs2,200 (from Rs1,535) as we increase target multiple to reflect the demand recovery. We increase TP for Ambuja to Rs184 (up 15%), ACC to Rs1,350 (up 13%), and Grasim to Rs2,900 (up 5%). The key risk is if demand growth stays less than 7-8%. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION Client-Driven Solutions, Insights, and Access

2 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E Focus table and charts Figure 2: Prefer companies with high capacity growth and high operating leverage Company Mkt cap Rec FY14 cap. Capacity FY14 Operating Financial EBITDA EV/EBITDA EV/ton RoE (%) CAGR util. leverage leverage CAGR (x) (US$ mn) mn t FY14-16 % EBITDA/T % # FY15 # FY14-17 FY15 FY16 FY15 FY16 Large-Caps ACC Limited 4,374 N % 81% 14% net cash 20.9% % 16% Ambuja 5,305 U % 77% 9% net cash 24.5% % 15% Shree Cement* 4,190 NR % 104% 8% net cash 25.1% % 20% Ultratech 10,987 N % 80% 8% 8.2% 24.2% % 15% Mid-Caps Dalmia Bharat 576 O % 59% 15% 54.8% 48.5% 78 5% 9% J K Cement 432 O % 71% 14% 51.1% 38.0% 72 9% 13% JK Lakshmi 481 O % 89% 9% 35.3% 38.0% 75 13% 13% India Cements* 509 NR % 74% 16% 50.0% 33.6% 66 3% 6% Ramco * 1,111 NR % 69% 10% 27.9% 30.6% % 14% # Operating leverage indicates EBITDA/t change for a 10% increase in volumes; financial leverage = debt as % enterprise value; * IBES estimates. Source: Company data, IBES, Credit Suisse estimates Figure 3: Double-digit demand growth possible in FY16E 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% 11% 10% 8% 8% 7% 6% 15% -1% 9% 9% 6% 9% 12% 9% 8% 7% 11% 5% Forecast 8% 7% Figure 5: South to improve, but high additions in East 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% North South East Capacity CAGR West FY14 util FY16 util FY14 util FY16 util FY14 util FY16 util FY14 util North South East West 3% FY16 util 8% 11% 80% 75% 70% 65% 60% 55% 50% Figure 4: Breakdown of Indian cement demand % of cement demand FY15 growth FY16 growth Rural Housing 40% 10% 12% Urban Housing 25% 4% 7% Power 3-4% 5% 5% Irrigation 4% 5% 20% Roads 3-4% 15% 20% Railways 3% 10% 15% Others (incl private capex) 20% 8% 10% Total 100% 8% 11% Figure 6: Cement cycles mid-caps re-rate in an up-cycle 0% -10% -20% -30% -40% -50% -60% -70% Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Capacity CAGR FY14-16 (LHS) Utilization (RHS) Midcap average discount to replacement cost Source: Company data, Reuters, Credit Suisse research India Cement Sector 2

3 Mid-caps closing gap with largecaps, should re-rate Prefer firms with high capacity growth near term, high operating and financial leverage We believe cement demand should benefit from easing funding constraints for infrastructure projects (REIT clarity and CRR/SLR exemption). In a demand upcycle, we prefer stocks with high capacity growth in the near term, and high operating and financial leverage. Based on our framework, fast-growing mid-caps such as Dalmia, JK Cement (JKCE) and JK Lakshmi (JKLC) (with FY14-17E EBITDA CAGRs of 40-50%) are better positioned to capitalise on an expected demand revival. These stocks have expanded capacities recently and have high financial leverage. India Cements and Ramco screen well in terms of leverage, but not capacity growth. At large-caps, relatively high utilisations (~80%) and low capacity additions in the near term make ACC and Ambuja growth more reliant on price increases. Shree Cement plans to add capacity at a CAGR of 26% over FY14-16E, but has low operating leverage and is net cash. This is similar for Ultratech. As the upcycle transpires, cash flows at mid-caps should reduce leverage, whereas free cash at large-caps would either be invested in new capacity (with benefits after a few years) or accumulate on balance sheets. Thus, we prefer Dalmia, JKCE and JKLC with potential upside of 25-40%. Mid-caps are better positioned to capitalise on expected demand revival with high capacity growth and leverage Large-caps have low operating leverage; in an upcycle, mid-caps' EBITDA CAGR should be 40-50% and should help reduce leverage Mid-caps should re-rate with increasing scale, regional diversification, and higher growth In the past, mid-caps traded at discounts of 50-60% to large caps, narrowing in upcycles. We note that this time mid-caps are better prepared for the upcycle: (1) the scale gap versus large-caps has narrowed with Dalmia already having a 24 mt capacity (vs ACC and Ambuja's mt), and JK Cement and JK Lakshmi both ~11 mt each; (2) mid-caps now operate in 3-4 regions with less concentration risk than in the past. Dalmia has exposure to the South, East, North East and West, JKLC to the North, West and East, and JKCE to the North, West and South; (3) capacity expansions are due in the near term (Dalmia, JKCE and JKLC are raising capacities at 18-28% CAGRs over FY14-16E); and (4) as high financial leverage reduces (net debt equal to market cap), mid-caps should re-rate. Demand-supply gap should turn favourable in 2H15 With supply additions for FY15 and FY16 known (equipment already ordered), margin expansion mainly depends on demand growth. We expect a supply addition CAGR of 7% for the next two years, with a 30 mt capacity addition in FY15E and mt in FY16E. The demand growth required to balance new capacities should be 7-8% each year. We expect FY15E demand growth of 7-8% with 2H15E higher due to a low base, and demand growth for FY16 could be in double digits driven by more projects in roads, irrigation, private capex and higher rural development spend (last two years' spend was low to contain fiscal deficit). Initiating on Dalmia, JKLC, JKCE with OUTPERFORM We initiate coverage on Dalmia, JKCE and JKLC with OUTPERFORM and target prices of Rs585 for Dalmia, Rs540 for JKCE, and Rs300 for JKLC. The investment phase is nearing completion in all three, and returns should more than double over FY14-17E. The key catalyst for Dalmia is based on a simplification of the group structure (a merger of Adhunik and Calcom with the parent, higher stake in OCL and KKR's exit). For JKCE, the catalyst is restoration of coal linkages and for JKLC it is the start of East plant. We upgrade Ultratech to NEUTRAL with a TP Rs2,200 (from Rs1,535), Ambuja Rs184 (up 15%), ACC Rs1,350 (up 13%) and Grasim Rs2,900 (up 5%). The key risk is if demand growth stays <7-8%. Mid-caps have reduced the gap with large-caps in scale and geographical footprint; expansions commissioning in near term should imply faster volume growth and strong earnings growth Supply should grow at a 7% CAGR in FY We expect margin expansion as demand growth is expected at 8% in FY15 and 11% in FY16 Key catalysts are (1) Dalmia: simplification of the group structure; (2) JKCE: restoration of coal linkages; and (3) JKLC: the start of the East plant in Oct-14 India Cement Sector 3

4 India Cement Sector 4 Regional comparables Figure 7: Summary of cement comps Company MCAP Current Price Target Price Rec. EV/EBITDA Sales (US$ mn) Net Profit (US$ mn) Earnings growth P/E (x) P/B (x) RoE (%) (x) ($ mn) (lc) (lc) FY14E FY15E FY16E FY14E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16E FY15E FY16 E FFY15E FY16E Y India - Large Caps ACC Limited 4,373 1,400 1,350 N 1,815 1,978 2, % 24.4% % 16% Ambuja Cements Ltd 5, U 1,512 1,732 2, % 13.3% % 15% Ultratech Cement Ltd 10,985 2,406 2,200 N 3,340 3,889 4, % 30.9% % 15% India - Mid Caps Dalmia Bharat Ltd O (1) n.a. 76.9% % 9% JK Cement Ltd O % 64.8% % 13% JK Lakshmi Cement Ltd O % 12.5% % 13% Indonesia Holcim Indonesia 2,006 3,030 2,825 N % 7.7% % 14% Indocement 7,935 24,950 25,700 O 1,792 1,774 1, % 4.3% % 22% Semen Indonesia 8,494 16,575 19,100 O 2,348 2,338 2, % 3.0% % 25% China Anhui Conch Cement Co 19, O 8,988 10,215 11,162 1,527 1,949 2, % 11.1% % 19% China National Building 5, N 19,141 21,630 22, ,088 1, % 9.9% % 16% Thailand Siam Cement 17, N 14,147 14,229 14,595 1,196 1,129 1, % 10.7% % 21% Siam City Cement 3, U 976 1,064 1, % 2.3% % 26% Taiwan Taiwan Cement 5, O 3,913 4,187 4, % 6.5% % 9% Asia Cement 4, O 2,365 2,593 2, % 12.9% % 9% Europe Lafarge 23, N 20,184 18,510 19, ,090 1, % 41.4% % 7% Holcim 27, N 21,278 22,262 23,987 1,373 1,587 1, % 24.9% % 10% CRH 18, U 23,946 25,710 27, , % 36.4% % 11% Source: Company data, Reuters, Credit Suisse estimates Figure 8: Summary of model changes Company Ticker Mkt cap Recommendation Earnings per share Target price (Rs) (US$ mn) Old New FY15 chg % FY16 chg. % Old New ACC ACC.BO 4,374 N N -2.8% 5.0% 1,200 1,350 Ambuja Cements ABUJ.BO 5,305 U U 0% 4.8% Grasim Industries GRAS.BO 4,910 N N -1.3% 3.8% 2,700 2,900 Ultratech Cement ULTC.BO 10,987 U N 8.4% 10.1% 1,535 2,200 Dalmia Bharat. DALA.BO 576 Initiate with O 585 JK Cement. JKCE.BO 432 Initiate with O 540 JK Lakshmi Cement. JKLC.BO 481 Initiate with O 300

5 Prefer firms with high capacity growth near term, high operating leverage With the Indian government easing funding constraints for infrastructure projects through clarity on REIT structures and waiving off CRR/SLR requirements for banks for infrastructure lending, cement demand should benefit from an expected recovery in infrastructure projects. In a demand up-cycle, we prefer stocks that combine high capacity growth in the near term with high operating and financial leverage. Based on our framework, fast-growing mid-caps, such as Dalmia Bharat, JK Cement and JK Lakshmi (with FY14-17 EBITDA CAGRs of ~40-50% based on CS estimates) are better positioned to capitalise on a demand revival. These stocks have all expanded capacities recently and have high financial leverage. As the up-cycle transpires, cash flows at mid-caps would be used to reduce the leverage (which should help in re-rating as well) whereas free cash flow at large caps would either largely be invested for new capacity creation (where the benefit is expected to emerge only after few years) or accumulate on the balance sheet (as with ACC and Ambuja in the past). Therefore, we prefer Dalmia Bharat, JK Cement and JK Lakshmi, and expect potential upside of 25-40% The government's focus on infrastructure could drive a recovery in cement demand; in an upcycle, we prefer fast-growing mid-caps (DBEL, JKCE and JKLC) where EBITDA CAGRs of ~40-50% can drive deleveraging Figure 9: Prefer companies with high capacity growth and high operating and financial leverage Company Mkt cap Rec FY14 cap. Capacity FY14 Operating Financial EBITDA EV/EBITDA EV/ton RoE (%) CAGR util. leverage leverage CAGR (x) USD mn mn t FY14-16 % EBITDA/T % # FY15 # FY14-17 FY15 FY16 FY15 FY16 Large-Caps ACC Limited 4,374 N % 81% 14% net cash 20.9% % 16% Ambuja 5,305 U % 77% 9% net cash 24.5% % 15% Shree Cement* 4, % 104% 8% net cash 25.1% % 20% Ultratech 10,987 N % 80% 8% 8.2% 24.2% % 15% Mid-Caps Dalmia Bharat 576 O % 59% 15% 54.8% 48.5% 78 5% 9% J K Cement 432 O % 71% 14% 51.1% 38.0% 72 9% 13% JK Lakshmi 481 O % 89% 9% 35.3% 38.0% 75 13% 13% India Cements* % 74% 16% 50.0% 33.6% 66 3% 6% Ramco * 1, % 69% 10% 27.9% 30.6% % 14% # Operating leverage indicates EBITDA/T change for a 10% increase in volumes; Financial leverage = debt as % enterprise value; * IBES est. Source: Company data, IBES, Credit Suisse estimates Large caps lack leverage (operating + financial) Minimal capacity additions near-term and relatively high utilisations (already near ~80%) make ACC and Ambuja s EBITDA growth more reliant on accretive price increases. Shree Cement has a strong expected capacity CAGR of 26% over the next two years, but has low operating leverage and is net cash. This is similar to Ultratech (Figure 10). ACC has the highest operating leverage among the large caps due to high fixed costs, but utilisation is high at 80% (and most of the unutilised capacity is in the South West). India Cement Sector 5

6 Figure 10: Dalmia, JK Cement and JK Lakshmi best placed based on our analytical framework Company Capacity Operating Financial EBITDA EV/EBITDA FY17E Geographical exposure growth leverage leverage CAGR FY14-17E FY16E East North South West Central Large-Caps ACC 21% 12.5 Y Y Y Y Y Ambuja 25% 11.0 Y Y Y Y Y Shree Cement 25% 10.8 Y Y Y Ultratech 24% 12.6 Y Y Y Y Y Mid-Caps Dalmia Bharat 48% 6.7 Y Y Y India Cements 34% 5.7 Y Y Y J K Cement 38% 6.6 Y Y Y JK Lakshmi 38% 6.9 Y Y Y Ramco Cements 31% 8.6 Y Y India Cement Sector 6

7 Mid-caps should re-rate given increasing scale, regional diversification, and higher growth In the past, mid-caps have traded at average discounts of 50-60% to large caps with the discount narrowing during up-cycles. Figure 11 and Figure 12 show the JK Cement and JK Lakshmi EV/t discount to large-cap average during the last cycle (the up-cycle is denoted by rising EBITDA/t where we have used Ambuja EBITDA/t as a proxy). Midcap discount to large caps narrows in an upcycle Figure 11: JK Cement's EV/t discount to large caps -45% 1,200-50% 1,150 1,100-55% 1,050-60% 1, % % % % 700 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Figure 12: JK Lakshmi's EV/t discount to large caps -40% 1,200-45% 1,150 1,100-50% 1,050-55% 1, % % % % 700 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 JKCE.NS Ambuja EBITDA/T (RHS) JKLC.NS Ambuja EBITDA/T (RHS) Source: Company data, Reuters, Credit Suisse Source: Company data, Reuters, Credit Suisse We note that this time, mid-caps are better prepared for the up-cycle: (1) with capacity expansions scheduled in the near term (Dalmia, JKCE and JKLC are growing capacities at c.18-28% CAGRs over FY14-16E); (2) capacity-wise, the gap with large caps has narrowed with Dalmia Cement already having a 24mt capacity (versus ACC and Ambuja s 28-30mt), and JK Cement and JK Lakshmi both ~11mt each; (3) each of the three midcaps are now operating in 3-4 regions and has less concentration risk than in the past. Dalmia Cement has exposure to the South, East, North East and with the recent Belgaum expansion will start supplying the Western market as well. JK Lakshmi so far has focused on the North and West markets and is now expanding into the East market. JK Cement already has exposure to the North, West and Southern markets; and (4) as high financial leverage reduces at mid-caps (net debt is almost equal to market cap currently), we expect mid-caps to re-rate. We highlight that even without re-rating, the stocks do offer good potential upside as the expected cement up-cycle transpires due to high financial leverage. We expect c % EBITDA CAGRs over FY14-17E for the three mid-caps. Dalmia and JKCE especially stand to benefit from an uptick in utilisation (Dalmia's existing utilisation is low at 60% and JK Cement s South plant operated at just 50% utilisation in FY14), and both have high operating leverage (10% higher volumes can add 14-15% to EBITDA/t). We note that India Cements and Ramco screen well in terms of financial and operating leverage, but score poorly on capacity growth near-term. In the current upcycle, midcaps are closer to large caps in size and scale. DBEL, JKCE and JKLC are expanding capacity rapidly and towards the tail end of their capex cycles High operating leverage and low utilisation mean Dalmia and JKCE could benefit from a revival of South India demand India Cement Sector 7

8 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Demand-supply gap expected to turn favourable With supply additions for FY15 and FY16 certain (considered projects where equipment has been ordered), margin expansion and volume growth for the large caps mainly depend on demand growth. We expect a supply addition CAGR of 7% for the next two years with a 30mt capacity addition in FY15E and mt in FY16. Here, we also consider Ultratech's expansion in Karnataka and Chattisgarh as new expansion, as utilisation from both the units is very low today and therefore act as new capacity to the market. Supply should see 7% CAGR in FY We expect margin expansion as demand growth is expected at 8% in FY15 and 11% in FY16 Figure 13: In terms of absolute capacity adds, east India is expected to add the most capacity FY15,16 capacity adds Figure 14: Large companies account for half of capacity adds over FY15-16E North South East West - FY 12 FY 13 FY 14 FY 15 FY 16 Large Players Mid-size companies Small companies + Others Large Players Mid-size companies Small companies+new entrants * FY14 - Ultratech's expansion in Karnataka has been pushed out to FY15 as the unit has not yet started production. The demand growth required to balance new capacities should be 7-8% each year for next two years (assuming 40% utilisation for the first year for new capacities and 60% for second year). If demand growth is >8%, the sector should benefit from accretive price increases. Figure 15: Double-digit demand growth possible in FY16 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% 11% 10% 8% 8% 7% 6% 15% -1% 9% 9% 6% 9% 12% 9% 8% 7% 11% 5% Forecast 8% 7% 3% 8% 11% Figure 16: Demand growth to be sharp in 2H15 (low base) 14% 12% 10% 8% 6% 4% 2% 0% Demand growth YoY FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Source: Company data, Credit Suisse research India Cement Sector 8

9 In our view, demand growth should increase to 7-8% in FY15E (with demand growth expected to be higher in 2H FY15 due to a low base last year (Figure 16)) and demand growth for FY16E could be in double digits. We present a bottom-up framework of our demand projections in Figure 17 where we expect a significant recovery in roads, irrigation, and private capex, etc. Figure 17: Breakdown of Indian cement demand recovery in road, irrigation and private capex key to double-digit growth in FY16E % of cement demand FY15E growth FY16E growth Rural housing 40% 10% 12% Urban housing 25% 4% 7% Power 3-4% 5% 5% Irrigation 4% 5% 20% Roads 3-4% 15% 20% Railways 3% 10% 15% Others (incl. private 20% 8% 10% capex) Total 100% 8% 11% Source: Credit Suisse estimates Budget documents show FY14 spending on Indira Awaas Yojna (rural housing scheme) (4-5% of cement demand) did increase 46% YoY and therefore most of FY14 demand growth was driven by rural housing and the contribution from the infrastructure segment was nil or negative. In the recent budget, total spending on rural housing is proposed to increase by 17% (Figure 18) but based on FY14 actuals, the increase is about 36%. Figure 19 shows that spending on rural development activities had been above budget for most of the past years with the exceptions of only FY13 and FY14 where spending was about 75%, as the government curtailed the spending to contain the fiscal deficit. Despite lower budgeted headline growth (17%), FY15 outlays on rural housing could be up 36% YoY because of curtailed FY14 spending Figure 18: Union budget allocations to various sectors Rs bn Budget plan FY14 Actuals FY14 Budget plan FY15 Budget plan YoY % FY15 budget vs. Actual Rural development % 35% NREGA % 1% Rural housing % 36% PMGSY (rural roads) % 66% Roads % 13% Ports % -27% Airports % 12% Railway % 10% Source: Company data, Credit Suisse India Cement Sector 9

10 Figure 19: Government spent only 75-80% of budget in the past two years on rural development and roads Figure 20: Irrigation six states account for 67% of the plan spend 200% 180% Actuals vs. budgeted for Government spend 160% 140% 120% Others 33% Andhra Pradesh 18% Gujarat 13% 100% 80% 60% FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Madhya Pradesh 7% Uttar Pradesh 7% Maharashtra 12% Karnataka 10% Road Rural development (IAY, PMGSY, NREGA) Source: Company data, Credit Suisse Source: Company data, Credit Suisse India Cement Sector 10

11 Initiating on Dalmia, JK Lakshmi, JK Cement with OUTPERFORM We initiate coverage on Dalmia, JKCE and JKLC with OUTPERFORM ratings and with a target price of Rs585 for Dalmia, Rs540 for JKCE and Rs300 for JKLC. Our underlying thesis is similar with the investment phase nearing completion within a year and returns set to more than double over FY14-17E. Company-specific catalysts are seen to be the highest for Dalmia based on the simplification of the group structure (the merger of Adhunik and Calcom with the parent, an increase in stake in OCL and KKR s exit). For JK Cement, the key catalyst is restoration of coal linkages and for JKLC, the catalyst is the commissioning of its East capacity in Oct-14. Dalmia Bharat, OUTPERFORM, TP Rs585 Dalmia is the fifth-largest cement group in India with a 24mt capacity and has exposure to the South, East, North East and West markets. We like DBL as: (1) its scale of operations are ramping up to large-cap levels; (2) the simplification of its group structure should unlock value; (3) DBL has both high operating and financial leverage and is well positioned to capture upside from the expected cement upcycle; (4) the company has significantly strengthened its Board; and (5) its investment phase should be completed this year with Calcom and Belgaum expansions commissioning by Nov-14. We expect a strong EBITDA CAGR of 50% over FY14-17E for DBL factoring in both an expected demand upturn and also cost saving initiatives at East and North-East plants, such as volume swap benefits at Bokaro, the new clinker plant at Calcom, and the power cost reduction at OCL and the South operations. Simplification of group structure is the key catalyst for Dalmia. The merger of Adhunik and Calcom with DCBL should help utilise accumulated tax losses of Rs6 bn in the North East operations. Furthermore, the Calcom merger is scheduled for FY17 (no cash outgoing for an additional 26% stake) and OCL s stake increase should unlock value, as OCL is trading at an EV/t of just US$50 and the same stake is likely to gain a higher value after the merger. The reverse merger of DCBL and DBL should provide an exit to KKR. JK Lakshmi, OUTPERFORM, TP Rs300 JKLC is doubling its cement capacity within a year to 11.4mt and has exposure to the North, West and East markets. Half of this expansion is in the East which helps diversify regional exposure, as so far JKLC mostly focuses on the North and West. We highlight that the investment phase for JKLC is nearing completion and returns should more than double over next three years. We expect a volume CAGR of 16% and EBITDA CAGR of 40% over the next three years with the cost of production in the East expansion being Rs /t lower than current operations due to lower power and personnel costs. The key catalyst for JKLC is the commissioning of East capacity where out of the 2.7 mt expansion, Chattisgarh s capacity of 1.7 mt is expected by October JK Cement, OUTPERFORM, TP Rs540 JKCE will have a 10.5mt grey cement capacity (after its expansion in North) and 1.7mt for white cement and Wall putty. JKCE operates in the North, West and South-West markets. JK Cement has expanded grey cement capacity by 3mt in North which should allow JKCE to gain market share as so far the company has been capacity constrained in the North. Additionally, a 1.5mt grinding unit in Haryana helps save freight cost of Rs500 mn or 14% of FY14 EBITDA. In addition, restoration of coal linkages could add Rs300 mn or 8% of FY14 EBITDA. Factoring in the cost savings, we expect an EBITDA CAGR of 45% over the next three years (with an 18% volume CAGR). The key catalyst for JK Cement should be restoration of coal linkages for the North plants and that is expected this year. We initiate coverage on Dalmia, JKCE and JLKC with potential upside of 25-45%. They are near the end of their investment phase and returns could double over FY14-17E The strongest catalyst for Dalmia is simplification of its group structure: (1) tax benefits from Adhunik/ Calcom losses; and (2) value unlocking from the acquisition of the OCL/ Calcom stake The commissioning of lower-cost East India capacity and a volume CAGR of 16% can drive a 40% CAGR in EBITDA over the next three years We like JK Cement because of: (1) its stable white cement profitability; (2) the restoration of coal linkages to North plants; and (3) cost savings from the Haryana grinding unit India Cement Sector 11

12 JKCE has a 40% market share in white cement in India and has expanded India capacity by 60% recently. White cement comprises about one third of total EBITDA and lends stability to profitability. JKCE is trading at an EV/t of US$75. Capex on white cement is 1.5x that of grey cement and therefore adjusted for white cement capacity, JK Cement is trading at US$75/t or a 40% discount to replacement cost. Our target price of Rs540 is based on 7x FY17 EV/EBITDA discounted to FY16. Figure 21: Summary of Initiations on mid-caps Mkt cap (US$ mn) Liquidity (US$ mn) FY16E capacity (mt) Rating Target price (Rs) EV/t trading at (US$) Implied EV/t by CS TP (Rs) Dalmia O JK Cement O JK Lakshmi O Investment risks for Dalmia, JKCE, and JKLC Demand growth stays less than 7-8%. Key risk to our view is if demand growth stays less than 7-8%. Supply CAGR expected for next two years is 7% and we have assumed margin expansions for the sector assuming demand growth of 8% in FY15E and 11% in FY16E. Large caps start gaining market share. Large caps so far have sacrificed market share to maintain prices in the sector. If large caps start gaining market share and the production discipline breaks, our estimates on both volume growth and margin expansion would be at risk. Reduction in coal availability for cement sector or increase in petcoke prices. Most cement plants have increased usage of petcoke especially in last one year and reduced dependence on market purchased coal (through E-auction or imported coal). However, if supplies of E-auction coal reduce or petcoke prices go up materially, our cost inflation assumption of 5% for power cost is at risk. Increase TP for large-caps, increase sector multiples Given the expected recovery in demand growth and full benefit of expanded capacity largely visible in FY17, we have changed our valuation methodology to discount FY17 EBITDA to FY16 and use 10x EV/EBITDA multiple. Therefore we increase target price for Ultratech to Rs2,200 (from Rs1,535), Ambuja Rs184 (from Rs160), ACC Rs1,350 (from Rs1,200) and Grasim Rs2,900 (Rs2,750). We increase large cap cement multiples from 9x FY16 EV/EBITDA to 10x FY17 EV/EBITDA (discounted to FY16) and increase FY16E EPS by 4-10% as shown in Figure 22. Figure 22: Summary of model changes Company Mkt cap Recommendation Earnings per share TP (Rs) (US$ mn) Old New FY15E FY16E - new (Rs) new(rs) FY15E chg. FY16E chg. % Old New ACC 4,374 N N % 5.0% ,350 Ambuja Cements 5,305 U U % 4.8% Grasim Industries 4,910 N N % 3.8% 2,700 2,900 Ultratech Cement 10,987 U N % 10.1% 1,535 2,200 Dalmia Bharat. 576 Initiate with O JK Cement. 432 Initiate with O JK Lakshmi Cement. 481 Initiate with O India Cement Sector 12

13 Asia Pacific / India Dalmia Bharat Ltd. Rating OUTPERFORM* [V] Price (28 Jul 14, Rs) Target price (Rs) ¹ Upside/downside (%) 37.3 Mkt cap (Rs mn) 34,602.9 (US$ 575.7) Enterprise value (Rs mn) 91,413 Number of shares (mn) Free float (%) week price range ADTO - 6M (US$ mn) 0.43 *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. ¹Target price is for 12 months. [V] = Stock considered volatile (see Disclosure Appendix). Share price performance Price (LHS) Research Analysts Anubhav Aggarwal anubhav.aggarwal@credit-suisse.com Badrinath Srinivasan badrinath.srinivasan@credit-suisse.com Rebased Rel (RHS) 0 Aug-12 Dec-12 Apr-13 Aug-13 Dec-13 Apr The price relative chart measures performance against the S&P BSE SENSEX IDX which closed at on 28/07/14 On 28/07/14 the spot exchange rate was Rs60.11/US$1 Performance over 1M 3M 12M Absolute (%) Relative (%) (DALA.BO / DBEL IN) INITIATION Graduating to the major league Initiating with an OUTPERFORM. We initiate coverage of Dalmia Bharat (DBL) with an OUTPERFORM rating and target price of Rs585. Dalmia is the fifth-largest cement group in India with a 24mt capacity and has exposure to the South, East, North East and West markets. High operating and financial leverage. We like DBL as: (1) its scale of operations are ramping up to large-cap levels; (2) the simplification of group structure should unlock value; (3) DBL has both high operating and financial leverage, and is well positioned to capture upside from a cement upcycle; (4) the company has significantly strengthened its Board; and (5) its investment phase should be completed this year with the Calcom and Belgaum expansions commissioning by Nov-14. We expect a strong EBITDA CAGR of 50% over FY14-17E for DBL factoring in both an expected demand upturn and also cost-saving initiatives at the East and North-East plants, such as the volume swap benefit at Bokaro, new clinker plant at Calcom, and power cost reduction at the OCL and South operations. Simplification of group structure is key catalyst. The merger of Adhunik and Calcom with DCBL should help utilise accumulated tax losses of Rs6 bn in North-East operations. Furthermore, the Calcom merger is scheduled for FY17 (no cash outgoings for an additional 26% stake) and the OCL stake increase should unlock value as OCL is trading at an EV/t of just US$50 and the same stake is likely to gain a higher value after the merger. The reverse merger of DCBL and DBL should provide an exit to KKR. Trading at 35-40% discount to replacement cost. Dalmia is trading at an EV/t of US$80 and as the demand upcycle transpires and group structure is simplified, the stock should re-rate. Management maintains that they will not opt for organic expansion until FY17 with focus on net debt reduction. We value the stock at 7x EV/EBITDA where we discount FY17 EBITDA by one year. Our target multiple is at a 30% discount to large-cap peers and implies an EV/t of US$85/t. Key risk to our view is if demand growth stays <7-8%. Financial and valuation metrics Year 3/14A 3/15E 3/16E 3/17E Revenue (Rs mn) 29, , , ,130.6 EBITDA (Rs mn) 4, , , ,093.2 EBIT (Rs mn) 1, , , ,458.2 Net profit (Rs mn) , , ,525.7 EPS (CS adj.) (Rs) Change from previous EPS (%) n.a. Consensus EPS (Rs) n.a EPS growth (%) n.m. n.m P/E (x) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) Net debt/equity (%) Source: Company data, Thomson Reuters, Credit Suisse estimates India Cement Sector 13

14 Graduating to the major league We like DBL because: (1) it is transitioning from a regional to a geographically diversified, pan-india player; (2) its scale of operations is ramping up to large-cap levels; (3) the consolidation of the group structure should unlock value; (4) DBL is well positioned to capture upside from an expected cement upcycle, as it has both high operating and financial leverage (group utilisation is low at 58% with net debt/ev high at almost 60% of market cap); and (5) the company has significantly strengthened its Board recently. Dalmia Bharat is at the tail end of its capex cycle, with capacities experiencing a 13% CAGR over FY11-15E, through acquisitions and greenfield expansions. The last of its capacity expansions should commission by Nov-14. We expect a strong EBITDA CAGR of 50% for FY14-17E, factoring in both higher ASPs from demand upturn and also cost saving initiatives at the East/North-East plants. Strong EBITDA generation should help in deleveraging. About Dalmia Bharat Dalmia Bharat is the fifth-largest cement player in India, with a headline capacity of 24 mt. A series of expansions has helped DBL diversify its footprint from the South market to the East and North-East markets and with its most recent organic expansion, Dalmia will be diversifying into the West region as well. DBL's assets are spread across five key units: (1) Dalmia Cement (DCBL: an 85% subsidiary; 11.5 mt in South); (2) OCL (associate company): DCBL owns a 48% stake; 6.8mt in East); (3) Calcom (a 76% subsidiary of DCBL; 2.2mt in the North-East); (4) Adhunik (a 100% subsidiary of DCBL; 1.5mt in the North-East); and (5) Bokaro (a 74% subsidiary of DCBL; 2.1mt in East). DCB power ventures hold power plants for the South operations of DCBL and receive a flat royalty for power that DCBL generates from these plants. We see EBITDA having a 50% CAGR over FY15-17E because of: (1) a demand revival; (2) operating leverage across plants; and (3) cost-saving initiatives Dalmia's operations are spread across the following regions: (1) South DCBL (subsidiary); (2) East OCL (associate), Bokaro (subsidiary); (3) North East Adhunik (subsidiary), Calcom (subsidiary) Figure 23: Dalmia Bharat s group structure KKR 15% Dalmia Cement (Bharat) Ltd Dalmia Bharat Ltd 85% 100% Dalmia Power Ltd. 100% Adhunik Cement 9.0MT in South; Expanding to 11.5MT 1.5MT in NorthEast; 25MW power plant 26% 74% DCB Power Ventures 72MW power plant; expanding to 97MW 76% 48% Calcom Cement OCL India 1.3MT in NorthEast; expanding to 2.2MT 6.7MT in East; 54MW power plant 74% Bokaro JV 2.1MT plant in East Source: Company data, Credit Suisse India Cement Sector 14

15 Figure 24: Dalmia Group capacities Cement (mn t) Power (MW) Existing Expansion/ Total Existing Expansion/ Total acquisition acquisition Dalmia Dalmiapuram, TN Cement Ariyalur, TN Kadapa, AP Meghalaya Lanka* Belgaum, Karnataka Bokaro, Jharkhand Total DCBL OCL Rajgangpur, Odisha Kapilas, Odisha* Medinipur, WB* Total OCL Group Total * Grinding; Source: Company data, Credit Suisse Investment phase to be largely over by FY15 Dalmia's organic expansions are scheduled for completion during FY15. They comprise: (1) a 2.5mt integrated plant at Belgaum, Karnataka (Nov-14 start); (2) a 1.35mt grinding unit at Medinipur, Bengal (part of OCL; already commissioned); and (3) a 0.9mt grinding (commissioned) and 1.0mt clinker expansion (Nov-14) at Assam (in the Calcom subsidiary). Dalmia's acquisition of JPA's 74% stake in the Bokaro JV (2.1mt) should reinforce the company's presence in Bihar and Jharkhand (c. 8% of group sales). The Medinipur expansion will be OCL's first plant outside Orissa, and apart from freight cost savings, the group's West Bengal presence (c. 8% of group sales) will be materially strengthened. The greenfield project at Belgaum should expand DBL's footprint in new markets North Karnataka and Maharashtra taking the company one step closer to the vision of being a pan-india player. DBL signed a Letter of Intent with the Rajasthan government for limestone mining, with the intention of setting up a 2 mtpa cement plant; a mining lease is yet to be signed, but we think this highlights DBL's intent to expand its geographical presence via greenfield projects in the North. Dalmia is at the tail end of its capex cycle; the Belgaum expansion will increase company exposure to South/West, while Bokaro acquisition and OCL/Calcom expansions will increase East/North East volumes Figure 25: Breakdown of group-level volumes and utilisation Company Region Volumes YoY growth Utilizations FY14 FY15E FY16E FY17E FY15E FY16E FY1E7 FY14 FY15E FY16E FY17E DCBL South/West % 16.9% 10.6% 61.6% 58.5% 60.9% 67.3% Bokaro East % 6.9% 6.5% 70.0% 72.0% 77.0% 82.0% Adhunik North East % 7.9% 7.9% 54.9% 58.9% 63.5% 68.5% Calcom North East % 73.6% 47.5% 23.7% 20.7% 35.9% 53.0% OCL East % 16.1% 7.8% 64.3% 57.5% 66.8% 72.0% Total % 16.8% 11.1% 59.0% 55.8% 61.8% 68.7% Note: Bokaro added to total group only in FY15 India Cement Sector 15

16 Figure 26: FY14 sales: Largely a South and East player Figure 27: Bokaro acquisition and expansion at Belgaum can expand footprint in new markets (highlighted) Bokaro JV (2.1MT) Meghalaya 1.5 MT (Adhunik) Lanka/ Umrangshu 1.3MT -> 2.2MT (Calcom) Bihar 5% Jharkhand 3% West Bengal 8% North East 11% Orissa 17% Rajgangpur 4.0 MT Medinipur 1.4MT Karnataka 8% Andhra Pradesh 6% Kapilas 1.4MT Kadapa 2.5MT OCL units Kerala 13% Tamil Nadu 25% Belgaum (2.5MT) Ariyalur 2.5 MT Dalmiapuram 4.0MT Dalmia units New capacity being added Source: Company data, Credit Suisse Source: Company data, Credit Suisse Simplification of group structure is a key catalyst Dalmia Bharat's effective tax rate is ~40-50% due to: (1) accelerated depreciation in its income tax books and therefore a deferred tax liability in the P&L; (2) DCBL not being able to set off losses in the North-East operations as the assets were in the Adhunik and Calcom subsidiaries. DCBL owns 76% of Calcom and 100% of Adhunik. With the current structure, accumulated losses at Adhunik and Calcom (Rs6.1 bn, with Rs3.4 bn at Adhunik and Rs2.7 bn at Calcom) are only likely to be set off beyond FY17E as the North-East operations start generating material profits. Merging the subsidiaries (and their accumulated losses) into the parent company can result in material tax savings sooner. Adhunik merger can save tax of Rs1 bn and the Calcom merger could save tax of Rs0.9 bn). Dalmia (the parent) cannot claim tax benefits from accumulated losses at Adhunik and Calcom subsidiaries; integration can allow the tax benefits to accrue sooner Why has Adhunik not already been merged despite a 100% stake? Adhunik (a 100% subsidiary) is a prime candidate for a merger with the parent; however, there was uncertainty if, in the case of such a merger, state benefits extended to Adhunik would be extended to the parent company as well. A capital subsidy takes 2-3 years after commissioning and now the capital subsidy has been received. The unit will continue to enjoy other exemptions, such as excise, VAT and freight subsidies which together amounts to Rs 600/t. DBL s management has already started the process of merging Adhunik and the merger is likely to be effective in FY16E. Calcom merger unlikely before FY17; but likely to be value accretive DBL has an option to buy the remaining 24% stake in Calcom at 5x FY17E EBITDA. Based on our models, losses at Calcom over FY15-16E (higher interest costs, depreciation, time to ramp-up clinker output) as well as ongoing capex might necessitate higher levels of debt and the 5x EBITDA valuation may result in no net outgoings to the erstwhile promoters. Nevertheless, the acquisition of a 24% stake in 2.2mt integrated plant Adhunik has not been merged so far due to uncertainty over state benefits being extended; that is largely resolved and we expect the merger in FY16E A 24% stake in Calcom could be acquired at an inexpensive 5x EBITDA; given debt levels, this could happen with no cash outgoings India Cement Sector 16

17 at 5x EBITDA should be value accretive for DBL as larger listed players trade materially higher. Increase in OCL stake in the long term could unlock value The promoter group owns 75% in OCL with DBL owning 48%. Currently the timeline is not clear when DBL will acquire a 26% stake from the family and start consolidating OCL in DBL. OCL currently trades at c. US$50/t (c. a 60% discount to replacement cost). Consolidation should help re-rate OCL by gaining a consolidated multiple of DBL. Will KKR exit be valued higher through holding company discount: Less likely KKR is likely to be given an exit through the reverse merger of DCBL and DBL. Here, a potential concern could be that if KKR s stake in DCBL is given the benefit of a holding company discount then KKR's stake in DBL could be higher than 15%. However, given that the promoter's interest here is aligned with the minorities, the probability of this concern becoming reality is lower. Strong EBITDA CAGR of 50% seen over FY14-17E We forecast a 50% EBITDA CAGR for DBL over FY14-17E factoring in: (1) strong volume growth from a modest base and resulting operating/financial leverage; and (2) cost-saving initiatives at Calcom, Bokaro and Adhunik. Cost-saving initiatives at various group entities As described below, DBL has a good track record of taking over inefficient units and improving substantially on their cost structure. This gives us comfort on the efficacy of further cost-reduction initiatives under way. Adhunik: Adhunik s FY14 variable costs have already fallen 15% YoY, as DBL optimised operations: power consumption per unit reduced from 126Kwh to c. 90Kwh while power costs reduced from Rs6.5/unit to Rs4.5/unit, by shifting fuel mix towards more petcoke. We believe that 10% volume growth at this asset can add 19% to EBITDA/t due to operating leverage. Calcom: Volumes at Calcom have been weak due to: (1) a lack of availability of clinker and (2) technical issues with the kiln (now rectified). Construction of a 1.0mt clinkerisation unit is under way, with commissioning targeted for Nov-14. This should resolve the clinker bottleneck and RM costs should fall to Rs1,600/t (from a Rs2,200/ in FY13). A 0.9mt grinding expansion has already been commissioned in Feb-14 and the company should see a sharp pick-up in volumes over 4Q FY15/FY16. Calcom is the only integrated cement plant in Assam; management suggests this should be one of the lowest cost producers in the area, which should allow the company to grow market share substantially. Bokaro: Located near the Jharkhand-West Bengal border, the Bokaro unit can benefit from volume swaps with OCL saving Rs300 mn annually (spread across both DBL and OCL) in freight costs. Bokaro can also expand the group's footprint further in Bihar and Jharkhand (5/3% of current group sales respectively). DBL suggests that the installation of variable frequency drives on all motors can help save some power costs at the unit. Management guidance indicates the plant can generate EBITDA/t of Rs1,100-1,200. The raw material cost increase for Bokaro unit is linked to realisations (JPA supplies clinker on a 30-year supply contract, while SAIL supplies slag with a 30-year contract). DCBL South operations: The use of petcoke was increased last year to 70% of fuel mix, but the full impact will be visible in FY15 only. OCL: Fuel mix at OCL is linkage coal and the market purchase of E-auction coal. Dalmia is planning to increase petcoke usage at OCL which should help in power cost reduction. OCL trades at a 60% discount to replacement cost (Dalmia at a 35% discount). Integration to be value accretive Cost reduction to be an additional kicker: (1) Adhunik shift of fuel mix to petcoke and operating leverage; (2) Calcom commissioning of a (cheaper) clinker unit and operating leverage; (3) Bokaro freight optimisation and power cost savings; (4) DCBL South operations full impact of fuel mix shift; and (5) OCL higher petcoke mix to save power expenses India Cement Sector 17

18 Operating and financial leverage DBL's group level capacity utilisation in FY14 was ~58%, largely due to; (1) weak Andhra Pradesh operating rates; (2) clinker issues at Calcom; and (3) Adhunik still in the ramp-up phase. An uptick in utilisations could then be significantly accretive to earnings. Large gearing to South India The South accounts for c. 50% of FY14 group sales. Utilisation at the Kadapa (Andhra Pradesh) and Ariyalur (Tamil Nadu) plants is 55-60%. This is a market where DBL has a strong presence and we believe that the company is well placed to capture any upcycle in cement demand. Supply additions in the states of Andhra Pradesh, Tamil Nadu and Kerala (44% of group sales) are benign for the next 2-3 years. Even assuming growth in line with industry, we see Dalmia South India utilisation increasing to 75%. We estimate 10% growth in group level volumes could add 15% to EBITDA/t. The political logjam in Andhra Pradesh has resulted in a sharp slowdown in decision making and several projects had been stuck for want of clearance. With this overhang now out of the way, pent-up demand could be supportive of cement sales from 2HFY15. Over half of group sales are in the South, where Dalmia plants are operating at ~62% utilisation. Demand revival from a low base could drive large operating leverage benefits FY16/17 free cash flows (minus interest) could equal 8-15% of net debt During its current expansionary phase, Dalmia has accumulated a significant amount of debt (we estimate peak net debt of Rs 53 bn in FY15 (including OCL); 1.5x equity, 4.6x FY16 EBITDA). Debt now accounts for 55% of current enterprise value. The gradual rampup of capacity should drive a significant increase in free cash flow FY16/17 FCF (minus interest) could equal 8-15% of net debt. A 10% fall in net debt (c. 60% of current EV) with no multiple expansion could drive a 15% increase in equity value. Figure 28: EBITDA/t to recover on operating leverage, accretive price increases 1,500 1,250 1, FY13 FY14 FY15 FY16 FY17 (250) (500) DBL Consol DCBL Bokaro Adhunik Calcom OCL Figure 29: Volume growth and operating leverage could help sustain deleveraging 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 - (2,000) INR mn EBITDA FY14 FY15 FY16 FY17 - DCBL Bokaro Adhunik Calcom Standalone/adj. Debt:EBITDA (RHS) Acquisitions: Looking at acquisitions if synergies are high DBL has been acquisitive despite having high leverage. The group s philosophy is to look at acquisitions in the regions it is present in, in addition to organic growth opportunities, but for the new regions, the group is mainly focusing on organic growth. In past acquisitions, DBL has been able to attract synergies, such as: (1) substantial power cost reduction at Adhunik; (2) cost reduction at Calcom; and (3) synergies through volume swaps in Bokaro acquisitions. Past acquisitions have typically been with synergy benefits and cost reductions in mind India Cement Sector 18