Indian Cement Sector. Initiating Coverage. Near term macros improve. Demand growth accelerates. Oversupply is inevitable

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1 April 2, 29 Cement Initiating Coverage Indian Cement Sector Near term macros improve With softening interest rates, sharp correction in coal and petcoke prices and firming up of cement prices due to strong demand, we believe the near term macroeconomic conditions for the cement industry have improved significantly. We believe that due to healthier balance sheets, moderate consolidation, use of more cost efficient technology and change in the macro environment over the last two quarters cement players will be better off compared to the earlier down cycle. We are initiating coverage on the cement sector with a positive view on Shree Cement, Orient Paper, JK Cement and UltraTech Cement, neutral on India Cement and negative view on ACC, Ambuja and Dalmia Cement. Demand growth accelerates After reporting cement dispatch growth of merely 6.7% in the first seven months of FY9 (April-October 8), cement growth has accelerated to 1.5% in November 8-March 9. We believe the Indian cement industry will continue to grow by 1.2x GDP growth in FY1. Oversupply is inevitable About 62 million tonnes (MT) of cement capacity is scheduled to come on stream by the end of FY1. We expect the capacity utilisation of the industry to drop from 88% in FY9 and further to 79% in FY1. Thus, cement prices are likely to come under pressure with the beginning of the monsoon season. Subsiding cost pressure to cushion margins in near term A 4% cut in excise duty, sharp correction in imported coal, petcoke and crude prices by 67.8%, 49% and 66% respectively from their peak levels have reduced cost pressures for the cement industry. Apart from this, softening of interest rates would reduce the interest burden of smaller cement players, who have funded their capex by debt and cushion their PAT margins. However, we believe that in the long run, the demand-supply situation will force cement players to cut prices and pass on the benefits. Recommendation Some of the cement stocks are currently trading at valuations lower than the value given to loss making cement companies in the last 1 years. This is despite the fact that replacement cost for cement companies has increased significantly over the last decade. We believe that long-term value has emerged in select cement stocks. We also believe that companies that have completed a majority of their capacity addition, undertaken cost cutting measures or have low cost structure with lower earning sensitivity to price declines will be better off compared to their peers. Timely capacity addition will reduce the payback period while a low cost structure will enable them to cut prices and push volumes in a down cycle. We prefer UltraTech Cement among large caps, Shree Cement in the mid cap space and JK Cement and Orient Paper in small caps. Analysts Name Ravi Sodah ravi.sodah@icicidirect.com Vijay Goel vijay.goel@icicidirect.com Ambuja Cement (GUJAMB) CMP 8 TP 64 Rating Underperformer Dalmia Cements (DALCEM) CMP 95 TP 81 Rating Underperformer India Cements (INDCEM) CMP 12 TP 11 Rating Hold Orient Paper & Ind. (ORIPAP) CMP 28 TP 36.2 Rating Outperformer ACC (ACC) CMP 617 TP 5 Rating Underperformer JK Cements (JKCEME) CMP 54 TP 62 Rating Performer Shree Cement (SHRCEM) CMP 796 TP 9 Rating Performer UltraTech Cement (ULTCEM) CMP 546 TP 63 Rating Performer CMIE Cement Stock Index Mar'8 Apr'8 May'8 Jun'8 July'8 Aug'8 Sep'8 Oct'8 Nov'8 Dec'8 Jan'9 Feb'9 Mar'9 ICICIdirect.com Equity Research 1

2 Content Page No. Demand growth accelerates 3 Oversupply unavoidable 7 Subsiding cost pressure to cushion margins in near term 12 Recommendation 19 Companies Section Initiating Coverages Ambuja Cement 23 Dalmia Cement 32 India Cements 42 Orient Paper & Industries 54 Company Updates ACC 68 JK Cements 73 Shree Cements 78 Ultratech Cements 82 2

3 Demand growth accelerates After reporting cement dispatch growth of merely 6.7% in the first seven months of FY9, cement growth has accelerated to 1.5% in November 8-March 9. Exhibit 1: All-India cement dispatches & YoY growth Lakh tonnes Apr-7 May-7 Jun-7 Jul-7 Aug-7 Sep-7 Oct-7 Nov-7 Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 YoY growth(%) Mar-9 Dispatched(LHS) YoY Growth(RHS) Source: CMA, ICICIdirect.com Research Exhibit 2: Capacity utilisation (%) % Apr-7 May-7 Jun-7 Jul-7 Aug-7 Sep-7 Oct-7 Nov-7 Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Source: CMA, ICICIdirect.com Research 3

4 Increased plan expenditure in the fiscal stimulus package by Rs 2, crore, pre-election spending led increase in demand from the infrastructure sector coupled with capacity additions have driven the volumes of the industry. Also, cooling off of raw material prices and softening interest rates have increased the viability of infrastructure projects that had turned unviable. We have determined that individual housing demand in rural and semi-urban areas has revived due to the following factors: Efforts by the government to boost the demand for houses in the below Rs 2-lakh category in stimulus packages Cooling off of land prices and steel prices Good agricultural harvest Increase in minimum support price (MSP) (wheat's MSP has risen to Rs 1,8 per quintal in 28-9 from Rs 75 per quintal in 26-7 while the figure for rice in the corresponding period has jumped to Rs 85 per quintal from Rs 58 per quintal), Increase in pay for workers under the flagship rural job guarantee scheme Implementation of debt waiver scheme and Implementation of the Sixth Pay Commission All-India cement dispatches grew by 6.7% in April-October 8, mainly driven by the southern region, which had reported growth of 11.5% (Andhra Pradesh had been the main contributor in the southern region with growth of 15.7% mainly driven by higher spending on irrigation projects) as compared to just 4.4% for the rest of India, which forced players like ACC and Shree Cement to shut down their plants. In November 8-March 9, cement demand accelerated in other regions with the central region growing at 8.8% due to higher cement demand on part of the UP government on low-cost housing and demand from infrastructure projects such as Yamuna (Taj) Express Highway. In the northern region the growth was 18.7% due to incremental demand from major projects, viz Commonwealth Games, sewerage line project in Punjab, national irrigation project in Haryana and Delhi Metro, fly-over & Delhi Airport and re-imposition of countervailing duty (CVD) of 8% and Special CVD (special additional duty of customs) of 4%, which has dried up cement imports. Demand in the western region has continued to be muted as the organised real estate sector, which contributes a significant chunk in overall demand, has witnessed a slowdown. Exhibit 3: Region wise cement dispatches growth in FY9(in Lakh tonnes) Regions Apr-Oct'8 Apr-Oct'7 Var.(%) Nov-Mar'9 Nov-Mar'8 Var.(%) North East West Central South All India Ex South All India Inc South Source: CMA, ICICIdirect.com Research 4

5 Cement demand had grown at 8.1% CAGR during FY94-FY8 and at 1% CAGR during FY6-FY8. In the near future, cement consumption has been growing in line with the GDP growth rate with the correlation being close to 97%. We believe that in the long run, the cement industry will continue to grow by 1.2x GDP. With a consensus estimate of 5.9% GDP growth, we expect cement demand to grow at 7% in FY1. We are expecting around 59 MT of demand to be generated by the infrastructure sector and 11 MT by real estate projects in Tier-I cities. Exhibit 4: Cement consumption growth, GDP growth and cement to GDP multiple 14 Average GDP to cement consumption growth multiple of last 15 years is 1.2x 2.5 Growth(%) FY94 FY95 FY96 FY97 FY98 FY99 FY r =.97 FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY Cement consumption to GDP Multiple Cement consumption growth(%) (LHS) Cement consumption to GDP Multiple (RHS) GDP growth(%) (LHS) Source: Bloomberg, CMA, ICICIdirect.com Research Exhibit 5: Per capita consumption of cement of major countries 1 Per capita consumption (Kg) China Europe World Average USA 31 Asia (ex china) 131 India Source: ICICIdirect.com Research 5

6 Exhibit 6: Estimated cement demand from infrastructure sector 11th Five year Plan Roads/ Railways Urban Irrigation Ports *Power Bridges Infra Investment expected from 11th Plan (Rs. Bn) Assumed that 7% will be spent Civil Construction (%) Cement Component(%) Total Cement (Rs. Bn) Cement Prices Rs/Tonne Total cement required (Mn Tonnes) Total Cement for 11th Five year Plan (Mn Tonnes) 295 Average annual Cement consumption (Mn Tonnes) 59 *Cement demand as estimated by "White Paper on strategy for 11th Plan" Source: Planning Commission, ICICIdirect.com Research Exhibit 7: Year-wise planned expenditure Investment in Rs Billion FY8 FY9 FY1 FY11 FY as a % of GDP Investment in infrastructure (Rs Crore) (LHS) Investment as % of GDP (RHS) Source: Planning Commission, ICICIdirect.com Research Exhibit 8: Estimated cement demand from real estate projects in Tier-I cities Residential (Mn.Sq.Ft.) Commercial (Mn.Sq.Ft.) Retail (Mn.Sq.Ft.) City Supply Supply Supply Mumbai NA Pune NA Chennai NA Delhi NCR NA Bangalore NA Hyderabad NA Kolkata NA Total Total developable area Cement consumptions per sq ft per tonne Cement demand over next two years (Mn Tonnes) Average annual cement consumption (Mn Tonnes) Source: Industry, ICICIdirect.com Research

7 Oversupply unavoidable About 62 MT of cement capacity is scheduled to come on stream by the end of FY1. We expect the capacity utilisation of the industry to drop from 95% in FY8 to 87% in FY9 and further to 79% in FY1. Thus, cement prices are likely to come under pressure from the beginning of the monsoon season. Exhibit 9: Demand-Supply scenario; Capacity Utilisation to drop Million Tonnes FY5 FY6 FY7 FY8 FY9 FY1E Effective Capacity Production Capacity Utilisation (%) Domestic consumption *Export Import.4.7. Source: CMA, ICICIdirect.com Research *Cement and clinker Exhibit 1: Region wise capacity addition in FY1 12% 11% 47% 3% South North East West Source: Industry, ICICIdirect.com Research 7

8 Exhibit 11: Capacity addition in FY9 Capacity at the beginning of the year was Mn.T. Name of the Plant State Month of Capacity Capacity Commissioning Existing Added (a) New OCL India-Kapilas (G) Orissa May Rain Comdt. Unit-II Line 2 A.P. Jun-9-2. India Cements-Vallur (G) T.N. Aug UltraTech-Ginigera (G) KAR Sep Lakshmi Cmt-Kalol (G) GUJ Feb Madras Cmts-Ariyalur T.N. Mar-9-2. Chettinad-Ariyalur T.N. Mar-9-2. Total (a) 9.9 (b) Expansion Madras Cements - R.S. Raja Nagar TN Apr Vasvadatta Cement KAR Apr Rain Comdt. Unit-1 A.P. Jun Rain Comdt. Unit-II Line 1 A.P. Jun My Home Indus. Ltd. A.P. Jun Mangalam Cement RAJ Sep J.K. Gotan RAJ Sep Kesoram Cement A.P. Nov Dalmia Cement T.N. Dec Total (b) 3.7 Total (a+b) 13.5 Capacity as on 31 st March Mn.T. Source: CMA, ICICIdirect.com Research Over the last 13 years, the steepest annual fall in cement WPI has been 3.4% as the quantum and timing of the decline has historically been different for different regions. Historically, the southern region has reported the highest decline in cement prices (due to its larger size and presence of a number of players) while the western region has shown least price declines. Exhibit 12: Cement WPI WPI % 15.% 1.% 5.%.% 12 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 Change(%) -5.% Change(%) (RHS) WPI (LHS) Base Year =1 Note: Cement WPI indicates movement of average cement prices in India Source: MOSPI, ICICIdirect.com Research 8

9 Exhibit 13: Cement price changes in major cities 3% 25% Unlike other regions, prices in South had declined by 1% for 2 consecutive years 2% 15% 1% 5% % -5% -1% -15% -2% We believe that moderate concentration of the industry and low leverage will prevent a very sharp decline in prices. It should be noted that in the last down cycle, the cement sector was not consolidated as ACC and Ambuja were not under one group and UltraTech was not a part of the AV Birla group. The top five players now control about 52% (38% by combined Holcim and AV Birla group) of the total capacity. Exhibit 14: Debt equity ratio of cement industry FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY98 FY5 FY99 FY6 FY FY7 FY1 FY8 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 Delhi Mumbai Chennai Kolkata Source: CMA, ICICIdirect.com Research Debt equity ratio (x) Source: Capitaline, ICICIdirect.com Research 9

10 Exhibit 15: Herfindahl -Hirschman Index Un-concentrated Moderately concentrated Highly concentrated India Cement Industry Source: ICICIdirect.com Research Note: HH Index is calculated by adding square of market share of industry players. The Indian cement industry has HHI of approx..1, which indicates moderate concentration An increase in the level of coordination in the industry was seen in the recent past in the northern region, which witnessed oversupply in the initial part of FY9. During April-November 8, when cement consumption grew by 6.3% in Rajasthan and only by 2.3% in the northern region, cement players were able to maintain retail cement prices on a YoY basis despite the fact that Rajasthan added 9.2 MT (38%) capacity while the northern region added 12.1 MT (33%) capacity during the period. However, prices had declined in the bulk cement segment. North-based players, having a presence in the bulk cement segment, reported a decline in net realisations of 6.5% YoY in Q3FY9 on account of their inability to pass on the higher excise duty on bulk cement due to weak demand. Exhibit 16: Installed capacity (million tonne) and consumption growth (%) Consumption Growth Installed Capacity (%) Nov'8 Nov'7 Capacity additions Apr-Nov'8 Rajasthan Northern region Source: CMA, ICICIdirect.com Research Exhibit 17: Cement prices in major northern cities Rs/Bag Nov'8 Nov'7 Var.(%) Delhi % Jaipur % Ludhiana % Chandigarh % Jammu % Source: CMA, ICICIdirect.com Research 1

11 In order to recover cost of capital, a cement company should earn EBITDA per tonne of Rs 7 on a Greenfield plant and Rs 49 on a brownfield plant. Thus, even with 1% price correction and over Q3FY9 levels, cement industry will be able to recover its cost of capital. The actual price decline will also be a function of the decline in average cost of production of the industry. Exhibit 18: Sustainable EBITDA per tonne for cement industry (a) Average Realisations 3493 (b) Average EBITDA Per tonne 946 (c) Capex For Greenfield 5 (d) Cost of capital 14% (e) Required EBITDA per tonne (c*d) 7 (f) Decline in EBITDA per tonne (b-e) 246 (g) Implied decline in cement price( f/a) 7% (h) Capex For Brownfield 35 (i) Required EBITDA per tonne (h*d) 49 (j) Decline in EBITDA per tonne (b-i) 456 (k) Implied decline in cement price (j/a) 13% (h) *Average Implied decline in cement price((k+g/2)) 1% *assuming cost structure remain same and no capacity is added by debottlenecking Source: ICICIdirect.com Research Exhibit 19: Cement stock price index and major developments Liberalisation in Import duty withdrawn imports from Pakistan Cement players agreed to hold prices Jan-7 Dual excise duty on cement introduced Feb-7 Mar-7 Apr-7 May-7 Ad valorem duty introduced Abolition of CVD & SAD Jun-7 Jul-7 Aug-7 Sep-7 Oct-7 Excise duty on clinker increased to Rs 45/tn and on bulk cement increased to Rs 4/tn or 14% Nov-7 Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 Export ban Cement clinker ban onexport to Nepal lifted May-8 Jun-8 Export allowed from Gujarat ports Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Excise duty on bulk cement decreased to Rs 23/tn or 8% Cenvat duty cut of 4% Dec-8 Jan-9 Feb-9 Mar-9 Source: CMIE, ICICIdirect.com Research 11

12 Subsiding cost pressure to cushion margins in near term Power & fuel constitutes 3-35% of the total expenditure for cement manufacturers. Companies mainly use coal and petcoke as fuel for power plants and kilns during the process of making cement. Due to worsening of the macroeconomics scenario, international coal and domestic petcoke prices have corrected by 67.8% and 49%, respectively, from their peak levels. The correction in sea freight has further reduced the landed cost of imported coal. The benchmark index for sea freights, the Baltic Dry Index is 8.8% down from its peak level. However, part of the benefit of softening of international coal prices has been taken away by a weaker rupee, which has deprecated 31% YoY. Exhibit 2: Baltic Dry Index & international coal prices USD per Tonne % decline from peak of $177/tonne $57/Tonne 8.8% decline from peak of Aug-7 Sep-7 Oct-7 Nov-7 Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Baltic dry Index (RHS) Coal price Richards Bay, South Africa (LHS) Note: Baltic Dry Index indicates the movement of sea freight rate Source: Bloomberg, ICICIdirect.com Research Exhibit 21: Rupee US dollar exchange rate 52 5 Rupee has depreciated nearly 31% from its peak of 39.8, which has partly neutralised the benefits of decline in international coal prices Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Source: Reuters, ICICIdirect.com Research 12

13 Exhibit 22: Thermal coal prices spot prices, NCDEX Rs per Tonne % decline from its Sept high of Rs 456/tonne Rs 343/tonne Sep- 8 Oct- 8 Oct- 8 Nov- 8 Dec- 8 Dec- 8 Jan- 9 Feb- 9 Mar- 9 Source: NCDEX, ICICIdirect.com Research Exhibit 23: Domestic petcoke prices Rs per tonne Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Source: Industry, ICICIdirect.com Research 13

14 As far as domestic linkage of coal prices is concerned, it was last revised in Q3FY8 by 1-15%. Players, who depend on domestic coal, are unlikely to see a sharp decline in their average coal cost per tonne due to a decline in incremental coal linkages. Exhibit 24: Fuel receipts by cement industry (in million tonne) Year Coal linkage Receipts against linkage Coal production Coal Receipts as % of Coal production Source: CMA, Crisil, Coal India, ICICIdirect.com Research Exhibit 25: Pithead coal prices Rs per tonne Dec-91 Jun-92 Dec-92 Jun-93 Dec-93 Jun-94 Dec-94 Jun-95 Dec-95 Jun-96 Dec-96 Jun-97 Dec-97 Jun-98 Dec-98 Jun-99 Dec-99 Jun- Dec- Jun-1 Dec-1 Jun-2 Dec-2 Jun-3 Dec-3 Jun-4 Dec-4 Jun-5 Dec-5 Jun-6 Dec-6 Jun-7 Dec-7 Note: Coal prices are for D-grade coal from Singareni Collieries. Source: Crisil, ICICIdirect.com Research 14

15 Exhibit 26: Fuel mix of ICICIdirect.com cement universe Company Domestic Coal(%) Imported Coal(%) Petcoke(%) ACC Ultra Tech Cement Shree Cement 1 Dalmia Cement 1 India Cement 3 7 JK Cement 1 9 Orient Paper 1 Ambuja Cement 7 3 Exhibit 27: Fuel and power cost of major players for FY8/CY7 Average per tonne coal of Fuel in last FY8/CY7 Power cost per unit Grid cost per unit % of power requirement met through CPP(Coal &pet coke based) Company Rate/tonne for coal used in Klin CPP cost per unit ACC #Ambuja Cement #India Cement 3863 NA 3.22 NA #Ultra Tech *Shree cement *JK Cement Orient Paper 218 NA 3.1 Dalmia Average *Use Petoke # Imported Coal Exhibit 28: Electricity consumption per tonne of cement KWH/tonne ACC 85 Ambuja Cement 89 India Cement 85 Ultra Tech 79 Shree cement *JK cement Orient paper 74 Dalmia *Including white cement 15

16 Crude oil prices have also corrected by 66% from their peak. This, in turn, has led to a saving in packing cost (decline of about Rs 4 per bag) and cut in domestic diesel prices by Rs 2 per litre each in December 8 and January 9. However, Indian Railways has changed the product classification for cement and coal in December 8, which has resulted in an increase of 7-8% in freight charges. Apart from this, Railways has continued to levy a busy season surcharge of 7%. About 38% of the total industry volumes are dispatched by rail. With a worsening of the demand-supply situation, the lead distance to market is also expected to increase. Thus, we do not expect any significant saving in freight cost for the cement industry, which constitutes 25-3% of the total expenditure for cement manufactures. Exhibit 29: Transport mix Company Road Rail Sea ACC 5 5 Ultratech Cement Shree Cement 7 3 JK Cement Dalima Cement 7 3 Orient Paper 6 4 Ambuja Cement Exhibit 3: International crude oil prices & domestic diesel price Rs per litre Govt has cut diesel prices by Rs 4 per ltr Dec-7 Jan-8 Feb-8 Mar-8 Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 US$ per barrel Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Diesel (LHS) Crude Oil (RHS) Source: Bloomberg, ICICIdirect.com Research 16

17 Exhibit 31: Indian road freight index May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Source: TCIL, ICICIdirect.com Research Exhibit 32: HDPE prices (packing material) 25 2 USD per tonne USD 97 Per tonne Mar-8 Apr-8 May-8 Jun-8 Jul-8 Aug-8 Sep-8 Oct-8 Nov-8 Dec-8 Jan-9 Feb-9 Mar-9 Source: Bloomberg, ICICIdirect.com Research 17

18 In Q3FY9, the impact of receding cost pressures was already visible in the form of sequential improvement in financials of some of the cement companies. It should be noted that high cost inventories and contracts that cement players had entered into, have prevented major cost relief in Q3FY9. Q3FY9 Result review Exhibit 33: QoQ (Q3FY9 vs. Q2FY9) change in OPM (in bps) bps ACC -42 Ambuja Cement UltraTech Cement -68 India Cement Shree Cement JK Cement Orient Paper -1 Dalmia Cement Exhibit 34: QoQ (Q3FY9 vs. Q2FY9) % change in net profit and operating profit QoQ growth(%) ACC Ambuja Cement UltraTech Cement India Cement Shree Cement JK Cement Orient Paper Dalmia Cement Net Profit Growth QQ (%) Operating Profit growth QoQ (%) 18

19 Recommendation Some of the cement stocks are currently trading at valuations lower than the value given to loss making cement companies in the last 1 years. This is despite the fact that the replacement cost for cement companies has increased significantly over the last decade. We believe that long-term value has emerged in select cement stocks and companies that have completed a majority of their capex, undertaken cost-cutting measures or have a low cost structure and have lower earning sensitivity to price declines. These companies will be better off than their peers. Timely capex will reduce the payback period while low cost structure will enable them to cut prices and push volumes in a down cycle. We prefer UltraTech in large caps, Shree Cement in mid caps and JK Cement and Orient Paper in small caps. Our rating rationale is based on P/E & earnings risk, RoNW, EBITDA margins & EV per tonne and normalised P/E & RoNW matrix. We believe that as the cement sector is expected to witness a surplus in the near future, earnings risk will be key rather than CAGR of earnings (PEG). We have estimated the earning risk of cement companies by estimating the impact of cement price decline on earnings. Cement being a cyclical industry, we have also considered EV per tonne and normalized P/E as during a downturn, earnings contract significantly on account of the companies high earnings sensitivity to cement prices. We have calculated normalised earnings of cement companies by multiplying book value with normalized RoNW (average of business cycle RoNW). Cyclical industry stocks normally have a low P/E at the end of boom and a high P/E at the end of a down cycle. Use of normalized P/E reduces this anomaly. We have used this valuation methodology for pure cement companies having a long history. It is inappropriate to use it for diversified companies as the portion of capital employed in a cement division changes over a period of time. Exhibit 35: Some past M&A deals Year Acquirer Target Capacity (mt) EV/tonne (US$) 1998 Guj Ambuja Modi Grasim Sri Digvijay Ambuja ACC Grasim L&T cement Holcim ACC Holcim Guj Ambuja Cimphor Sri Digvijay CRH My Home Vicat Sagar Source: ICICIdirect.com Research 19

20 Exhibit 36: RoNW vs. EV/tonne RoNW (%) EV/Tonne (US$) ACC Ambuja UltraTech Shree Cem India Cem JK Cem Orient Paper Dalmia Cem Source: ICICIdirect.com Research Note: The size of the bubble indicates FY1E/CY9E OPM (%) Exhibit 37: FY1 P/E vs. earnings risk Earnings risk (%) P/E ACC Ambuja UltraTech Shree Cem India Cem JK Cem Orient Paper Dalmia Cem Source: ICICIdirect.com Research 2

21 Exhibit 38: FY1 Normalised P/E & normalised RoNW (%) 24 2 Normalized P/E Normalized RoNW(%) ACC Ambuja Shree India Cem Source: ICICIdirect.com Research Exhibit 39: Earnings yield (%) & Earnings CAGR (%) Earning CAGR(%) 2-2 AAA bond yield As ACC and Ambuja has a negative earning CAGR with earning yield close to AAA bond, investors have no reward for bearing systematic risk in these stocks Earning yield(%) ACC Ambuja Shree Cem India Cem JK Cem Orient Paper Dalmia Cem UltraTech Source: ICICIdirect.com Research 21

22 Exhibit 4: Q3FY9 cost structure of cement industry Rs Per tonne ACC Ambuja Cement India Cement Ultra Tech Shree Cement *JK cement Stock Adj Raw material Employee cost Power and Fuel Freight Other Expenditure EBIDTA *includes White Cement Exhibit 41: Valuation matrix EPS P/E EV/EBITDA EV/Tonne RoNW (%) RoCE (%) FY8 FY9 FY1 FY8 FY9 FY1 FY8 FY9 FY1 FY8 FY9 FY1 FY8 FY9 FY1 FY8 FY9 FY1 ACC Ambuja UltraTech Shree Cem India Cem JK Cem Orient Paper Dalmia Cem Note: ACC s and Ambuja s numbers are for CY7, CY8 and CY9 22

23 April 2, 29 Cement Initiating Coverage Ambuja Cements (GUJAMB) Current Price Rs 8 Potential upside -2% Target Price Rs 64 Time Frame 12 months Unjustified premium Ambuja Cements (ACL) is trading at steep premium to its peers despite not having best return ratios and margins in the industry. Also, company is adding 4.5 million tonnes (MT) of new capacity by CY11, the time by which the demand-supply situation will turn adverse. With realisation and capacity utilisation set to fall, we expect EPS to decline by 12.5% CAGR (CY8-CY1). Hence, we are initiating coverage on the stock with an UNDERPERFORMER rating on account of its expensive valuations. Capacity addition to bring modest volume growth Ambuja has expanded its capacity to 22 MT by adding 3.5 MT in CY8. The company is planning to further add 4.5 MT, which will take its capacity to 26.5 MT by CY MT of capacity is scheduled to come on stream after mid CY9, the time by which the demand-supply situation will turn adverse. Industry to face demand-supply mismatch; pricing pressure ahead With 62 MT of capacity addition in FY1 and an expected slowdown in construction activities, we expect the demand-supply scenario to worsen. We have seen demand growth in the last couple of months on the back of pre-election spending and the government s stimulus packages. However, we believe this is a temporary relief for the players. We expect a decline in realisations and capacity utilisation. Cement exports to come under pressure Ambuja has exported.8 MT of cement (4.7% of the total sales volume) in CY8. The company mainly exports to Middle East countries. As the infrastructure and real estate projects around the Middle East slow down, Ambuja will find it difficult to divert higher volumes to export. Valuations At the CMP of Rs 8, Ambuja Cement is trading at 11.1x and 14.x its CY9E and CY1E earnings, respectively. On an EV/tonne basis, it is trading at $16/tonne and $94/tonne of its CY9E and CY1E capacities, respectively. Thus, we are initiating coverage on Ambuja Cement with an UNDERPERFORMER rating and a target price of Rs 64. Exhibit 1: Key Financials CY6 CY7 CY8 CY9E CY1E Net Profit 1, , , , EPS % Growth P/E (x) P/BV (x) EV/EBITDA (x) OPM% NPM % RoNW % RoCE % Analysts Name Ravi Sodah ravi.sodah@icicidirect.com Vijay Goel vijay.goel@icicidirect.com Sales & EPS trend Rs Crore 6,4 6,2 6, 5,8 5,6 5,4 Stock Metrics CY6 CY7 CY8 CY9E CY1E Net Sales EPS Bloomberg Code ACEM IN Reuters Code ABUJ.BO Face value (Rs) 2 Promoters Holding 46% Market Cap (Rs cr) week H/L 119 / 43 Sensex 1947 Average volumes Comparative return metrics Stock return(%) 3M 6M 12M Ambuja Cements ACC India Cement Ultratech Cement Price Trend UNDERPERFORMER Close Price Target Price Apr- Jun- Aug- Oct- Dec- Feb- Apr- Rs ICICIdirect.com Equity Research 23

24 Company Background Ambuja Cements was set up in The company is controlled by the Holcim group, which owns 45.68% of the company. The total capacity of the company, as on CY8, is 22 MT. Ambuja has a presence in the north, east and western regions of India. Its plants are situated in Gujarat, Maharashtra, Himachal Pradesh, Punjab, Rajasthan, Uttarakhand, Chhattisgarh and West Bengal. Ambuja has bulk cement terminals at Muldwarka (Gujarat), Panvel, Navi Mumbai and Surat. Ambuja is the largest exporter of cement in India. The company largely exports to the Middle East. The company was one of the first to be equipped with a shipping fleet and make use of the sea as a medium to transport cement across the globe. It has a port terminal at Muldwarka, Gujarat that handles ships with 4, DWT. Exhibit 2: Region wise capacity break up(as on Mar 9) Share holding pattern (Q4CY8) Shareholder % holding Promoters Institutional investors Other investors 11. General public 4.62 Promoter & Institutional holding trend (%) 1% 8% 6% 4% 2% % 46% 46% 46% 46% 38% 37% 37% 37% Q1 Q2 Q3 Q4 Promoter Holding Institutional Holding 22% 35% 43% North West East 24

25 Investment Concerns Capacity addition to bring modest volume growth Ambuja has expanded its capacity to 22 MT by adding 3.5 MT in CY8. The company is planning to further add 4.5 MT, which will take its capacity to 26.5 MT by CY MT of capacity is scheduled to come on stream after mid CY9, the time by which the demand-supply situation will turn adverse. Thus, the sales volume of Ambuja is expected to grow at a CAGR of only 5.7% (CY8-CY1) while the end of the year installed capacity is expected to grow at 8% CAGR during the same period. Exhibit 3: Capacities commissioned in CY8 (million tonnes) Location Caoacity Completion Surat (GJ) 1 CY8 Bhatapara (CG) 1 CY8 Maratha (Chandrapur) 1.5 CY8 Total 3.5 Exhibit 4: Capex plan (million tonnes) Location Grinding Clinker Expected Completion Bhatapara (CG) Mid 29 Ahemdabad (GJ) First half of 211 Rauri (HP) End of 29 Dadri (UP) Mid 29 Nalagarh (HP) First half of 21 Total Industry to face demand-supply mismatch; pricing pressure ahead With around 62 MT of capacity addition in FY1, we expect the demandsupply scenario to worsen. We have seen demand growth in the last couple of months on the back of pre-election spending and government s stimulus packages. However, we believe this is a temporary relief for the players. We expect a decline in realisations and capacity utilisation. Cement exports in difficulty; gulf region faces oversupply Ambuja has exported.8 MT of cement (4.7% of the total sales volume) in CY8. The company mainly exports to Middle East countries. As infrastructure and real estate projects around the Middle East slow down, Ambuja will find it difficult to divert higher volumes to exports. 25

26 Financials Earnings to decline During CY8-CY1, Ambuja s net sales are expected to remain flat, a CAGR of.1% to Rs 6243 crore in CY1 from Rs 6235 crore in CY8 on account of 5.3% CAGR decline in realisation in the next two years. However, the sales volume is expected to grow at a CAGR of only 5.6% (CY8-CY1). Exhibit 5: Revenue to remain flat; volume to grow by 5.6% CAGR CY5 CY6 CY7 CY8 CY9E CY1E Sales Sales Volume The operating profit is expected to decline by 4.% CAGR to Rs crore in CY1 from Rs crore in CY8 on account of a decline in operating margin. Exhibit 6: Margins to decline CY6 CY7 CY8 CY9E CY1E EBITDA margin (%) NPM % 26

27 The reported net profit is expected to decline by 21.3% CAGR to Rs 869 crore in CY1 from Rs 142 crore in CY8 as Ambuja had a high base in CY8. The company had a net extraordinary income on account of sale of investments, change in inventory policy and one-time retirement benefits charges. Thus, the adjusted PAT is expected to decline by 12.5% CAGR to Rs 869 crore in CY1 from Rs 1134 crore in CY8. Return ratios to decline Exhibit 7: RoNW & RoCE 5% 4% 3% 2% 1% 3.8% 39.6% 27.7% 21.9% 18.% 23.1% 16.9% 12.8% % CY7 CY8 CY9E CY1E RoNW ROCE 27

28 Risks to our call Captive power usage Ambuja sources around 64% of its power requirements from captive power generation. During 28, one new 18.7 MW power plant was commissioned at the Rabriyawas plant. Additional captive power projects are in progress at Ambujanagar, Bhatapara and Maratha. These will add approximately another 9 MW, most commissioned in 29 and taking the total capacity to more than 4 MW. For CY8, the average cost of power generation from coal-based CPP was Rs 2.6/Kwh as against Rs 3.86/Kwh for the power purchased from grid. Strong balance sheet Ambuja has cash and bank balance of Rs 852 crore and investments of Rs 332 crore at the end of CY8. It has a debt/equity ratio of.5 at the end of CY8. We expect it to further reduce to.3 by CY1 as the company s total capex plan of Rs 35 crore will be funded totally through internal accruals. Cost pressure eases The company meets 3% of its fuel requirement through imported coal. As international coal prices have dropped sharply by 67.8% from their peak, the company is expected to benefit from the March quarter only because it had been consuming high-cost coal inventory till now. With a worsening of the demand-supply scenario, the lead distance of the company to the markets is expected to increase. However, the cut in diesel prices by Rs 4/litre would enable the company to maintain its freight cost at current levels on a per tonne basis. Quantum of clinker purchase to decline in future Ambuja purchased 7.4 lakh tonnes of clinker (Rs crore) in CY8 accounting for 38% of the total raw material cost. With new clinker capacities coming up, the company is likely to reduce clinker purchase in CY9 and CY1. The impact on the EBITDA margin of using purchased clinker rather than own produced clinker is approximately 26 bps. 28

29 Valuations On an EV/tonne basis, Ambuja is trading at a steep premium to its peers despite the fact that it does not have the best return ratios and best margins in the industry. Even on a P/E basis, it is trading at richer valuations to its peers despite the fact that it does not have the lowest earnings risk in the industry. At the CMP of Rs 8, Ambuja Cement is trading at 11.1x and 14.x its CY9E and CY1E earnings, respectively. On an EV/tonne basis, it is trading at $16/tonne and $94/tonne its CY9E and CY1E capacities, respectively. Thus, we are initiating coverage on Ambuja Cement with an UNDERPERFORMER rating and a target price of Rs 64. Exhibit 8: Movement of EV/tonne with change in RoE and RoCE EV/tonne ($) % FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 CY7 CY8E CY9E CY1E EV/Tonne ($) (RHS) ROE(%) (LHS) ROCE (%) (LHS) Exhibit 9: P/BV, Market cap to sales, P/CEPS, EV/EBITDA P/BV & Mcap/ Sales FY93 FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 CY7 CY8E CY9E CY1E P/CEPS & EV/EBITA P/BV (LHS) M Cap/Sales (LHS) P/CEPS (RHS) EV/EBIDTA (RHS) 29

30 Profit and Loss Account Rs Crore Year Ending March 31 CY6 CY7 CY8 CY9E CY1E Net Sales 6, ,74.8 6, , ,243. % Growth Total Expenditure EBITDA Other income Depreciation Interest Extra ordinary items PBT Taxation Reported PAT Extra ordinary items(net of tax) Adjusted PAT EBITDA margin (%) NPM % Shares O/S (crore) EPS (Rs) Balance Sheet Rs Crore Year Ending March 31 CY6 CY7 CY8 CY9E CY1E Sources of funds Equity Share Capital Reserves & Surplus 3, , ,368. 6,156. 6,782. Secured Loans Unsecured Loans Deferred Tax Liability Total Liability 4,741. 5,37.1 6, ,1.3 7,696.3 Application of Funds Net Block 2, , , ,92.8 5,821.3 Capital WIP , Investments 1, , Cash ,526.7 Sundry Debtors Inventories Loans & Advances Current Liabilities & Provisions , , , ,521.8 Miscellaneous Expenditure Total Asset 4,741. 5,37.1 6, ,1.3 7,

31 Cash Flow Statement Rs Crore Year Ending March 31 CY6 CY7 CY8 CY9E CY1E Profit Before Tax 1, , , ,54.3 1,241.1 Depreciation Changes In working Capital 46.3 (117.9) (261.2) 2.6 (.3) Others (412.3) (1,279.1) (1,2.2) (511.2) (418.9) Cash Flow from Operating activities 1,81.7 1, , ,235.2 Inc/Dec in Investment , Capex (756.4) (521.5) (1,641.5) (1,273.8) (219.1) others Cash Flow from Investing activities (632.7) (162.9) (274.9) (1,194.4) (162.8) Inc/Dec in capital Inc/Dec in Loan Funds (34.2) (525.3) (43.4) (3.) (3.) Others (596.7) (631.4) (439.9) (32.5) (252.5) Cash Flow from Financing activities (888.9) (1,124.4) (482.1) (35.5) (282.5) Net Inc/dec in cash (115.) Opening Balance of Cash Closing Balance of Cash ,526.7 Ratios Year Ending March 31 CY6 CY7 CY8 CY9E CY1E EPS Cash EPS OPM (%) NPM (%) Debt/Equity RoCE (%) RoNW (%) Valuation Ratios P/E (x) P/BV (x) EV/EBITDA (x) EV/Tonne (US$) Turnover Ratios Fixed asset turnover ratio inventory turnover ratio Debtors turnover ratio

32 April 2, 29 Cement Initiating Coverage Dalmia Cement (DALCEM) Current Price Rs 95 Potential upside -15% - Target Price Rs 81 Time Frame months Caught in equity market woes Dalmia Cement (Bharat) (DCBL) is expanding its capacity from 3.5 million tonnes (MT) to 8 MT. All plants of the company will be located in the southern region, which is expected to have surplus supplies in the next financial year. This will lead to deterioration in the return ratio below WACC. Apart from this, DCBL has had notional loss on its investments and has highest leverage in our coverage universe. Hence, we are initiating coverage on the stock with an UNDERPERFORMER rating and one-year target price of Rs 81 per share. Regional player The company has presence only in southern markets. Out of the expected 62 MT capacity addition at an all-india level in FY1, around 47% is coming up in the southern region, which will lead to a worsening High debt to equity DCBL has total capex of around Rs 125 crore and is funded by debt of Rs 11 crore and balance through internal accruals. The company has debt equity ratio of 1.9 for FY9E, highest among our coverage universe. High exposure to equity investments DCBL has exposure to equity market investments on which it had a notional loss of Rs 16 crore on its investment books as on December High debt to increase payoff period The company is adding capacity at nearly Rs 2778/tonne. 8% of the capex has been funded through debt. The payoff period for the company after accounting for interest expense and interest accrued during the moratorium period will be close to six years. Valuations At the CMP of Rs 95, DCBL is trading at 5.2x and 5.5x its FY9E and FY1E earnings, respectively. On an EV/tonne basis, it is trading at $116/tonne and $6/tonne its FY9E and FY1E capacities, respectively. We are initiating coverage on the stock with an UNDERPERFORMER rating and a target price of Rs 81. Exhibit 1: Key financials FY7 FY8 FY9E FY1E FY11E Net Profit EPS % Growth P/E (x) P/BV (x) EV/EBITDA (x) OPM% NPM % RoNW % RoCE % Analysts Name Ravi Sodah ravi.sodah@icicidirect.com Vijay Goel vijay.goel@icicidirect.com Sales & EPS trend Rs Crore Stock Metrics FY7 FY8 FY9E FY1E FY11E Net Sales EPS (Rs) Bloomberg Code DCB IN Reuters Code DLMI.BO Face value (Rs) 2 Promoters Holding 54.8% Market Cap (Rs cr) week H/L 355 / 67.2 Sensex 1947 Average volumes Comparative return metrics Stock return(%) 3M 6M 12M Dalmia Cem Jk Cem Shree Cem Orient Paper Price Trend UNDERPERFORMER Close Price Target Price Mar- May- Jul- Sep- Nov- Jan- Mar Rs ICICIdirect.com Equity Research 32

33 - Company Background Dalmia Cements (Bharat) Ltd (DCBL) was established in DCBL has two major business segments cement and sugar. The company started its cement operations in DCBL has a presence only in the southern region. The company s other product profile includes power, refractories and refractory products, multilayer ceramic chip capacitors, industrial alcohol and others. Share holding pattern (Q3FY9) Shareholder % holding Promoters Institutional investors 5.6 Other investors 11. General public Promoter & Institutional holding trend (%) DCBL has a current cement capacity of 3.5 MT with a plant in Tamil Nadu. The company is in the process of expanding its cement capacity by 4.5 MT by setting up plants at Kadapa, Andhra Pradesh and Ariyalur, Tamil Nadu of 2.25 MT each. DCBL has expanded its sugar business to 225 TCD at three locations of Uttar Pradesh with cogeneration power plant capacity of 79 MW and ethanol plant with a capacity of 8 KL per day. 1% 8% 6% 4% 2% % 55% 55% 55% 55% 5% 5% 5% 6% Q4 Q1 Q2 Q3 The company also has a 16-MW wind farm power generation unit. The power generated from this unit is utilised for consumption at the cement unit by wheeling through the state electricity grid. Promoter Holding Institutional Holding Exhibit 2: Revenue mix (FY8) 18% 5% 77% Cement Sugar Others Exhibit 3: Cement geographical mix (FY8) 9% 4% 27% 6% Tamil Nadu Kerala Karnataka Others 33

34 - Investment concerns Regional player The company has 1% presence in the southern markets. Out of the expected 62 MT capacity addition at an all-india level, around 47% is coming up in the southern region in FY1. This will lead to a worsening of the demand-supply scenario. High debt to equity DCBL has a total capex of around Rs 125 crore and is funded by debt of Rs 11 crore with the balance through internal accruals. The company has a debt equity ratio of 1.9 for FY9E. This is the highest in our coverage universe. However, the debt repayment will start after two years. Thus, we do not expect the company to face a cash crunch for two years. High debt to increase payoff period The company is adding capacity at nearly Rs 2778/tonne. 8% of the capex has been funded through debt. The payoff period for the company after accounting for interest expense and interest accrued during the moratorium period will be close to six years. High exposure to equity investments The company has exposure to equity market investments on which it had notional loss of Rs 16 crore on its investment books as on December High-cost coal inventories procurement till Q4FY9 Dalmia had procured imported coal at nearly $19 per tonne. We expect these high-cost coal inventories to be consumed by Q4FY9. Thus, it will depress the Q4FY9 earnings of the company. We expect the company to only benefit in terms of coal cost from Q1FY1 as imported coal prices have corrected by nearly 67.8% from their peak. 34

35 - Financials Topline to grow at 22% CAGR (FY8-FY11) Net sales is expected to grow at 23.1% CAGR (FY8-FY11) to Rs crore in FY11 from Rs 1482 crore in FY8 on the back of 25.2% CAGR increase in cement sales volume during the same period. Exhibit 4: Revenue to grow at 23% CAGR (FY8-FY11) Rs crore FY8 FY9E FY1E FY11E 6% 5% 4% 3% 2% 1% % Net Sales % Growth Exhibit 5: Revenue mix Rs crore FY8 FY9E FY1E FY11E Cement Sugar Others 35

36 - Margins The OPM is expected to decline to 17.9% in FY11 from 31.8% in FY8 on the back of a fall in cement realisations. Exhibit 6: OPM of cement and sugar business 5% 44% 4% 3% 36% 32% 27% 2% 1% 11% 11% 1% 6% % FY8 FY9E FY1E FY11E Cement Sugar Exhibit 7: OPM & NPM 35% 3% 25% 2% 15% 1% 5% % 31.8% 25.4% 25.2% 23.5% 23.3% 21.6% 17.9% 8.4% 5.9% 3.8% FY7 FY8 FY9E FY1E FY11E OPM% NPM % Exhibit 8: EBITDA per tonne of cement and sugar business Rs per tonne FY8 FY9E FY1E FY11E Cement Sugar 36

37 - Net profit The net profit is expected to decline by 33% CAGR (FY8-FY11) to Rs 15.2 crore from Rs 348 crore on account of the lower operating margin and high interest cost. Exhibit 9: Net profit to decline by 33% CAGR (FY8-FY11) Rs FY7 FY8 FY9E FY1E FY11E Net Profit Return ratios to decline RoNW and RoCE are expected to decline to 7.1% and 8.9% in FY11 from 36.6% and 22.9% in FY8, respectively. Exhibit 1: RoNW & RoCE 4% 39.% 36.6% 3% 2% 22.8% 22.9% 1% 1.7% 12.1% 1.3% 1.% 7.1% 8.9% % FY7 FY8 FY9E FY1E FY11E RoNW % RoCE % 37

38 - Risks to our call Capacity addition to drive cement volume growth by 25% CAGR (FY8-FY1) DCBL is expanding its cement capacity by 4.5 MT to 8 MT by adding two units of 2.25 MT each. Clinker production from the AP plant has already been commissioned in December 28 whereas production from the Tamil Nadu plant is expected from July 29. We expect the cement sales volume of DCBL to grow at 25% CAGR (FY8-FY1). This would enable the company to maintain its bottomline in FY1 despite a fall in cement prices. Location Capacity (Million Tonnes) Expected Completion Kadapa, Andhra Pradesh * 2.25 Mar-9 Ariyalur, Tamil Nadu 2.25 Jul-9 * Clinker unit commisioned in Dec'8 Presence in highly priced markets The company has a presence in the highly priced southern region markets, viz. Tamil Nadu, Kerala, Karnataka and Andhra Pradesh. On account of its market mix, DCBL has the highest realisations in our coverage universe. The net realisation of the company for Q3FY9 was Rs 3891/tonne and for 9MFY9 was Rs 3758/tonne. Exhibit 11: Net realisation of our coverage as of Dec 8 quarter Rs per tonne ACC Ambuja India Cem Ultratech Shree Cem JK Cem Orient Paper Dalmia Meets entire fuel requirement through imported coal The company meets its entire fuel requirement through imported coal for its kiln and power plant operations. As imported coal prices have corrected by nearly 67.8% from their peak, the company is likely to benefit in terms of coal cost from Q1FY1. Firm sugar prices to drive sugar revenue India s sugar inventory has declined to 4.6 MT in 29 from 9.1 MT in 28. The current favourable demand-supply scenario has led to a surge in sugar prices to Rs 23 per kg (ex-factory). In the short to medium term, sugar prices are likely to remain firm on the back of tight supply in India and a global deficit. 38

39 - Valuations At the CMP of Rs 95, DCBL is trading at 5.2x and 5.5x its FY9E and FY1E earnings, respectively. On an EV/tonne basis, it is trading at $116/tonne and $6/tonne its FY9E and FY1E capacities, respectively. We believe Dalmia Cement being a regional player having high debt/equity is more vulnerable to its peers in a down cycle. Also we expect the return ratios of DCBL to decline below WACC in the current down cycle. Factoring in concerns like lower return ratios, high leverage and presence in price sensitive markets of southern India, we expect Dalmia Cement to continue to trade at a steep discount to its replacement cost. Thus, we are initiating coverage on Dalmia Cement with an UNDERPERFORMER rating and a target price of Rs 81. Exhibit 12: Historical Valuations P/CEPS, EV/EBITDA FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9 FY1 FY11 P/BV, MCap/Sales P/CEPS (LHS) EV/EBIDTA (LHS) P/BV (RHS) M Cap/Sales (RHS) 39

40 - Profit and Loss Account Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Net Sales ,482. 1, , ,762.7 % Growth Total Expenditure EBITDA Other income Depreciation Interest Extra ordinary items..... PBT Taxation Reported PAT Extra ordinary items(net of tax)..... Adjusted PAT EBITDA margin (%) NPM % Shares O/S (crore) EPS (Rs) Balance Sheet Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Sources of funds Equity Share Capital Reserves & Surplus ,131. 1, , ,524. Secured Loans ,5.1 1,7.1 1, ,918.1 Unsecured Loans Deferred Tax Liability Total Liability 1, , ,89.8 4, ,354.5 Application of Funds Net Block 1, , ,82.2 2,453. 2,371.7 Capital WIP Investments Cash Sundry Debtors Inventories ,13.4 Loans & Advances Current Liabilities & Provisions ,134. 1,345.7 Miscellaneous Expenditure..... Total Asset 1, , ,89.8 4, ,

41 - Cash Flow Statement Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Profit Before Tax Depreciation Changes In working Capital (299.2) (81.5) (21.6) (111.4) Others (12.8) (88.8) Cash Flow from Operating activities Inc/Dec in Investment (66.9) Capex (611.5) (575.2) (1,22.4) (5.) others (.1) (345.3) Cash Flow from Investing activities (678.5) (67.2) (1,8.4) (34.6) Inc/Dec in capital Inc/Dec in Loan Funds Others (81.2) (139.8) (141.8) (26.1) (231.5) Cash Flow from Financing activities (18.1) (111.5) Net Inc/dec in cash 44.8 (16.7) (14.) Opening Balance of Cash Closing Balance of Cash Ratios Year Ending March 31 FY7 FY8 FY9E FY1E FY11E EPS Cash EPS OPM (%) NPM (%) Debt/Equity RoCE (%) RoNW (%) Valuation Ratios P/E (x) P/BV (x) EV/EBITDA (x) Turnover ratios Fixed asset turnover ratio inventory turnover ratio Debtors turnover ratio

42 April 2, 29 Cement Initiating Coverage India Cement (INDCEM) Current Price Rs 12 Potential upside -9% Target Price Rs 11 Time Frame 12 months Fairly valued India Cement (ICL) is currently trading at lower valuations on EV/tonne and EV/EBIDTA basis than the last down-cycle, in which it incurred losses due to higher leverage. However, in terms of P/BV, Mcap/sales and normalised P/E it is still trading at a premium to the last down cycle. Even on a relative valuations basis, it is richly valued compared to north-based players. Thus, we are initiating coverage on the stock with a HOLD rating and price target of Rs 11 per share. To benefit from decline in coal prices Imported coal meets approximately 7% of ICL s fuel requirement. The prices of imported coal have declined by 67.6% to $57 per tonne from their peak of $177 per tonne. The benefit of the decline in coal prices is likely to be visible from Q4FY9. Dependence on grid power India Cement (ICL) does not have captive power plants (CPPs) at any of its unit except for a waste heat recovery power plant (of 8 MW), wind power (of 1 MW) and DG sets. However, it has power supply arrangement with APGPCL and Coromondel Power Company for the rest of the requirement. FCCB may require Rs 575 crore cash outflow in FY12 ICL has outstanding foreign currency convertible bonds (FCCBs) of US475 million, which are to be converted at the price of Rs 35 or are redeemable at 147.7% of its face value. Thus, this could result in a cash outgo of Rs 575 crore (i.e. approximately half of the reported EBITDA of FY8) in May 211. Valuations At the CMP of Rs 12 per share, the stock is trading at 6.5x and 6.4x its FY9E and FY1E earnings, respectively. It is trading at an EV/tonne of $87 and $6 its FY9E and FY1E capacities, respectively. We are initiating coverage on the stock with a HOLD rating and a price target of Rs 11 per share. Exhibit 1: Key Financials Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Net Profit (Rs Cr) EPS (Rs) % Growth P/E (x) P/BV (x) EV/ OPM(%) NPM (%) RoNW (%) RoCE (%) Analysts Name Ravi Sodah ravi.sodah@icicidirect.com Vijay Goel vijay.goel@icicidirect.com Sales & EPS trend Rs Crore FY7 Stock Metrics FY8 Sales FY9E Bloomberg Code ICEM IN Reuters Code ICMN.BO Face value (Rs) 1 Promoters Holding 28 Market Cap (Rs cr) week H/L 195 / 68 Sensex 1947 Average volumes Comparative return metrics Stock return (%) 3M 6M 12M India Cement ACC Ambuja Cements Ultratech Cement Price Trend Apr-8 Jun-8 Aug-8 HOLD Oct-8 Close Price EPS FY1E Dec-8 FY11E Feb-9 Target Price Apr-9 R ICICIdirect.com Equity Research 42

43 Company background Established in 1946, India Cement (ICL) is among the largest players in South India, with a cement capacity of 1.8 million tonnes (MT). The company has seven plants of which four are in Andhra Pradesh and three are in Tamil Nadu. India Cement s key markets are Andhra Pradesh, Tamil Nadu, Kerala, parts of Karnataka and Maharashtra. ICL has historically been a south-based player. However, going forward, it is in the process of diversifying its presence by venturing into North India. India Cement sells its cement under the brand name of Sankar Super Power, Coromandel Super Power and Raasi Super Power. India Cement has acquired the Chennai franchisee in the Indian Premier League (IPL), the 2:2 format tournament started by the Board of Control of Cricket in India (BCCI) for US$91 million in January 28. The investment in IPL was done by the company from the point of view of advertising its brands all across the country. Shareholding pattern (Q3FY9) Shareholder % holding Promoters 28. Institutional investors 46.9 Other investors 17.9 General public 7.2 Promoter & Institutional holding trend (%) 4% 2% % 35% 36% 37% 37% 27% 28% 28% 28% Q4 Q1 Q2 Q3 Promoter Holding Institutional Holding Exhibit 2: Volume break up 7% 2% 15% 36% 16% 24% Tamil Nadu Andhra Pradesh Kerala Karnataka Maharashtra Others 43

44 Investment Rationale To benefit from decline in coal prices Imported coal meets approximately 7% of ICL s coal requirements. The prices of imported coal have declined by 66% to $57 per tonne from their peak of $177 per tonne. The benefit of decline in coal prices is likely to be visible from Q4FY9. India Cement has also acquired two second-hand dry bulk carriers of about 4, tonne each to transport coal from international markets. However, due to sharp corrections in sea freights (benchmark index Baltic Dry Index has corrected around 8% from its peak), we do not expect any significant saving in transportation cost of coal. Nevertheless, it will hedge the company from the volatility in sea freights. Exhibit 3: Power & fuel cost per tonne FY6 FY7 FY8 FY9E FY1E Rs per tonne FY11E Capacity additions to contribute to volume growth ICL is in the process of increasing its cement capacity from 1.8 MT to 14.3 MT through debottlenecking and brownfield expansions. India Cement will be further adding 1.5 MT in Rajasthan. The company has deferred its 2 MT greenfield plant in Himachal Pradesh for the time being. On account of capacity additions, we expect India Cement s volumes to grow at a CAGR of 1.7% between FY8 - FY11 period. Exhibit 4: Cement sales volumes (in million tonnes) Cement Sales volumes FY8 FY9E FY1E FY11E 44

45 Exhibit 5: Installed capacity (in million tonnes) 16 Million tones E Exhibit 6: Cement prices in major cites in first week of March 9 Rs per City 5 kg Jammu N 293 Trivandrum S 28 Cochin S 28 Bangalore S 268 Chennai S 265 Mumbai W 259 Presence in high priced, high growth markets of South India The company sells more than 91% of its production in the high-priced and high growth market of South India. As against an all-india cement consumption growth of 8%, South India s consumption has grown by 1% in FY1. Apart from this, cement prices in South India are higher than in any other region in India by about Rs 29 per bag (13%). However, it may also be noted that historically cement prices have declined much more sharply in the southern region compared to other regions in the event of surplus due to it bigger size, presence of a number of small players and higher leverage of south-based players. Exhibit 7: YTD (Apr8-Feb9) cement consumption growth Consumption Growth(%) 11% 9% 7% 5% 8.% All India Source: CMA, ICICIdirect.com Research 1.% Southern Region Guwahati E 25 Simla N 242 Ludhiana N 236 Calcutta E 235 Chandigarh N 233 Delhi N 232 Ahmedabad W 228 Nagpur W 227 Karnal N 223 Patna E 219 Bhubaneshwar E 219 Jaipur N 219 Hyderabad S 217 Lucknow C 26 Bhopal C 25 All India Average 24 All India Average ex South 233 South India Average 262 Source: CMA, ICICIdirect.com Research N-North, S-South, W-West, E-East, C-Central 45

46 Financials ICL s revenue is expected to grow at 9.5% CAGR (FY8-FY11) to Rs crore in FY11 from Rs crore in FY8. OPM is expected to shrink by 12 bps to 25.2% in FY11 from 35.4% in FY8 due to decline in cement realisations. The adjusted net profit is expected to decline at 7.3% CAGR (FY8-FY11) to Rs crore in FY11 from Rs crore in FY8. Exhibit 8: Revenue to grow at CAGR of 9.5% 5 55% Rs crore % 35% 25% 15% Growth (%) 2 5% FY7 FY8 FY9E FY1E FY11E Revenue Growth(%) Exhibit 9: PAT to decline at a CAGR of 7.3% Rs in crore FY7 FY8 FY9E FY1E FY11E 125% 1% 75% 5% 25% % -25% Growth (%) Net profit Growth(%) 46

47 Exhibit 1: EBITDA margin (%) and adjusted net profit margin (%) 4% 3% 2% 1% FY7 FY8 FY9E FY1E FY11E EBIDTA Margin(%) Adjusted Net Profit Margin (%) 47

48 Risks & concerns Capacity additions to put pressure on cement prices About 29 million tonnes of cement capacity is scheduled to be added in South India by the end of FY1. Historically, cement prices in South India have been more vulnerable than other region on account of its bigger size. Also, out of the seven plants of the company, three are located in Tamil Nadu while the balance is in southern Andhra Pradesh. Due to the location of its plants, India Cement will find it difficult to divert its volume to other regions. Dependence on grid power ICL does not have CPPs at any of its units except for a waste heat recovery power plant (of 8 MW) wind power (of 1 MW) and DG set, which in FY8 met about 11% of the company s power requirement. However, it has power supply arrangements with APGPCL and Coromondel Power Company for the rest of the requirement. Exhibit 11: Sources of power and per unit cost Rs per unit % 75% 5% 25% % FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9E FY1E FY11E % of own generation % of Own Generation (RHS) Power purchased from external sources (LHS) Own generation (LHS) Average rate per unit (LHS) Had lower EBITDA per tonne than efficient players in last down cycle In the last down cycle, ICL reported net losses (on account of higher debt equity ratio) and had to undergo debt restructuring. Also, the company had earned EBITDA of only Rs 66 per tonne as compared to Rs 5 per tonne earned by efficient players. However, in the current down cycle, we do not expect the company to incur losses as it has lower gearing than the last down cycle. Apart from this, improvement in technology and increase in blended cement proportions have improved the cement to clinker ratio of the company, which, in turn, has reduced power consumption and made its cost structure more efficient compared to the last down cycle. 48

49 Exhibit 12: Net realisation and EBITDA per tonne Rs per tonne FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9E FY1E FY11E Net Relisation per tonne EBIDTA per tonne Source: Company,ICICIdirect.com Research Exhibit 13: Net debt equity ratio, interest cover and interest expenses as a % of sales Net debt/equity & InterestCoverage % 3% 2% 1% % FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 Interestas a % of Sales FY8 FY9E FY1E FY11E Net Debt/Equity (LHS) Net Interest Cover (LHS) Interest exp as a % to Sales (RHS) 49

50 Valuations At the CMP of Rs 121 per share, the stock is trading at 6.5x and 6.4x its FY9E and FY1E earnings, respectively. It is trading at an EV/tonne of $87 and $6 its FY9E and FY1E capacities, respectively. We are initiating coverage on the stock with a HOLD rating and a price target of Rs 11 per share. On EV-based multiples (EV per tonne and EV/EBIDTA), ICL is available at the valuations of the last down cycle when it had incurred losses due to higher leverage as compared to the current down-cycle. In terms of P/BV and market cap to sales (Mcap/sales), it is still trading at 118% and 442% premium, respectively, to its last down-cycle valuations. In the last downcycle, the company was trading at the lowest multiple of.46x its book value and.17x Mcap to sales. As the company had reported losses in the last down cycle, on a P/E base it cannot be compared to its last down-cycle valuation. Thus, we have used normalised P/E (we have calculated EPS for each year by multiplying book value with RoNW) for determining if the company is available at trough valuations. In terms of normalised P/E, ICL is trading at 96% premium to the last down-cycle. In terms of relative valuations, ICL is available at a premium to efficient North Indian players. We expect an oversupply situation in South India, similar to North India (witnessed in H1FY9). Thus, we believe, going ahead, the valuation gap between North Indian and South Indian players will get reduced. Exhibit 14: Movement of EV/tonne with change in RoCE & RoNW (%) 17 4 EV/tonne (in USD) FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY8 FY9E FY1E FY11E % -5 EV/Tonne(USD) ROE(%) ROCE (%) 5

51 Exhibit 6: 15: Valuations Ratios ratios Source: ICICIdirect 4. Research P/BV & Mcap/ Sales P/CEPS & EV/EBITA. FY94 FY95 FY96 FY97 FY98 FY99 FY FY1 FY2 FY3 FY4 FY5 FY6 FY7 FY9E FY1E FY11E Price to Book Value ( P/BV) Market Cap/Sales Price/Cash EPS (P/CEPS) EV/EBIDTA Exhibit 16: Normalised P/E Normalized P/E FY94 FY96 FY98 FY FY2 FY4 FY6 FY8 FY1E 51

52 Profit and Loss Account Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Net Sales % Growth Total Expenditure EBITDA Other income Depreciation Interest Expenses Extra ordinary items PBT Taxation RPAT EO (net of tax) Adj. PAT EBITDA margin (%) NPM (%) Shares O/S (crore) EPS (Rs) Balance Sheet Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Sources of funds Equity Share Capital Revaluation Reserves Free Reserves Secured Loans Unsecured Loans Deferred Tax Liability Total Liabilities Application of Funds Net Block Capital WIP Investments Cash Sundry Debtors Inventories Loans & Advances Current Assets Less: Current Liabilities & Provisions Net Current Assets Miscellaneous Expenditure Deferred Tax Asset Total Asset

53 Cash Flow Statement Rs Crore Year Ending March 31 FY7 FY8 FY9E FY1E FY11E Profit Before Tax Depreciation Others Cash flow from Operations before WC Change Changes In Working Capital Cash flow from operations Capex Inc/Dec in Investment Others Cash Flow from Investing activities Inc/Dec in Loan Funds Inc/Dec in capital Others Cash flow from Financing Net Cash Inflow / Outflow Taken over on Amalgamation Op Bal Cash & Cash equivalents Closing Cash/ Cash Equivalent Ratios Year Ending March 31 FY7 FY8 FY9E FY1E FY11E EPS Cash EPS EBIDTA margin (%) NPM (%) Net Debt Equity RoNW (%) RoCE (%) Valuation Ratios P/E (x) P/BV (x) EV/EBIDTA (x) EV/tonne in US$ Turnover ratios Asset Turnover Inventory turnover ratio Debtors turnover ratio

54 April 2, 29 Cement Initiating Coverage Orient Paper & Industries (ORIPAP) Current Price Rs 28 Potential upside 28% Target Price Rs 36.2 Time Frame months Regional champ We are initiating coverage on Orient Paper & Industries Ltd (OPIL) with an OUTPERFORMER rating and a price target of Rs We believe that OPIL being a cost-efficient cement player will be able to leverage its cost structure by cutting prices and pushing volumes in a down cycle. New CPPs coming on stream in Q1FY1 will enable OPIL to maintain its cost leadership while new cement capacity additions will drive the sales volume. Despite having highest return ratios margins and low earning risk, OPIL is trading at a steep discount to it peers and its replacement cost. Growing three time faster than the industry On account of capacity addition in the recent past, OPIL has been growing three times faster than the industry. In FY9 it had reported dispatch growth of 2.2% as compared to 7.9% of the industry. With another 1.6 million tonnes (MT) of capacity, which is expected to come onstream by the end of Q1FY1, OPIL will continue to grow faster than the industry. Highest margins in the industry Despite having lower realisation as compared to its peers, OPIL s cement division has highest EBIT per tonne (Rs 1118 per tonne) and EBIT margin (37.9%) in the industry due to low cost of production. Diversifying into related businesses On account of lower fixed cost, higher efficiency and diversified revenue stream, OPIL s earnings are least sensitive to price decline. A 1% decline in cement prices reduces the company s EPS by 3.3% as compared to 4.2%-8.1% for its peers. Valuations At the CMP of Rs 28 per share, the stock is trading at 2.5x and 3.x its FY9E & FY1E earnings, respectively. It is trading at an EV/tonne of $33.5 & $17.7 its FY9E and FY1E capacities, respectively. We are initiating coverage on OPIL with OUTPERFORMER rating and a price target of Rs 36.2 per share. Exhibit 1: Key Financials FY7 FY8 FY9E FY1E FY11E Net Profit EPS % Growth P/E (x) P/BV (x) EV/EBITDA (x) OPM% NPM % RoNW % RoCE % Source: Company,ICICIdirect.com Research 23.1 Analysts Name Ravi Sodah ravi.sodah@icicidirect.com Vijay Goel vijay.goel@icicidirect.com Sales & EPS trend Rs Crore 2, 1,5 1, 5 Stock Metrics FY7 FY8 FY9E FY1E FY11E Net Sales EPS (Rs) Bloomberg Code OPI IN Reuters Code ORPP.BO Face value (Rs) 1 Promoters Holding 37 Market Cap (Rs cr) week H/L 51.95/16.9 Sensex 1947 Average volumes 1254 Comparative return metrics Stock return (%) 3M 6M 12M Orient Paper Jk Cem Shree Cem Dalmia Cem Price Trend OUTPERFORMER Close Price Target Price Apr- Jun- Aug- Oct- Dec- Feb- Apr- Rs ICICIdirect.com Equity Research 54

55 Company Background OPIL is the flagship company of the CK Birla Group with business segments viz. cement, paper and electric fans. OPIL has a cement capacity of 3.4 MT. The company has a clinker unit of 2.1 MT & grinding unit of 2.4 MT at Devapur in the Chandrapur cement cluster of Andhra Pradesh. It also has a split grinding unit of 1 MT at Jalgaon, Maharashtra. The locations of cement plants give access to key consumer markets in Maharashtra, Andhra Pradesh and Gujarat. Share holding pattern (Q3FY9) Shareholder % holding Promoters 36.8 Institutional investors 3.8 Other investors 17.2 General public 15.1 Promoter & Institutional holding trend (%) 4% 2% 35% 36% 37% 37% 32% 31% 31% 31% Exhibit 2: Cement plant and markets % Q4 Q1 Q2 Q3 Promoter Holding Institutional Holding Exhibit 3: Cement volume break up (FY8) 1% 37% 57% 5% Andhra Pradesh Gujarat Maharashtra Others 55