CONTENTS. Sector COMPANIES. Cement. Cement: How expensive can it get? Coverage summary..4. How much can cement demand grow?...

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1 CEMENT October x Rs331/bag 11.5x Rs284/bag 8.0x Rs278/bag Rs239/bag How expensive can it get? Analysts: Nitin Bhasin Tel: Achint Bhagat Tel:

2 Cement Sector CONTENTS Cement: How expensive can it get?... 3 Coverage summary..4 How much can cement demand grow?... 5 Pricing remains uncertain. 10 Realisation growth determinants 13 Consensus building in too much optimism.. 19 Valuations- Stretched! Indian cement stocks- the most expensive globally!...23 Relative Valuation.. 24 What is the correct multiple? Look for Quality at a reasonable price UltraTech 32 - Ambuja Cement 36 - ACC. 40 COMPANIES Shree Cement (BUY): Right player, right market. 45 Ramco Cement (SELL): Recovery hopes priced in.69 October 14, 2014 Ambit Capital Pvt. Ltd. Page 2

3 THEMATIC October 14, 2014 How expensive can it get? Recovery in India s GDP/GFCF will catalyze cement demand recovery and drive sharp earnings growth of cement companies over FY14-16 (from the low base of FY14). However, we do not see structural concerns like over capacity, fragmentation etc, waning in the near-future, which could restrict pricing growth beyond 7-8% (especially in an infra spending led demand recovery). Cement stocks have re-rated in anticipation of a strong and sustained demand recovery and now trade at all-time high valuations 14-43% premium to 5-yr average EV/EBITDA (despite lower RoCE expectations than previous averages). We are SELLers on UltraTech, ACC, Ambuja and Ramco (for expensive valuations), and BUYers on Shree (for superlative growth and RoCE). Demand growth can be understood with relative ease We believe that recovery in India s GFCF and impetus on infrastructure construction of the current government will support cement demand growth over the next 2-3 years. Assuming a 1.2x multiplier to our economy s team GFCF growth expectation of 5.6%/8% in FY15/FY16, we estimate cement demand growth of 7%/10%, primarily led by public infrastructure. but pricing recovery could be at best steady and not parabolic Pricing growth in India has been ~5-6% over the last two decades, barring FY06-09, wherein prices grew >10% supported by 90%+ utilization levels. We expect utilization to remain at 75-77% by FY16-end, which will restrict double-digit pricing growth (we build in 8% growth each in FY15 and FY16). Moreover, with bargain-seeking-institutional-clients expected drive demand growth, smaller players may distort pricing discipline to gain market share. Earnings upgrades lagging stock price and target price upgrades Cement stocks have rallied in spite of lackadaisical demand or net realisation improvement. Since Apr-14, consensus target prices have been upgraded by 30-65% but FY16 earnings by 3-20%, implying trading-multiple upgrades. We see no room for further trading-multiple upgrades as we prefer to see present multiples (11-15X one-year forward consensus EV/EBITDA) in light of RoCE/RoIC, currently materially lower than historical averages. Valuations- consider not just growth but RoCE to pay for quality After building in optimistic volume and realisations over FY14-16, we model secular 7%/13% volume/unitary EBITDA CAGR over FY16-24; required reinvestment capex for growth restricts RoCE expansion and valuations for pan- India players. Marginal negative surprises on pricing/volumes in upcoming season could be the key catalyst. We remain BUYers of Shree Cement for nearly 2X industry growth rates and relentless focus on cost optimization which supports industry leading RoCE across cycles. Large caps trading at expensive valuations; prefer high quality mid-caps FY16 EV/EBITDA Not-so-good and expensive Dalmia India Not-so-good but attractive Ramco JK Cement Birla Corp UltraTech, Bloomberg Note: Size of the BUBBLE indicates FY16-end capacities Ambuja ACC JK Lakshmi Key Recommendations UltraTech Cement NEGATIVE Ambitbit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. OCL SELL Target Price: 2,202 Downside 11.3 Ambuja SELL Target Price: 203 Downside: 2.9 ACC SELL Target Price: 1,181 Downside: 14.9 Shree Cement BUY Target Price: 9,158 Upside: 11.1 Ramco Cement SELL Target Price: 283 Downside: 8.7 Sector One-yr fwd EV/EBITDA Apr-09 x Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Sector EV/EBITDA 5-yr avg EV/EBITDA Oct-13 Apr-14 Source: Bloomberg, Company, Ambit Capital research Analyst Details Nitin Bhasin Tel: nitinbhasin@ambitcapital.com Achint Bhagat achintbhagat@ambitcapital.com Good but expensive Orient Mangalam FY16 RoE Shree Good and attractive

4 Coverage summary Exhibit 1: Ambit Cement coverage valuation summary CMP TP Upside Rating MCap MCap EV/EBITDA (X) EV/tonne (US$) P/E (X) (`) (`) (%) (` bn) (US$ mn) Cement FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E UltraTech 2,482 2,202 (11.3) SELL 520 8, ,525 11,364 11, Ambuja (2.9) SELL 327 5, ,721 9,655 9, ACC 1,387 1,180 (14.9) SELL 253 4, ,680 7,680 6, Ramco (8.7) SELL ,518 6,123 6, Shree 8,246 9, BUY 208 3, ,908 12,917 11, Exhibit 2: Ambit Cement unitary metrics summary Cement despatches Utilisation Realisation (`/tonne) Cost/tonne EBITDA (`/tonne) (mn tonnes) FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E UltraTech ,914 5,241 5,641 4,029 4,260 4, ,044 1,227 Ambuja ,207 4,706 4,954 3,477 3,749 3, ,086 ACC ,377 4,688 5,082 3,828 4,135 4, ,032 Ramco ,157 4,557 4,921 3,624 3,784 3, ,016 Shree ,149 4,522 4,884 2,830 2,917 3, ,113 1,289 Exhibit 3: Ambit Cement financial summary Revenues (` bn) EBITDA (` bn) EBITDA margin PAT (` bn) EPS FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E FY14 FY15E FY16E UltraTech Ambuja ACC Ramco Shree October 14, 2014 Ambit Capital Pvt. Ltd. Page 4

5 How much can cement demand grow? After three years of weak growth in cement demand, Industry participants hope that cement demand will see a strong recovery in the next two-three years with the impetus of the new BJP-led Central government on driving economic/infrastructure recovery. Our economy team believes that India s GDP growth rate could improve to 5.6% in FY15 and 6% in FY16 (from 4.5% in FY14), driven primarily by improvement in the industrial sector. Moreover, they expect GFCF growth to improve to 5.7% in FY15 and 8% in FY16 against -0.1% in FY14. Indeed, pick-up in the capex cycle will drive cement consumption growth (on a suppressed base), but we believe that significant cement demand will be visible with a lag of months (as observed historically) and hinges largely on effective implementation of economic policies of the government. We believe that impetus on infrastructure could be a key driver of volume growth but needs ironing out of concerns around land acquisition and more importantly the funding deficit of infrastructure developers in India. Is GDP a right metric? We believe that GDP is not a correct metric to gauge cement demand (given low share of industrial component in GDP) and historically the GDP-cement demand growth multiplier has been fairly volatile. The twenty year correlation of cement demand growth and GDP growth is a paltry 27%. In a country like India, wherein services account for ~2/3 rd of GDP, cement intensity to GDP is bound to be low, however service growth generates disposable income which in-turn translates in steady cement demand through housing/real-estate but with a 1-2 year lag. Steadiness of this segment s demand can be gauged by only one year of decline in cement volumes over last two decades Exhibit 4: GDP has low correlation to cement demand growth Cement Recovery in Infrastructure construction can support cement demand for the next few years Twenty year correlation of cement demand growth and GDP growth is a paltry 27% 12% 8% 4% 20.0% 15.0% 10.0% 5.0% 0.0% Cement multiplier to GDP has been volatile Cement GDP Multiplier Period demand average (x) CAGR FY % 6.5% 1.26 FY % 5.8% 1.46 FY % 7.3% 1.13 FY % 8.4% % -5.0% FY % 6.2% 0.76 FY94 FY95 FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Source: MOSPI, Ambit Capital reserach GDP growth Cement demand growth Source: MOSPI,CMA, Ambit Capital research GFCF - a better indicator We prefer to base our volume growth estimate using a GFCF multiplier which has a higher correlation to cement demand growth. GFCF captures industrial and infrastructure activity and hence has been a more accurate indicator of cement demand growth. The twenty year correlation of GFCF growth and cement demand growth is 57%, which is fairly significant. Whilst not completely accurate (there have been years of materially higher growth) but in general GFCF multiplier to cement demand growth has worked well. Assuming a twenty year average multiplier of 1.2x multiplier and using our economy team s GFCF assumption, cement volume growth estimate for FY15 and FY16 would be 7% and 10%. Twenty year correlation of GFCF growth and cement demand growth is 57%, which is fairly significant October 14, 2014 Ambit Capital Pvt. Ltd. Page 5

6 Cement Exhibit 5: GFCF s predictive power on Cement demand has been better than GDP 20% 16% 12% 8% 4% 0% -4% FY94 FY96 FY98 FY00 FY02 FY04 FY06 FY08 FY10 FY12 FY14 25% 20% 15% 10% 5% 0% -5% Cement demand growth GFCF real growth (RHS) Source: MOSPI,CMA, Ambit Capital research Demand drivers Housing will continue to be a steady contributor Housing forms 65% of the cement demand in India and within that rural housing form roughly 40%. Sharp increase in rural income led by ~18% wage inflation, good farm output, increasing allotment to welfare schemes like MNREGA and housing construction schemes like IAY supported strong cement demand growth from retail customers which in-turn kept demand growth positive despite significant slow-down in infrastructure construction. We believe that rural demand growth will remain stable at (~5-6%) but it will likely not see a sharp increase given poor rainfall hampering farm output in certain pockets (especially North India). Increase in rural income supported housing growth Exhibit 6: Sharp increase is residential housing stock No of residential housing stock (mn units) Exhibit 7: Strong growth in Agri GDP driving rural income FY00-FY04 FY05-FY09 FY10-FY Source: Census, 2011, Ambit Capital research Exhibit 8: Continuous increase in MSPS and (`/quintal) 1,400 1, CAGR FY06-14: Rice- 11% Wheat-10% Minimum support prices FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Rice Wheat Source: Census, 2011, Ambit Capital research FY00-FY04 FY05-FY09 FY10-FY14 Source: AT Kearney,RBI Exhibit 9: significant rural wage inflation led to sharp increase in rural cement demand 20% 19% 19% All-India average rural wage growth (YoY change, in %) 15% 10% 5% 0% Source: AT Kearney,RBI 1% 2% 10% 10% FY01-05 FY06-10 FY11-14(ytd) Ploughing Unskilled Labourers October 14, 2014 Ambit Capital Pvt. Ltd. Page 6

7 Cement Infrastructure holds key for a growth impetus Infrastructure demand has been extremely weak in the last four years with major demand drivers misfiring such as a) slow-down in infrastructure projects (roads etc)- due to delays in clearances and poor finances of the private players, b) irrigationsharp reduction in key regions like Andhra Pradesh due to political turmoil and c) real-estate- sharp increase in inventory, credit unavailability of real-estate developers and declining purchasing power of the urban customers due to high inflation and an adverse economic cycle. Moreover, corporate capex has dropped materially (declining for the last three years) as companies refrained from committing capex in an adverse macro-economic environment (see exhibit 11). Exhibit 10: Sharp increase in stalled infrastructure projects Significant slow down in infrastructure growth in the last few years Stalled infrastructure projects (` bn) 1,600 1,200 1, FY08 FY09 FY10 FY11 FY12 FY13 FY14 Source: Ambit Capital research, CMIE Exhibit 11: Sharp decline in corporate capex since FY12 (` bn) 12,000 10,000 8,000 6,000 4,000 2,000 0 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 60% 40% 20% 0% -20% -40% -60% Corporate Capex Growth Source: Ambit Capital research, Capitaline (sum of capex of listed and unlisted companies) October 14, 2014 Ambit Capital Pvt. Ltd. Page 7

8 Incumbent government has made the right noises The newly formed central government has raised hopes of a speedy infrastructure recovery and recent announcements (see table below) signify a focus on infrastructure development. Alongside, impetus on construction of national highways, ports etc, single window clearances etc could have a major impact on reviving the reeling infrastructure sector in India, thereby driving cement consumption. Exhibit 12: Recent announcements/measures by the central government to drive Infrastructure construction Cement Announcement Description Investment (` bn) Streamlining of highway projects Emphasis on National Highway Development Doubling in outlay on housing 100 'Smart Cities' to be built across the country Rural Housing Scheme by National Housing Board 500 'Model Cities' Single Window Clearances Road Transport and Highways Minister, Nitin Gadkari, said that the government has streamlined execution of highway projects worth ` 1.50 trillion. He also plans to construct concrete roads which are economically viable. The Government has laid down a target of 8,500 km of national highway development in the current fiscal. This outlay on roads and highways is 13% greater than the FY13 budget. Mr. Nitin Gadkari has laid down an aggressive target of developing 25 kms per day, as against less than 10 kms per day over the last three years. The budget 2014 has doubled the outlay on housing from the previous budget, and stress has been laid on slum redevelopment, which is now a mandatory CSR activity for companies. These 100 'Smart Cities' will be built in industrial corridors, and enabled with the latest in technology and infrastructure. The NHB will aim to create affordable housing, through the enhanced allocation they have received. The cities will be built via the PPP route, and will be developed as cost effective, scalable and effective townships. A one-stop single window system for investors to obtain all the clearances on one single online portal, which would expedite business and make it more friendly for businessmen. Even norms for environmental clearances have been greatly eased. Port projects Development of 16 new port projects in the current fiscal year. NA Public Private Partnership Programme to be set up An institution to provide support to mainstreaming PPPPs called 4PIndia to be set up with a corpus of ` 5bn Project Clearances Cabinet committee alongside the project monitoring group cleared projects worth US$86bn 48.6 Source: Budget Document, MOSPI, Ambit capital research But on-ground problems remain unresolved Whilst we agree that cement demand may see a sharp jump if execution of infrastructure projects pick pace, we think that it would take some time as several concerns which need rectified before a recovery can be envisaged. Following are a few of the larger concerns: Infrastructure developers funding constraints: We highlight that during the infrastructure-led cement demand growth several construction companies turned infrastructure developers and raised funds for infrastructure construction. The balance sheet of these companies have materially deteriorated in the last few years and do not have the spare cash to invest their equity share. Hence we believe that reviving the PPP model would be a challenge and might find limited developer interest. Exhibit 1: Few Indian developers have the balance strength to bid for new projects Infrastructure developers are grappling with equity issues and weak Balance sheets 1, NA NA 5.6 Source: Company data, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 8

9 Cement Weak credit offtake and weakened PSU banks Balance Sheets Our Banks team expects relatively sluggish credit growth in FY15 (14%) as well as FY16 (18%). Although according to the FM, the Public Sector Banks (PSBs) will require `2.4 trillion of incremental tier-1 capital (equivalent to 85% of their current market cap) by 2018, the Government has not yet laid down a clear roadmap as to how this capital will be raised. If the Government fails to come up with a clear plan on PSB recapitalisation, we cannot see how credit growth will exceed 18% in FY16 and hence how industrial growth will exceed 6.5% in FY16. In this context, consensus industrial growth estimates of 8% in FY16 appear to be overoptimistic. If credit growth fails to pick up, public infrastructure construction will suffer for want of funds. Exhibit 13: Credit disbursements to industries have fallen in recent years Exhibit 14: Significant increase in banks stressed assets Credit growth (YoY, in %) 30% 25% 20% 15% 10% 5% 0% FY10 FY11 FY12 FY13 FY14 FY15 (E) FY16 (E) FY08 FY09 FY10 FY11 FY12 FY13 FY14 Non-food Bank Credit Industry Services Std. retructured (%) Total stressed (%) Source: RBI, Ambit Capital research Source: RBI, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 9

10 Pricing remains uncertain Whilst utilization is an important parameter to ascertain cement prices, FY12 and FY13 were exceptions wherein sharp pricing hikes were supported by production/pricing discipline. We believe that sustainable pricing growth hinges on high utilization levels and whilst in the short-term pricing discipline can support price hikes, but if demand fails to improve materially prices can come under pressure. We analyse the last two decades of demand, pricing and utilization of the Indian cement industry; based on learnings from reading annual reports of cement companies for the last fifteen years, we believe that there have been years wherein prices have correct downwards even if demand growth rates were in high-single digits due to sub-optimal utilization levels. Barring FY12, prices have grown by over 10% only in three years (FY07-09) in the last twenty years, and in each of the three years capacity utilization was higher than 90%. Exhibit 15: Price movement over the last two decades in India Cement Sustainable price hikes hinges on high utilization level and production discipline can support growth only in the short term 30% 25% 20% 15% Poor pricing, strong demand Reasonable demand, weak pricing The Heydays Unrestrained capacity expansion The Downcycle 100% 95% 90% 10% 85% 5% 0% -5% FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 80% 75% -10% Demand growth Pricing growth Capacity util (RHS) 70% Source: Ambit Capital research, Company FY Poor pricing despite strong demand growth Note in the exhibit below that during FY98-00, prices declined in each of three years, even though demand grew at a 11% CAGR. This was largely on account of low utilization of 80-85%. Ambuja s annual report of FY98 and FY99 read as follows: The year started with an excess capacity of 27 million tonnes of cement. Whereas, the large plants had a capacity o! 101 million tonnes, domestic demand was only 74 million tonnes. If that wasn't enough, during the year,1 further 8.46 million tonnes was added to the capacity, while the demand grew by only 5.87 million tonnes 8% over the previous year. This aggravated the problem of excess supply even further. As a consequence, the prices throughout the country remained depressed. The cement industry, therefore, continued to face an adverse situation once again during the year with the already thin margins coming under further pressure. The year was a mixed one for the cement industry. It began with a high surplus capacity. However a healthy 15% growth in demand and a modest 2mn tonne capacity addition caused the surplus to shrink considerably. Nature, on the other hand, played truant. Drought conditions prevailed in parts of the country and while the first half of the fiscal year (April-September 1999) showed a huge 21% growth in demand, the growth in the second half (October March 2000) tapered off to 11%. This eroded the confidence of the cement manufacturers and the general expectations were that the summer months would see lower consumption of cement due to the drought. Apprehensions of a sharp drop in construction activities led to panic selling. And the results were obvious: Prices dropped even further Prices declined in each of FY98-00, even though demand grew at a 11% CAGR October 14, 2014 Ambit Capital Pvt. Ltd. Page 10

11 Cement FY01-05: Reasonable growth, weak pricing During FY01-05, cement demand grew at reasonable 6.5% CAGR, largely driven by large infrastructure projects like the Golden Quadrilateral, Pradhan Mantri Gram Sadak Yojana etc and marginal pick up in rural housing. However, prices grew only at 1.5% CAGR as utilization levels remained between 80-85%. Media articles in 2002 highlighted The price decline during the Q4FY02 led to sharp contraction in the profits of the cement companies, even though the volumes were higher. With the economy in a downturn, investment demand continued to remain low, resulting in sharp decline in the prices during the year. The major demand drivers of cement during the year were the reconstruction activity in the earthquake hit Gujarat, road development project announced by the National Highway Authority of India (NHAI), the Golden Quadrilateral highway connecting the four major metros. Excerpt from the interview of L&T Cement s (now UltraTech s), President operations: The problem in the South is that most of the new capacities have come up in this region, which has led to a high surplus situation. With the slowdown in the capacity addition, this situation would ease out. In FY03, South grew by 14 per cent, the highest in the country. This is in spite of a good growth of 9 per cent in FY02. There will definitely be a pressure on prices in the current year but in the long run, prices would definitely improve. Only marginal pricing growth as utilization FY06-09: The heydays of cement industry During FY05-FY08, cement demand grew at a 10% CAGR and capacity utilization was north of 90% through-out FY Given that capacity additions were limited and demand from both the retail (MNREGA, IAY and services GDP growth increased disposable income) and institutional segment with strong order awards by NHAI, increase in commercial and retail real-estate with the IT boom and corporate capex in ramping up manufacturing capacities. Cement price grew at a 15% CAGR in this phase, the strongest in the last two decades. We highlight that in FY10, even though demand grew at 10.4%, prices grew by only 1% as utilization dropped to 86% with recently added capacities. Excerpt from UltraTech s FY07 annual report It registered a growth of around 9% in FY07.The Government s initiatives towards infrastructure development coupled with the growing housing demand have to a very large extent been the catalysts. The buoyancy in the industry was reflected in an average capacity utilisation of more than 90% in FY07, which will probably be bettered in FY08 Strong demand and high capacity utilization supported strong pricing growth in these years FY09-11: Unrestrained capacity addition Cement companies generated strong free cash flows over FY06-09 which was reinvested in capacity addition as they expected the strong demand growth to continue. Apart from large players like UltraTech, several regional players significantly increased capacities such as Shree Cement, Ramco Cement, and entrants like Jaypee aggressively added capacities across India. The installed capacity of the industry increased to 290mn tonnes in FY11 as against 190mn tonnes in FY08. Majority of these capacity expansions were in South India, and at the same time demand dropped materially in South Indian states which dragged utilization levels and forced the companies to start despatches outside the state as well. Cash flow generated over FY06-09 was reinvested by manufacturers, leading to sharp increase in installed capacities October 14, 2014 Ambit Capital Pvt. Ltd. Page 11

12 Cement Excerpt from UltraTech s FY10 and FY11 annual report Cement demand during H1FY10. However, new capacity additions in the sector resulted in a surplus supply scenario from H2FY10 onwards with a consequent fall in cement realisation and pressure on prices. In the last few years, new capacity additions of around 100 mtpa, coupled with the prevailing sluggish demand has resulted in a surplus scenario. Demand off-take was weaker than expected on account of lower housing demand, realty and infrastructure spending. On the supply front, overcapacity continued to plague the industry. In line with the fall in demand and over supply scenario, industry capacity utilisation was at 75% against 84% recorded in the previous year. The demand-supply mismatch is expected to stay for some time as the total cement industry capacity is expected to increase even further over the next months. Exhibit 16: Significant increase in installed capacities across regions FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 North Central West South East Source: CMA, Ambit Capital research FY11-14: The downcycle In this phase, demand grew at a 5% CAGR (lowest in the last twenty years), capacity utilization dropped to 70-78% and prices started to decline. However, FY12 and FY13 were unique years in the sense that prices were hiked sharply (16.3% in FY12 and 6% in FY13) despite poor demand. Even though institutional demand started declining, rural/retail demand remained strong as rural income grew sharply due to sharp increase in rural wages, government welfare schemes like MNREGA and good rainfall and farm output alongside sharp increase in MSPs. Owing to this, the bargaining power of the large brands improved substantially and production discipline of the smaller brands supported sustained price hikes. However, note that pricing discipline came under pressure as low utilization levels and waning expectations of demand recovery led to pricing wars especially from the mid-sized players. Failure of infrastructure demand, sub-optimal utilization levels and rising cost pressures dented profitability of cement companies October 14, 2014 Ambit Capital Pvt. Ltd. Page 12

13 Cement Realisation growth determinants Cement prices have increased materially in the last three months, especially in South India, where in prices reached all-time highs. Whilst demand growth continues to remain lukewarm, pricing growth has been on account of production discipline. Given no material price increases in recent years, we believe that pricing will improve and build in a reasonably high 8% realisation growth each in FY15 and FY16 for companies under our coverage. We do not expect a double digit pricing growth Note that prices have grown higher than 10% only in four out of last twenty years and barring FY12 in each of the three years, capacity utilization was higher than 90%. Note that apart from FY05-08, 3-yr cement price CAGR has been 1-6% over the six three year periods. Exhibit 17: Cement price has grown between 1-6% barring FY05-08 We expect a fairly high 8% realisation CAGR over FY15 and FY % 15.3% 10.6% 8.4% 8.7% 7.6% 4.7% 7.3% 4.6% 9.6% 8.0% 8.0% 7.5% 5.9% 4.7% 8.5% 8.0% 5.4% 2.1% 0.9% 1.4% FY95-98 FY99-02 FY02-05 FY05-08 FY08-11 FY11-14 FY14-16E Cement Price CAGR Cement demand CAGR Capacity CAGR Source: CMA, Ambit Capital research Note that based on AT Kearney and CIIs analysis, cement prices have historically grown lower than cost elements and overall inflation, which does not indicate a very strong pricing power on manufacturers and we have no reason to believe that this could change materially in future years. Exhibit 18: Cement prices have not grown in sync with cost inflation Source: AT Kearney, CII, Company, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 13

14 Cement Capacity utilization will continue to remain sub-optimal, despite slow-down in capacity addition rate Whilst announced capacity addition rate is likely to slow-down (55mn tonnes the next three years against 150mn over FY10-14), we believe utilization level will continue to remain low even if demand growth exceeds expectations. Note that exhibit 20 highlights announced capacity expansions and some of those are facing delays or are shelved, for our analysis, we have assumed only 40mn tonnes of capacity commissioning. We assume 40mn tonnes of capacity addition over the next three years Exhibit 19: Expect 55mn tonne of capacity addition over the next 3 years 41 Capacity addition (mn tonnes) FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E Source: CMA, Ambit Capital research Exhibit 20: Announced capacity expansions Company State Region Capacity (mn tonnes) FY15 FY16 FY17 Comments Ambuja Cement West Bengal East 0.8 Brownfield Grinding expansion Shree Cement Bihar East 2.0 Greenfield Grinding unit linked to Chattisgarh unit Ramco Cement Andhra Pradesh South 1.0 Grinding capacity at Vishakhapatnam Century Textiles West Bengal East 1.5 Greenfield Grinding Unit. Century Textiles Maharashtra West 2.8 Brownfield expansion at integrated plant JK Lakshmi Haryana North 0.5 Grinding unit JK Lakshmi Chhattisgarh East 2.7 Greenfield Integrated cement plant JK Cement Haryana North 1.5 Brownfield expansion at integrated plant JK Cement Rajasthan North 1.5 Brownfield expansion at integrated plant Birla Corp Rajasthan North 1.5 Brownfield expansion at integrated plant Dalmia Bharat Assam East 2.1 Brownfield expansion at integrated plant Dalmia Bharat Karnataka South 2.5 Greenfield Integrated unit OCL India West Bengal East 1.5 Greenfield grinding unit (0.9mn tonnes) and brownfield expansion of integrated cement plant UltraTech Cement Rajasthan North 2.9 Brownfield expansion at integrated plant Ambuja Cement Rajasthan North 4.5 Greenfield Integrated unit ACC Chhattisgarh East 3.5 Greenfield Integrated and Split Grinding Chettinad Tamil Nadu South 3.5 Brownfield expansion at integrated plant Orient Cement Karnataka South 3 Greenfield Integrated unit Shree Cement Chhattisgarh East 2.0 Greenfield Integrated cement plant India Cement Tamil Nadu South 3 Brownfield expansion at integrated plant Prism Cement Andhra Pradesh South 4.8 Greenfield integrated plant Zuari Karnataka South 2 Greenfield Integrated cement plant Emami Cement Chhattisgarh East 4 Greenfield integrated cement plant Total Source: Company, Media Articles, EIA reports, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 14

15 Cement Scenario Analysis depending on volume growth momentum We ascertain utilization levels based on three scenarios- Scenario I- 7% volume growth in FY15, 10% in FY16 and FY17, Scenario II- 7% in FY15, 10% in FY16 and FY17 and Scenario III- 7% in FY15, 12% in FY16 and FY17. Our utilization level in Scenario I/II/III by 17 is 77%/79%/80%, still materially lower than previous highs. Moreover, note in exhibit 17 that even if demand grows by 15% both in FY16 and FY17, utilization level increases at 85% in FY17. Exhibit 21: Even at high volume growth rates Volume Growth Capacity Utilisation FY15 FY16 FY17 FY15 FY16 FY17 Scenario I Exhibit 22: capacity utilization levels remain sub-optimal 100 Capacity utilisation (%) Scenario II Scenario III FY08 FY09 FY10 FY11 Scenario I Scenario III FY12 FY13 FY14 FY15E FY16E FY17E Scenario II Avg-FY08-14 Source: CMA, Ambit Capital research Source: CMA, Ambit Capital research Exhibit 23: A long way to go before optimal utilization levels are reached Demand growth in FY16 Demand growth in FY17 Source: Ambit Capital research Should utilization be seen ex-south India? Industry participants argue that utilization should be seen ex-south India given that the significant over-capacity in South India drags India s utilization levels. Whilst utilization levels (ex-south) have dropped to 75% by FY14, the sensitivity analysis below suggests that utilization could improve to 87% by end FY17 if demand grows at an unrealistic 12% in FY16 and 14% in FY17; historically the highest growth ex-south was 11.3% in FY10. Industry participants believe 87% is a fairly high utilization number and hence pricing will find support. Exhibit 24: Utilization levels ex-south India also dropped materially (mn tonnes) % 95% 90% 85% 80% 75% 70% FY00 FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Capacity-ex South Despatches-ex South Capacity utilisation Source: CMA, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 15

16 Exhibit 25: Utilisation level (ex-south) could reach 87% by end FY17 if demand remains strong Utilisation (FY17) Volume growth estimate in FY17 Source: Ambit Capital research, Company Volume growth estimate in FY16 8% 9% 10% 11% 12% 10% 81% 82% 83% 83% 84% 11% 82% 83% 83% 84% 85% 12% 83% 83% 84% 85% 86% 13% 83% 84% 85% 86% 86% 14% 84% 85% 86% 86% 87% We highlight that the above analysis is simplistic and does not factor in inter-regional dynamics. For instance, although Karnataka is geographically located in South India, majority of the sales are in Maharashtra. Similarly a large proportion of AP s despatches are meant for Maharashtra and Odisha. We have noticed multiple times in the past that weak demand and influx of regional manufacturers put pressure on prices in Maharashtra. Industry participants argue that influx of AP based players will stop once demand and pricing recovers, but we believe that this is unlikely. A marketing manager of a regional cement brand highlighted Even if demand grows at 15% for the next 5 years, AP will not hit peak utilisations. Then why should companies sit on idle capacities? Distance between Nalagonda and Maharashtra is 600 kms which means `1,200 transportation cost per tonne. Our manufacturing cost is `2800/tonne, hence total cost to reach the market is `4,000/tonne. If net selling prices/bag is Maharashtra is `220 also, we will make `400/tonne, which is better than sitting on idle capacities Exhibit 26: A majority of South India s production is exported to other regions Installed Effective Production Utilisation States Capacity Capacity Consumption* Imports Exports (FY14)** (%) (FY14) (FY14) Cement Exports as a% of production AP % % Karnataka % % Tamil Nadu % %, CMA How much can realisation grow? We assume that the recent price hikes will sustain and factor in 8% increase in both FY15 and FY16 for cement companies under our coverage; increase of `23 and `28 per 50kg bag in FY15 and FY16. Based on our discussion with cement companies, further price hikes seem difficult to push hence we do not build in overoptimistic realisation growth assumptions. Exhibit 27: Prices declined due to poor demand and sharp capacity increase Although Karnataka is geographically located in South India, majority of the sales are in Maharashtra. Similarly a large proportion of AP s despatches are meant for Maharashtra and Odisha. 30% 100% 20% 90% 80% 10% 70% 0% -10% FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04 Rolling 3-year cement capacities CAGR FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E Rolling 3-year cement despatches CAGR FY16E 60% 50% Cement price growth Annual capacity utilisations (RHS) Source: CMA, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 16

17 Cement But recent quarters have not shown any realisation increase despite on ground increase! Whilst the prices have been steady after a sharp pull up in June-14, the amount of net realisation increase to companies may be lower than the increase in the selling price in the market. In quarters ending Mar-14 and Jun-14, the net realisations of the players were stagnant on a QoQ basis despite sharp pull ups and in the final selling prices. Market participants indicate that increased dealer discounts, taxes and hidden commissions were the reason for no visible improvement in realisations. We believe that for pan-india players, net realisation increase in Sep-14 quarter may be lower than the final selling price increase. Exhibit 28: Poor realisation growth (barring Mar-14) for North based players 15% QoQ realisation growth 10% 5% 0% -5% -10% UltraTech Ambuja ACC Shree Ramco Dec-13 Mar-14 Jun-14 Factors that could restrict pan-india price hikes Increasing share of institutional demand It is fairly clear that infrastructure construction will be a large proportion of incremental demand growth in the coming years, given significant under-investment in recent years and the focus of the new government on driving infrastructure growth. Given that infrastructure clients are bargain seeking, pricing increase will be difficult especially with high levels of unutilized capacities. Note that the infrastructure minister Mr Nitin Gadkari has highlighted that the government will procure cement on a tender basis, a recent recent media interview read: "We will do concrete roads and give productions to cement companies. I want a cement bag whose cost is not more than ` 150. Our aim is to economise construction of concrete road than bitumen road. We believe that as infrastructure construction gathers momentum, cement prices will be negotiated with the manufacturers at materially lower than retail prices. Rising share of institutional clients will reduce pricing power Exhibit 29: Cement sales to Infrastructure segment is extremely low in India 21% 16% 12% 16% 45% 29% 55% 35% 63% 72% 30% 25% 36% 22% 22% India Brazil China Italy United states Residential Commercial Infrastructure Source: AT Kearney, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 17

18 Cement High fragmentation and channel influence We highlight that in the last five years the regional players have materially increased capacities and have become fairly large in their respective regions of operations. With their enhanced capacities, these mid-sized companies have gained market share by competing on prices. Furthermore, they also try to influence the dealers by offering better terms and higher discounts to increase shelf presence at the dealer level. Exhibit 30: Sharp decline in market share of top3/5 groups Increasing fragmentation reducing collective bargaining power 70% 60% 50% 40% 30% FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Capacity share- Top 5 groups Capacity share- Top 3 groups Source: Ambit Capital research, Company October 14, 2014 Ambit Capital Pvt. Ltd. Page 18

19 Cement Consensus building in too much optimism The future is never clear. You pay a very high price in the stock market for a cheery consensus. Warren Buffet Cement stocks have performed well in CY14 Cement stocks have performed exceptionally in CY14, especially post the central elections with rising hopes of an infrastructure-led demand recovery alongside pricing stability. Most of the cement stocks outperformed the Sensex materially (barring Ambuja), Shree and Ramco increased the maximum (93% and 66%, respectively). Exhibit 31: Cement stocks have performed exceptionally well in YTDCY Return since Jan-14 UltraTech-46% ACC-26% Ambuja-14% Shree-93% Ramco-66% Sensex-25% 80 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 UltraTech ACC Ambuja Shree Ramco Sensex Source: Bloomberg, Ambit Capital research Significant TP upgrades by consensus Consensus target prices of cement companies have been increased by 31-65% since Apr-14, as the central elections raised hopes of a demand recovery. Exhibit 32: Consensus estimates have undergone multiple increases Consensus TP upgrades UltraTech- 41% ACEM-38% ACC-31% Shree-65% Ramco-55% Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 UTCEM ACEM ACC SRCM Ramco Source: Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 19

20 Cement but limited earnings upgrades Whilst consensus target prices have been increased materially, earnings upgrades have been materially lower (3-22% upgrades against target price updates of 31-65%) Exhibit 33: EPS upgrades have been way lower than target price EPS upgrades-fy16 UltraTech-13% ACC-3% Ambuja-17% Shree-22% Ramco-5% 90 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 UTCEM ACEM ACC SRCM Ramco Source: Bloomberg, Ambit Capital research implying multiple re-rating expectation Note in the exhibit below that a large proportion of consensus target price updates is explained by multiple expansion and not by change in underlying near-term fundamentals. Exhibit 34: Multiple- re-rating expectation driving target price upgrades Target price Explained by EPS Explained by Company increase Expansion multiple expansion UltraTech 41% 13% 28% ACEM 38% 17% 21% ACC 31% 3% 28% Shree 65% 22% 43% Ramco 55% 5% 49% Source: Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 20

21 Cement Valuations- Stretched! Cement clearly remains one of the most favorable plays on a cyclical upturn in India given that cement companies have characteristics like high cash conversion, strong un-levered balance sheets and dearth of high quality and liquid infrastructure names. However, as explained above, the recent rally has resulted in peak valuation for the cement companies and despite factoring in majority of the positives we struggle to justify the current rich valuations. We ascertain the movement of the EV/EBITDA and EV/tonne band of cement companies over three cycles FY06-09, FY09-12 and FY12- YTDFY15. For this we aggregate the EV, EBITDA and capacities of five cement companies- UltraTech, Ambuja, ACC, Shree and Ramco Cement. We highlight that the average EV/EBITDA multiple has increased to 10.4x during FY12-FY15YTD against 7.4x in FY06-09 and 8.3x in FY Similarly, average EV/tonne has increased to `7,990 during FY12-FY15YTD from `5,376 in FY06-09 and `6,485 in FY Furthermore, note that the cement stocks are trading at a 25% premium to the average EV/EBITDA over FY12-14 (13.0x against average of 10.4x) which appears stretched in our view, especially since RoCE has declined materially during FY12- FY15, and we believe that RoCE will continue to remain lower than historical averages (see exhibit 37). In our view, arguments to own these expensive stocks for lack of high-quality infrastructure-linked franchises is perilous as little disappointments (price cuts, failure of volume recovery) can have a magnified impact on these stocks. Exhibit 35: Cement stocks are trading at all-time high EV/EBITDA and.. (x) Average EV/EBITDA multiple has increased to 10.4x during FY12- FY15YTD against 7.4x in FY06-09 and 8.3x in FY09-12 Significant premium multiples EV/EBITDA EV/EBITDA (Current) (5-yr avg) Premium UltraTech ACC Ambuja Shree Ramco Source: 6 2 Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 May-09 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 EV/EBITDA Avg EV/EBITDA Source: Bloomberg, Company, Ambit Capital research. The bandcharts are based on aggregate EV and EBITDA of UltraTech, Ambuja, ACC, Shree and Ramco Exhibit 36:.. EV/Tonne (`) 10,000 8,000 6,000 4,000 Title EV/Tonne EV/Tonne Prem- (5-yr (Current) ium avg) UltraTech 11,230 6, ACC 7,299 6, Ambuja 7,773 6, ,000 Jan-06 Jun-06 Nov-06 Apr-07 Sep-07 Feb-08 Jul-08 Dec-08 May-09 Oct-09 Mar-10 Aug-10 Jan-11 Jun-11 Nov-11 Apr-12 Sep-12 Feb-13 Jul-13 Dec-13 May-14 Shree 12,559 6, Ramco 6,216 4, Source: EV/tonne Avg EV/Tonne Source: Bloomberg, Company, Ambit Capital research. The bandcharts are based on aggregate EV and EBITDA of UltraTech, Ambuja, ACC, Shree and Ramco October 14, 2014 Ambit Capital Pvt. Ltd. Page 21

22 Cement RoCE continues to remain suppressed We highlight that RoCE of the five companies combined has dropped materially in recent years. Whilst the average RoCE over FY07-09 was 22.7%, it dropped to 11.2% during FY13-15 and expected to improve to only 12.4% over FY We assume a 25-45% EBITDA CAGR over FY14-16 for the cement companies under our coverage and a secular 8% unitary EBITDA CAGR till the end of the DCF period. But we believe that the companies will have to re-invest the cash flows for growth albeit at higher replacement costs (given rising land acquisition costs), which would restrict RoCE expansion to historic peaks. Exhibit 37: RoCE to remain materially lower than historical averages Average RoCE over FY07-09 was 22.7%, it dropped to 11.2% during FY13-15 and expected to improve to only 12.4% over FY15-17 (%) FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 RoCE (assuming 30% tax rate) Average RoCE. Exhibit 38: RoCEs of most cement companies (barring Shree), approximately half of FY07-09 levels Average RoCE FY07-09 FY10-12 FY13-15 FY15-17 UltraTech Ambuja ACC Shree Ramco Note: the above are reported numbers October 14, 2014 Ambit Capital Pvt. Ltd. Page 22

23 Cement Indian cement stocks- the most expensive globally! Note in exhibits 39and 40 that Indian cement stocks (highlighted as dark red) are the most expensive globally (albeit at marginally higher expected RoEs in FY16). Whilst superior RoEs to European (Holcim, Lafarge, Italcementi) and Latin American companies (Cemex) companies partially explains the superior trading multiple, however we note that other Asian cement companies like Indocement, Taiheyo and Anhui trade at materially lower valuations, despite materially better profitability. Exhibit 39: Indian cement companies are most expensive on EV/EBITDA RoE (FY16) 25 Indocement Shree 20 SIAM Anhui ACC UltraTech 15 Taiheyo Ramco Ambuja 10 Holcim CRH Heidelberg Buzzi Lafarge 5 Tangshan Cemex Italcementi EV/EBITDA (FY16) Source: Bloomberg, Company, Ambit Capital research Exhibit 40: and P/B, even though RoEs are slightly higher RoE (FY16) 25 Indocement Shree 20 Anhui SIAM ACC 15 Taiheyo UltraTech Ambuja Ramco 10 Holcim Heidelberg CRH 5 Lafarge Buzzi Tangshan Cemex 0 Italcementi P/B (FY16) Source: Bloomberg, Company, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 23

24 Relative Valuation Exhibit 41: Global relative valuation summary Capacity EV/EBITDA RATING Currency CMP Mcap Advt 6m (mn tonnes) (x) Large cap FY15 FY16 P/E (x) EV/tonne (US$) Cement CAGR (FY14-16) ROE (%) Local Local CCY US$ mn US$ mn FY15 FY16 FY15 FY16 FY15 FY16 Revenue EBITDA EPS FY14 FY15 CCY UltraTech SELL INR 2, , Grasim^ NA NA NR INR 3, , NA NA Ambuja* SELL INR , ACC* SELL INR 1, , JPA # SELL INR , Shree Cement ** SELL INR 8, , Total / Average , Mid cap Ramco Cements ** UR INR , Century Tex# NR INR India Cements NR INR NA Prism Cement NR INR NA # JK Cement NR INR Birla Corp # NR INR Jk Lakshmi Cement NR INR Total / Average Small Cap Dalmia Bharat #@ NR INR NA Orient Cement NR INR OCL India NR INR Mangalam Cement NR INR Sagar Cement NR INR NA Total / Average Global- Europe Heidelberg* NR EUR , Italcementi* NR EUR 5 2 2, (34.3) NA Buzzi* NR EUR , NA CRH* NR EUR , NA Lafarge* NR EUR , Total / Average , Global- Latam Cemex* NR MXN , (65.7) NA Holcim* NR CHF , Total / Average , Global-Asia Indocement* NR IDR 22,000 80,887 6,642 1, Anhui* NR HKD , Tangshan* NR CNY , Siam* NR THB , Taiheiyo* NR JPY ,592 4, Total / Average ,425 8, Source: Ambit Capital research, Company, Bloomberg * Represents Dec- year ending companies. # Represents companies with businesses including non-cement operations as well, we have not adjusted the EV for the includes capacities of Calcom and Adhunik. ** includes power operations October 14, 2014 Ambit Capital Pvt. Ltd. Page 24

25 Cement What is the correct multiple? The problem with multiples is not in their use but in their abuse. If we can find ways to frame multiples right, we should be able to use them better Aswath Damodaran Whilst we do not get questioned as much on our operational assumptions (our assumptions in most cases is higher than consensus), the main argument is on what is the correct multiple? Given the dearth of high quality infrastructure companies in India, cement remains a popular choice to play the infrastructure growth story, but the question is how much should one pay for quality? As explained in exhibit 35-37, cement stocks have undergone multiple re-ratings on the hope of a demand recovery in India, which would provide pricing stability and drive earnings growth in the coming years. The main reason we remain SELLers on the large cap names is because, we believe that valuations are stretched and we find little chances of RoICs recovering to previous peaks as capacity utilization would remain low and incremental capacity addition would be at higher cost than seen historically. Moreover, experts highlight that companies would need to invest large sums in acquiring mining leases given receding limestone reserves (now only 40 year reserves remain). Hence, even though we expect sharp earnings growth in the next few years, we believe current valuations of 11-15x one-yr forward EBITDA is not justified. If an investor prefers to remain invested in the cement space, we believe the decision could be evaluated based on a simple checklist: a) How much am I ready to pay? b) How much EBITDA growth do I expect and what is the market building in? c) Should I play momentum or look at valuation comfort? We analyse each of these questions for the five companies under our coverage, in the section below. Even though we expect sharp earnings growth in the next few years, we believe current valuations of 11-15x one-yr forward EBITDA is not justified. October 14, 2014 Ambit Capital Pvt. Ltd. Page 25

26 Cement Check#1: How much am I ready to pay? Investors question that why aren t the current multiples sustainable (and why not further re-rating) given that history suggests multiple expansions in an upcycle. Our argument is in the previous bull cycle (FY06-09) RoICs were at peak as utilization levels weren t as low as right now and we do not see RoIC recovering to similar levels. Below is a table for each of the cement companies and the FY16/FY17 EV/EBITDA multiple at CMP, our target price and what could the value be at various target multiples. UltraTech UltraTech is trading at 11.3x FY16 EBITDA (15x one-yr forward); the current stock price implies 26% premium to 5-yr average EBITDA and to justify a 5%/9%/14%/19% upside, the target multiple would be at a 31.4%/37%/42.6%/48.1% premium to 5-yr average respectively. Exhibit 42: To justify a 19% upside from current levels, investors need to pay a 48% premium to 5-yr average EV/EBITDA Based on FY16 EBITDA and FY15 net debt Target price 2,202 (Ambit TP) Target EV/EBITDA Multiple (X) ,482 (CMP) 2,599 2,716 2,833 2,949 Multiple premium to 5-yr average (9.0x) 12.6% 25.9% 31.4% 37.0% 42.6% 48.1% Upside/Downside (%) -11.3% 0.0% 4.7% 9.4% 14.1% 18.8% Ambuja UltraTech is trading at 10.5x CY15 EBITDA (11.5x one-yr forward), the current stock price implies 18% premium to 5-yr average EBITDA and to justify a 4%/8%/12%/17% upside, the target multiple would be at a 24%/29%/35%/40% premium to 5-yr average respectively. Exhibit 43: To justify a 17% upside from current levels, investors need to pay a 40% premium to 5-yr average EV/EBITDA Based on CY15 EBITDA and CY14 net debt Target price 202 (AMBIT TP) Target EV/EBITDA Multiple (X) (CMP) Multiple premium to 5-yr average (9.0x) 12% 18% 24% 29% 35% 40% Upside/Downside (%) -4% 0% 4% 8% 12% 17% ACC ACC is trading at 9.0x CY15 EBITDA (10.8x one-yr forward), the current stock price implies 14% premium to 5-yr average EBITDA and to justify a 5%/9%/14%/19% upside, the target multiple would be at a 20%/27%/33%/39% premium to 5-yr average respectively. Exhibit 44: To justify a 19% upside from current levels, investors need to pay a 39% premium to 5-yr average EV/EBITDA Based on CY15 EBITDA and CY14 net debt Target price 1,181 (AMBIT TP) Target EV/EBITDA Multiple (X) ,402 (CMP) 1,468 1,533 1,599 1,664 Multiple premium to 5-yr average (9.0x) 0% 14% 20% 27% 33% 39% Upside/Downside (%) -16% 0% 5% 9% 14% 19% October 14, 2014 Ambit Capital Pvt. Ltd. Page 26

27 Cement Shree Cement Shree is trading at 10.0x FY16 EBITDA (13.5x one-yr forward consensus EBITDA), the current stock price implies 43% premium to 5-yr average EBITDA and to justify a 5%/9%/14%/19% upside, the target multiple would be at 50%/57%/64%/71% premium to 5-yr average respectively. Exhibit 45: To justify a 19% upside from current levels, investors need to pay a 39% premium to 5-yr average EV/EBITDA Based on FY16 EBITDA and FY15 net debt Target price 9,158 (Ambit TP) Target Mutiple (X) ,445 (CMP) 8,845 9,245 9,645 10,045 Multiple premium to 5-yr average (7.0x) 56% 43% 50% 57% 64% 71% Upside/Downside (%) 8% 0% 5% 9% 14% 19% Ramco Cement Ramco is trading at 9.1x FY16 EBITDA (10.5x one-yr forward consensus EBITDA), the current stock price implies 21% premium to 5-yr average EBITDA and to justify a 8%/15%/23%/30% upside, the target multiple would be at a 27%/34%/41%/47% premium to 5-yr average respectively. Exhibit 46: To justify a 30% upside from current levels, target multiples would be at a 47% premium to 5-yr average EV/EBITDA Based on FY16 EBITDA and FY15 net debt Target price 283 (Ambit TP) Target EV/EBITDA Multiple (X) (CMP) Multiple premium to 5-yr average (9.0x) 13% 21% 27% 34% 41% 47% Upside/Downside (%) -9% 0% 8% 15% 23% 30% October 14, 2014 Ambit Capital Pvt. Ltd. Page 27

28 Cement Check#2: How much EBITDA growth do I expect and what is the market building in? As highlighted above our FY15 and FY16 assumptions are fair, but we believe that the main grey area remains the growth over FY17-21, as the economic reforms start reflecting in infrastructure growth and cement sales. We believe that FY21-25 is a fade period wherein EBITDA growth would start tapering and reach a 4% terminal growth by FY25. In this section, we evaluate what our assumptions imply and how would it differ if we increase volume and EBITDA/tonne growth estimate by 1% or 2% in each of FY Below is a company wise assessment: Our assumptions In our assumptions over FY17-21, we assume that volumes/realisations would grow in high single digits over and above the strong growth over FY We base our assumptions on a sustainable 6-7% industry volume CAGR and players with enhanced scale like UltraTech and Shree would grow higher. +1% volume and unitary EBITDA over FY17-21 Under this scenario, utilization levels would reach 90-94% by end-fy21 for most players. Industry volume growth estimate would be reset to 7-8%, and pricing growth would pricing growth will remain in excess of cost inflation by 5-6% sustainably. Moreover, this would also mean that that the fade period growth is on a higher base of FY21. Although achievable, we believe it would be tough and would require significant infrastructure growth. Realisation growth could be difficult as pricing power would wane as RMC/bulk cement gains popularity. +2% volume and unitary EBITDA over FY17-21 Under this scenario, utilization levels would reach peak levels by end-fy21 for most players. Industry volumes would need to grow at 8-9%. We believe this is a highly unlikely scenario and would require a strong and sustained economic recovery. Note that alongside pricing growth a key support to EBITDA/tonne historically was improvement in process efficiencies as cement plants moved from wet to dry process, experts argue that there is limited scope for increasing process efficiencies (except logistics) as India is now one of the most technically advanced cement producing country. Moreover, depleting limestone reserves would mean that limestone royalty could increase driving significant cost increase and pricing growth to offset that alongside maintaining EBITDA/tonne growth of 9% CAGR would be a daunting ask. October 14, 2014 Ambit Capital Pvt. Ltd. Page 28

29 Cement Exhibit 47: Change in target price assuming higher growth over FY17-21 Companies Key Variables Our assumptions +1% volume and unitary EBITDA (FY17-21) +2% volume and unitary EBITDA (FY17-21) Comments UltraTech Ambuja ACC Shree Cement Ramco Cement Volume CAGR FY16-21 Unitary EBITDA CAGR FY % 8.5% 9.5% 7.8% 8.8% 9.8% FY16 EBITDA (`/t) 1,227 1,227 1,227 FY21 EBITDA (`/t) 1,670 1,871 1,958 Capacity utilisation Range Target Price 2,202 2,471 2,764 Upside/(Downside) -11.3% -0.4% 11.4% Volume CAGR FY16-21 Unitary EBITDA CAGR FY % 8.3% 9.3% 7.8% 8.8% 9.8% FY16 EBITDA (`/t) 1,086 1,086 1,086 FY21 EBITDA (`/t) 1,589 1,648 1,710 Capacity utilisation Range Target Price Upside/(Downside) -4% 6% 18% Volume CAGR FY16-21 Unitary EBITDA CAGR FY % 8.2% 9.2% 8.5% 9.5% 10.5% FY16 EBITDA (`/t) FY21 EBITDA (`/t) 1,364 1,410 1,675 Capacity utilisation Range Target Price 1,188 1,331 1,402 Upside/(Downside) -15.3% -5.1% 0.0% Volume CAGR FY16-21 Unitary EBITDA CAGR FY % 9.3% 10.3% 8.4% 9.4% 10.4% FY16 EBITDA (`/t) 1,289 1,289 1,289 FY21 EBITDA (`/t) 1,959 2,051 2,146 Capacity utilisation Range Target Price 9,167 9,649 10,152 Upside/(Downside) 9.1% 14.9% 20.9% Volume CAGR FY16-21 Unitary EBITDA CAGR FY % 9.2% 10.2% 9.2% 10.0% 10.8% FY16 EBITDA (`/t) 1,016 1,016 1,016 FY21 EBITDA (`/t) 1,579 1,639 1,700 Capacity utilisation Range Target Price Upside/(Downside) -9% 5% 20% Source: Company, Ambit Capital Research UltraTech can grow ahead of the industry rates given aggressive capacity expansion, pan-india presence and high exposure to institutional clients. However, volume growth would come at the cost of realisations (and unitary EBITDA) as higher sales to institutional clients would lower blended realisations. We believe that Ambuja would struggle to grow higher than Industry average due to no material capacity additions. Note that if we increase volume growth by 1%/2% through CY16-20, capacity utilisation reaches over 100% (although we assume that the company would add 12mn tonnes of capacity over CY Similar to Ambuja, ACC's retail client dependence and long dated capacity expansions would limit long term growth to slightly lower than industry average. We believe ACC would have to re-invest if it has to grow higher than industry. Shree will maintain industry leading growth with significant capacity additions and entry into new regions. The company has historically shown ability to gain market share although at the cost of realisation, given its lower production cost advantages. Ramco Cement's exposure to South India should drive stable volume growth, however the company is largely a retail focussed player and hence rising sales to institutional customers could bring down EBITDA/tonne. We believe that the company's utilisation level would continue to remain sub-optimal given high underutilisation in South India and with the company already planning expansions despite idle capacities. October 14, 2014 Ambit Capital Pvt. Ltd. Page 29

30 Cement Check#3: Should I play momentum or look at valuation comfort? Several investors prefer to hold cement stocks, irrespective of the valuations (suggesting that trading multiples have undergone a structural re-rating even though RoCEs remain lower than previous peaks). We believe that one could either play a) volume growth momentum- which is a function of available capacities, upcoming expansions and exposure to institutional clients or b) valuation comfort, which is a function of premium to 5-yr averages alongside RoCE expectations. Volume growth momentum- Shree is the preferred bet We believe volume growth is a function of capacities (both current and upcoming) and exposure to institutional clients, since infrastructure would be a key driver of cement growth in the coming years. We believe Shree, UltraTech and Ramco cement are the preferred choices. We believe that UltraTech and Shree will grow higher than Industry growth rates given increasing scale and relatively higher exposure to institutional clients and Ramco due to volume recovery in South India (after four years of poor demand). We believe that Ambuja and ACC would continue to lose market share and grow lower than industry averages, given long-dated capacity expansions and significant increase in capacities of regional manufacturers. Shree appears the best placed given, ~50% capacity increase, highest volume/ebitda CAGR and highest institutional mix. Exhibit 48: Shree appears the best on growth momentum Capacity growth Companies Volume CAGR EBITDA CAGR by FY16 (as a% (FY14-16) (FY14-16) of FY14 end) Retail: Institutional mix Preference order Shree Cement 18.5% 41.6% 48% 55:45 1 UltraTech 12.9% 29.4% 20% 68:32 2 Ramco 9.4% 41.3% 12% 75:25 3 Ambuja 7.3% 28.6% 5% 82:18 4 ACC 7.0% 23.0% 11% 78:22 5 Source: Company, Ambit Capital estimates Investing decision should be based on volume growth momentum or valuation comfort Highest volume momentum in Shree and UltraTech Valuation Comfort- ACC trading at the least premium Given that most of the cement stocks have re-rated, another way of evaluating investing decision could be based on relatively less-expensive stocks which deliver better RoCEs. We highlight that the premium to 5-yr average EV/EBITDA is the least for ACC and Ambuja (18% and 14%, respectively), however we expect their RoCE also to be 8-9% points lower than their 5-yr average. UltraTech is trading at a 26% premium to 5-yr average EV/EBITDA but with 20% lower RoCE than 5-yr average. Whilst Shree trades at a 43% premium to 5-yr average EV/EBITDA, it is the only cement company under our coverage, the RoCEs of which are expected to be higher in FY14-16 as against FY Exhibit 49: Shree appears the best on growth momentum EV/EBITDA Premium to Avg RoCE Particulars (FY16) 5-yr average (FY14-16) Diff vs 5-yr average RoCE Preference order ACC % % 1 Ambuja % % 2 Ramco Cement % 9.2-3% 3 UltraTech % % 4 Shree Cement % % 5 Source: Company, Ambit Capital estimates ACC is the least expensive amongst the top-5 players October 14, 2014 Ambit Capital Pvt. Ltd. Page 30

31 Cement Look for Quality at a reasonable price Whilst the large sized companies would be amongst the major beneficiaries of demand/pricing revival, we believe the valuations are too rich to generate investment returns. Therefore, investors could consider investing in high quality mid-cap cement names, with high RoE expectation and available at reasonable valuations. We build a four quadrant matrix to ascertain valuation in light of RoE and size of the company (see exhibit 50). Quadrant#1-Good but expensive- UltraTech, ACC, Ambuja and Shree fall in this quadrant. We believe if investors are ready to invest in expensive stocks, then the best option is Shree as it offers the maximum RoE and long term superlative growth visibility. We prefer UltraTech over ACC and Ambuja, if growth based investing is the preference. Quadrant#2- Good and attractive- We believe this quadrant is the sweet spot as it constitutes companies with high profitability at reasonable valuations. We suggest investing in companies with high quality managements, relatively large scale alongside superior RoEs. Orient Cement would be our top pick in this matrix, followed by JK Lakshmi and Mangalam Cement. Quadrant#3- Not-so-Good but attractive: Whilst the companies falling in this quadrant are not the best in terms of RoEs but are available at discounted valuations. We believe investors preferring to invest in this quadrant should look at management quality keenly as despite reasonable size, low multiples could be a function of structural concerns. JK Cement would be our top pick in this quadrant. Quadrant#4- Not-so-good and expensive: We believe this is the riskiest quadrant to invest in. Not only are the RoEs of the companies low, but they also trade at rich valuations. Whilst the premium could be to account for the quality of the franchise and hopes of a disproportionate growth beyond FY16, we believe that negative shocks like lower pricing etc could have a magnified impact on stocks in this quadrant. We suggest SELLing Ramco Cement. Exhibit 50: Invest in Quality at a reasonable price (quadrant #2) 14 Not-so-good and expensive Good but expensive UltraTech Shree FY16 EV/EBITDA 11 Ambuja 10 Ramco ACC 9 JK Lakshmi JK Cement 8 Dalmia 7 6 India Orient Good and attractive 5 Birla Corp Mangalam Not-so-Good but attractive OCL FY16 RoE Source: Ambit Capital research, Company, Bloomberg. Bubble size denotes size of capacities end-fy16 October 14, 2014 Ambit Capital Pvt. Ltd. Page 31

32 Cement UltraTech Growth at the cost of Balance sheet (UTCEM IN, mcap US$11.2bn, SELL, TP `2,202, 13% downside) UltraTech recent aggressive capacity expansions (8mn tonnes additions in the last two years; further ~9mn tonnes increase in the next twelve months), exposure to institutional clients and South India, position it as one of the major beneficiaries of demand recovery in India. But the company is achieving growth at the cost of the Balance Sheet, as capacity utilization will at-best hover around 81-85% for the next three-four years, given significant capacity expansions (at highest cost in the industry). Moreover, the company has a targeted plan to increase capacities further either organically or inorganically (recent media articles indicate that the company is in talks to acquire cement assets in Central India), which could restrict RoCE expansion even though it may enjoy superlative volume growth. We have assumed 13% volume growth both in FY15 and FY16 and 8% realisation growth. Our estimates imply 29% EBITDA CAGR over FY We believe that the company s RoCE will improve to 10.5%/12.4% in FY15/FY16 (9.3% in FY14, 5-yr average of 14.2%). Note that continuous capacity addition is restricting a sharper RoCE expansion; we expect the company to generate `147bn CFO and invest `131bn in expansions. Valuation leadership at an expensive price UltraTech s stock has rallied sharply in the last few months, with rising hopes of demand recovery with a new Central government alongside sharp price hikes in most regions. We build in high volume and realisation growth estimates for UltraTech in FY15 and FY16 and secular EBITDA growth from FY16 to the end of the DCF period in FY25 (29% EBITDA CAGR over FY14-16 and 13% EBITDA CAGR over FY16-24). Despite these favorable assumptions our fair valuation of ` 2,202), implies 18% downside. Whilst we agree that UltraTech s aggressive capacity expansions and pan- India presence could drive strong volume growth, we expect the company s RoCE to improve only marginally and remain lower than last five-year averages (10-12% RoCE over FY15-16 against five year average of 15%) and materially lower peak than peak RoCE of 18-25% seen during FY07-FY09. The stock is trading at 15x one-yr fwd/11.3x FY16 EBITDA (a 50% premium to its last five-year average), which we find difficult to justify. Our DCF based target price of `2,202, implies 10.0x FY16 EBITDA. Exhibit 51: Assumptions summary Particulars Financial numbers YoY growth CAGR (` mn unless FY14-16 Mentioned) FY14 FY15E FY16E FY15 FY16 Dispatches (mn tonnes) % 13.0% 12.9% Utilisation % bps 405 bps 4% Realisation 3,999 4,322 4, % 8.0% 8.0% Net Revenues 202, , , % 21.6% 21.1% EBITDA 38,179 48,148 63, % 32.8% 29.4% EBITDA/Tonne 934 1,044 1, % 17.6% 14.6% EBITDA Margin % bps 182 bps PAT 21,445 26,736 34,368 25% 29% 27% Cash Flow metrics CFO 32,416 39,993 47,539 23% 19% 21% Capex (22,187) (68,000) (36,089) 206% -47% 28% FCF 10,229 (28,007) 11, % -141% 6% Turnover Ratios Gross Block T/O % 3% 1% Working Capital T/O % 12% 8% Profitability Ratios RoCE (%) bps 194 bps RoIC (%) bps 152 bps RoE (%) bps 189 bps October 14, 2014 Ambit Capital Pvt. Ltd. Page 32

33 Exhibit 52: Ambit vs consensus Revenue (` mn) Consensus Ambit Divergence Comments FY , ,589 1% FY , ,458 6% EBITDA (` mn) FY ,032 48,148 0% FY ,521 63,958 6% PAT (` mn) FY ,546 26,736 5% FY ,981 34,368 4% Our estimates are marginally higher than consensus as we expect sharp volume growth and better pricing Cement Higher than consensus EBITDA in FY16 is on account of higher realisation estimates Higher EBITDA leads to our PAT being higher-than-consensus Exhibit 53: Scale ramp-up to drive strong volume growth, realisation increase and.. Exhibit 54: stable costs to drive EBITDA growth and margin expansion (mn tonnes) FY11 FY12 FY13 FY14 FY15 FY16 FY17 Volume Realisation 6,000 5,000 4,000 3,000 2,000 (`/tonne) (` mn) FY11 FY12 FY13 FY14 FY15 FY16 FY17 EBITDA EBITDA margin (RHS) (%) Exhibit 55: High reinvestment rate to keep (` bn) (%) Exhibit 56:..RoCE/RoE expansion muted (%) FY11 FY12 FY13 FY14 FY15 FY16 FY FY11 FY12 FY13 FY14 FY15 FY16 FY17 CFO FCF Capex/CFO (RHS) RoCE RoIC Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 33

34 Cement Exhibit 57: PV of FCFF Exhibit 58: DCF valuation of `2,202 per share (` bn) % 17% PV of the forecasting period up to FY25 (` bn) 272 Terminal Value (` bn) % 16 13% Enterprise value (` bn) % 9% Less: net debt at Mar-15 (` bn) % -2 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 5% Implied equity value (` bn) 605 PV of FCFF (LHS) WACC RoCE Source: Bloomberg, Ambit Capital research Exhibit 59: UltraTech is trading at 15.2x one-yr fwd EV/EBITDA Implied equity value (` per share) 2,202 Source: Companyg, Ambit Capital research Exhibit 60: UltraTech is trading at 61% premium to 5-yr average EV/tonne (X) (X) 16 12,000 10, , ,000 4,000 2, Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 One-yr fwd EV/EBITDA 5-yr avg EV/EBITDA One-yr fwd EV/tonne 5-yr avg EV/tonne Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 34

35 Cement Balance sheet Year to March (` mn) FY14 FY15E FY16E FY17E Networth 170, , , ,454 Loans 51,993 70,993 71,993 68,993 Sources of funds 245, , , ,406 Net block 158, , , ,953 Capital work-in-progress 20,416 20,416 20,416 20,416 Investments 53,917 38,917 38,917 38,917 Current Assets 64,489 68,825 88, ,327 Current liabilities and provisions 51,613 54,992 65,718 75,206 Net current assets 12,875 13,833 22,365 45,120 Application of funds 245, , , ,406 Income statement Year to March (` mn) FY14 FY15E FY16E FY17E Revenue 202, , , ,274 Total expenses 164, , , ,041 EBITDA 38,179 48,148 63,958 76,233 Net depreciation / amortisation 10,523 12,815 15,157 16,923 EBIT 27,656 35,333 48,801 59,310 PBT 27,755 35,574 48,406 59,304 Adjusted PAT 21,445 26,736 34,368 42,106 EPS diluted (`) Cash flow statement Year to March (` mn) FY14 FY15E FY16E FY17E PBT 27,755 35,574 48,406 59,304 Change in working capital 685 (1,022) (3,692) (3,780) Direct taxes paid (6,584) (8,837) (14,038) (17,198) CFO 32,416 39,993 47,539 56,583 Net capex (22,187) (68,000) (36,089) (26,040) CFI (22,096) (49,069) (32,195) (21,816) Proceeds from borrowings (2,092) 19,000 1,000 (3,000) CFF (8,973) 10,717 (9,194) (14,463) Net increase in cash 1,347 1,641 6,150 20,304 FCF 10,229 (28,007) 11,450 30,543. Note: The cash flow statement of FY14 is based on our estimates, as the company has not reported the numbers. Ratio analysis / Valuation parameters Year to March FY14 FY15E FY16E FY17E EBITDA margin RoCE RoE P/E (x) Debt/Equity(x) EV/EBITDA(x) EV/tonne(`) 12,525 11,364 11,343 10,690 October 14, 2014 Ambit Capital Pvt. Ltd. Page 35

36 Cement Ambuja Cement Sliding to mediocrity (ACEM IN, mcap US$5.4bn, SELL, TP `202, 8% downside) Ambuja s reluctance to re-invest for capacity expansion at a time when regional players aggressively built scale has led to market share erosion in key markets like north and west India (it has lost its leadership position to Shree Cement in north India). The company s market share dropped to 8.7% in CY13 vs 10.1% in CY07 and it has grown slower than the industry in 5 out of the last 6 years (3.7% volume CAGR over CY09-13 vs 7% industry volume CAGR). Significant increase in industry-wide capacities (up 40% over CY09-13), amidst Ambuja s minimal additions (up 12%) would lead to continued loss of market share and lower growth than industry for at least the next two years. Moreover, significant retail client dependence at a time when institutional demand would be a major demand growth constituent would also hinder growth rates. We expect 8.2% volume CAGR over FY13-15 (marginally lower than industry growth rates as we expect market share loss to continue). We expect realisation growth of 8% in both years, our estimates imply 17% unitary EBITDA and 28% EBITDA CAGR over CY Valuation rich for a player losing its supremacy Ambuja is trading at 11.2x one-yr forward EV/EBITDA (10.5x CY15), at an unjustified 30% premium to its five-year average. Our DCF model fails to justify this; despite building in a sustained rise in profitability and higher cash reinvestment rates for maintaining market share. Over and above the 28% EBITDA CAGR over CY13-15 and on that higher base, we assume a 14% EBITDA CAGR over CY We maintain our SELL stance, with a target price of `203, implying 10.2x CY15 EBITDA. We highlight that Ambuja RoCE in CY14 and CY15 will likely be 14% and 14.6% respectively marginally lower that five-year average of 16.5% and materially lower than previous peaks of 25-37% of CY07-08, and during that period the stock traded at an average EV/EBITDA of 7.2x. Exhibit 61: Assumption summary Particulars (` mn unless mentioned) CY13 CY14 CY15 YoY growth CAGR CY14E CY15E CY13-15 Despatches % 8% 8% Utilisation % bps 348 bps 6% Realisation % 7% 8% Net Revenues 91, , ,587 19% 14% 16% EBITDA 16,507 22,692 26,788 37% 18% 27% EBITDA/Tonne ,086 27% 9% 18% EBITDA Margin % bps 80 bps PAT 10,289 14,677 16,998 43% 16% 29% Cash flow metrics CFO 12,003 18,891 18,422 57% -2% 24% Capex (6,884) (17,165) (17,509) 149% 2% 59% FCF 5,120 1, % -47% -58% Profitability Ratios Gross Block T/O (0.00) RoCE % bps 87 bps RoIC % bps -2 bps RoE % bps 82 bps October 14, 2014 Ambit Capital Pvt. Ltd. Page 36

37 Exhibit 62: Ambit vs consensus Revenue (` mn) Consensus Ambit Divergence Comments CY , ,703 3% CY , ,587 3% EBITDA (` mn) CY ,985 22,692 8% CY ,143 26,788 2% PAT (` mn) CY ,246 14,677 3% CY ,540 16,998-3% Cement Our estimates are marginally higher than consensus, as we expect higher volume growth Higher EBITDA estimate is a function of building in sharp realisation improvement Marginally lower PAT in CY15 is on account of lower depreciation assumption of consensus Exhibit 63: Expect volume growth rates in line with India a average at best Exhibit 64: Expect margin expansion with pricing recovery (mn (Rs/tonne) tonnes) 25 5, , , , , ,000 CY09 CY10 CY11 CY12 CY13 CY14 CY15 Volume (LHS) Realisation Realisation-ex freight (`/tonne) 1,200 1,100 1, CY09 CY10 CY11 CY12 CY13 CY14 CY15 EBITDA/tonne EBITDA margin (%) Exhibit 65: Hoarding cash and no major capacity expansion Exhibit 66: leading to declining market share (` mn) 50 45% 10.5% 10.0% 40 35% 9.5% 9.0% % 20 25% 8.0% 7.5% 10 15% CY08 CY09 CY10 CY11 CY12 CY13 Cash Cash as a % of networth (RHS) 7.0% CY08 CY09 CY10 CY11 CY12 CY13 Market share Capacity share October 14, 2014 Ambit Capital Pvt. Ltd. Page 37

38 Cement Exhibit 67: PVFCFF profile Exhibit 68: DCF Valuation of `202/share (` mn) 15,000 12,500 10,000 7,500 5,000 2,500 22% 19% 16% 13% PV of the forecasting period up to CY24 (` bn) 99 Terminal Value (` bn) 171 Enterprise value (` bn) 269 Less: net debt at Dec-14 (` bn) (42) E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E PV of FCFF (LHS) WACC RoCE 10% Implied equity value (` bn) 311 Implied equity value (` per share) 202 Exhibit 69: ACEM is trading at a 30% premium to5-yr average EV/EBITDA 16 (X) Exhibit 70: ACEM is trading at a 20% premium to 5-yr average EV/tonne (X) 12,000 10, , ,000 4,000 2, Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 One-yr fwd EV/EBITDA 5-yr avg EV/EBITDA One-yr fwd EV/tonne 5-yr avg EV/tonne October 14, 2014 Ambit Capital Pvt. Ltd. Page 38

39 Cement Balance Sheet Year to March (` Mn) CY13 CY14E CY15E CY16E Total Networth 94, , , ,582 Loans Sources of funds 100, , , ,226 Net block 60,625 71,948 82,748 86,070 Capital work-in-progress 6,949 6,949 6,949 6,949 Investments 17,885 17,885 17,885 17,885 Total Current Assets 44,438 48,100 50,851 64,616 Current liabilities and provisions 28,994 35,253 38,619 44,294 Net current assets 15,444 12,847 12,232 20,322 Application of funds 100, , , ,226 Income statement Year to March (` Mn) CY13 CY14E CY15E CY16E Revenue 91, , , ,955 Total expenses 75,096 86,011 96, ,915 EBITDA 16,507 22,692 26,788 33,040 Net depreciation / amortisation 4,901 5,842 6,709 7,415 EBIT 11,607 16,850 20,079 25,625 PBT 15,140 20,968 24,283 30,301 Adjusted PAT 10,289 14,677 16,998 21,059 EPS diluted (`) Cash flow statement Year to March (` Mn) CY13 CY14E CY15E CY16E PBT 15,141 20,968 24,283 30,301 Change in working capital 446 2,489 (1,082) (1,725) Direct taxes paid (5,101) (6,290) (7,285) (9,242) CFO 12,003 18,891 18,422 22,074 Capex (6,884) (17,165) (17,509) (10,737) CFI (4,736) (13,047) (13,305) (6,061) Proceeds from borrowings (23) (405) - - CFF (6,258) (5,952) (6,814) (9,647) Net increase in cash 1,010 (109) (1,696) 6,365 FCF 5,120 1, ,336 Ratio analysis / Valuation parameters Year to March (` Mn) CY13 CY14E CY15E CY16E EBITDA growth (33.2) RoCE RoE P/E (x) P/B (x) Debt/Equity (x) EV/EBITDA (x) EV/tonne (`) 9,994 9,928 9,269 8,065 October 14, 2014 Ambit Capital Pvt. Ltd. Page 39

40 Cement ACC Challenges to volume growth to continue (ACC IN, mcap US$4.3bn, SELL, TP `1,181, 20% downside) Lack of capacity expansions and high retail exposure will restrict ACC s volume growth especially in an infrastructure spending driven cement demand recovery. We build in a volume growth of 6% in CY14 (paltry 2% growth in 1HCY14) and 8% in CY15. We build in 6%/8% realisation increase in CY14/CY15 realisation as volume growth should drive better pricing discipline. Our estimates imply 17% unitary EBITDA CAGR and 23% EBITDA CAGR over CY We expect EBITDA/tonne to improve to `896 in CY15 as against `654 in CY13 and RoCE to improve to 12.6% in CY15 from 9% in CY13. Valuation premium valuation despite low profitability ACC s RoCE declined to 9% in CY13 as against 13% in CY12 and its five-year average of 17%. We expect only a marginal improvement to 11.6%/12.6% in CY14/CY15. ACC is currently trading at 9.4x CY15 EBITDA (20% premium to 5-yr average), despite materially lower RoCE than historical averages. We build in favorable volume and realisation growth and sharp rebound in EBITDA/tonne for the next two years and a 13% CFO CAGR over CY Despite such optimistic assumptions, our DCF model fails to justify the current rich valuations. Our fair valuation of `1,181 implies 7.9x CY15 EBITDA. We retail SELL. Exhibit 71: Assumption summary Particulars (` mn unless mentioned) CY13 CY14 CY15 YoY growth CAGR CY14E CY15E CY13-15 Despatches % 8% 7% Utilisation % bps 173 bps 3% Realisation 4,222 4,472 4,830 6% 8% 7% Net Revenues 109, , ,349 12% 15% 13% EBITDA 16,288 19,476 24,641 20% 27% 23% EBITDA/Tonne % 17% 17% EBITDA Margin % bps 153 bps 9% PAT 9,758 12,182 13,809 25% 13% 19% Cash flow parameters CFO 17,770 17,444 19,712-2% 13% 5% Capex (15,566) (15,826) (13,846) 2% -13% -6% FCF 2,205 1,618 5,866-27% 263% 63% Ratios Gross Block T/O (0.0) 0.0-1% RoCE % bps 100 bps 19% RoIC % bps -99 bps 5% RoE % bps 65 bps 10% October 14, 2014 Ambit Capital Pvt. Ltd. Page 40

41 Cement Exhibit 72: Ambit Vs Consensus Revenue (` mn) Consensus Ambit Divergence Comments CY , ,479 4% We are higher than consensus on top-line, both in CY14 and CY15 as we build in volume and pricing recovery from CY14 onwards CY , ,443 5% EBITDA (` mn) CY ,490 19,476 11% We are higher than consensus as not only do we expect higher revenue but also cost savings led by lower power and fuel costs CY ,921 24,641 8% PAT (` mn) CY ,937 12,182 11% We are only marginally lower than consensus in CY15 despite higher EBITDA, as we expect higher depreciation and lower other income than CY ,100 13,809-2% consensus Exhibit 73: We build in 8.2%/8% EBITDA CAGR over CY13-15 Exhibit 74: EBITDA margin to recover but still remain materially lower than previous highs (mn (`/tonne) tonnes) 30 5,000 4, , , ,000 CY09 CY10 CY11 CY12 CY13 CY14 CY15 Volume (LHS) Realisation Realisation (ex-freight) (`/tonne) 1,400 1,200 1, CY09 CY10 CY11 CY12 CY13 CY14 CY15 EBITDA/tonne EBITDA margin (%) Exhibit 75: FCF generation to decline as the company invests for Jamul expansion Exhibit 76: RoCE/RoIC to be materially lower than previous highs (` bn) CY09 CY10 CY11 CY12 CY13 CY14 CY15 CFO FCF (%) CY09 CY10 CY11 CY12 CY13 CY14 CY15 RoCE RoIC October 14, 2014 Ambit Capital Pvt. Ltd. Page 41

42 Cement Exhibit 77: PV of FCFF profile Exhibit 78: DCF valuation of `1,181/share 14 (` bn) 35% PV of the forecasting period up to CY24 (` bn) % 25% Terminal Value (` bn) % 15% 10% Enterprise value (` bn) 194 Less: net debt at Dec-14 (` bn) (28) -2 CY15 CY16 CY17 CY18 CY19 CY20 CY21 CY22 CY23 CY24 5% Implied equity value (` bn) 222 Exhibit 79: ACC is trading at a 20% premium to 5-yr average EV/EBITDA 12 (X) PV of FCFF (LHS) WACC RoCE Implied equity value (` per share) 1,181 Exhibit 80: ACC is trading at a 20% premium to 5-yr average EV/tonne (Rs/tonne) 10,000 8, , ,000 2, Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 One-yr fwd EV/EBITDA 5-yr ave EV/EBITDA One-yr fwd EV/tonne 5-yr avg EV/tonne Source: Bloomberg, Company, Ambit Capital research Source: Bloomberg, Company, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 42

43 Cement Balance Sheet Balance Sheet CY2013 CY2014E CY2015E CY2016E Total Networth 79,146 85,785 93, ,929 Loans 2,600 1,000 1,484 1,500 Sources of funds 86,945 91,984 99, ,628 Net block 61,671 72,662 82,754 85,178 Capital work-in-progress 10,000 8,500 5,000 7,000 Investments 25,535 25,535 25,535 25,535 Total Current Assets 30,795 29,756 35,207 46,273 Current liabilities and provisions 39,154 42,566 46,600 52,455 Net current assets (8,360) (12,811) (11,393) (6,183) Application of funds 86,945 91,984 99, ,628 Income statement Profit and Loss CY2013 CY2014E CY2015E CY2016E Revenue 111, , , ,459 Total expenses 95, , , ,854 EBITDA 16,288 19,476 24,641 30,605 Net depreciation / amortisation 5,646 6,335 7,254 7,989 EBIT 10,642 13,141 17,387 22,616 PBT 12,478 15,444 19,869 25,392 Adjusted PAT 9,758 12,182 13,809 17,647 EPS diluted (`) DPS (`) Cash flow statement Cash Flows CY2013 CY2014E CY2015E CY2016E PBT 12,478 15,444 19,869 25,392 Change in working capital 4,173 1,230 1,131 1,315 Direct taxes paid (2,690) (3,262) (6,060) (7,744) CFO 17,770 17,444 19,712 24,176 Capex (15,566) (15,826) (13,846) (12,414) CFI (13,328) (13,181) (11,246) (9,496) Proceeds from borrowings 970 (1,600) CFF (3,872) (7,485) (5,918) (8,155) Net Change in cash 571 (3,222) 2,549 6,525 FCF 2,205 1,618 5,866 11,762 Ratio analysis / Valuation parameters Performance ratios CY2013 CY2014E CY2015E CY2016E EBITDA growth (24.0) RoCE RoE P/E (x) P/B (x) Debt/Equity (x) EV/EBITDA (x) EV/tonne (`) 7,680 7,680 6,880 6,585 October 14, 2014 Ambit Capital Pvt. Ltd. Page 43

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45 Right player, right market Shree Cement s cost competitiveness (both in manufacturing and capacity installation) led to industry leading volume growth and continuous market share gains over last five years. Near-doubling of capacities over FY13-16, will support further market share gains, given an infra spending led demand recovery and Shree s relatively high exposure to the institutional segment. We expect the company to deliver 41% EBITDA CAGR over FY14-16, and its RoCE to expand to 22-24% in FY15-16 from 18% in FY14. Whilst Shree is trading at peak valuations of 10.0x FY16 EBITDA, we believe rich valuations are sustainable given superlative ROCEs and EBITDA growth expectations. We maintain BUY with a revised target price to `9,158, implying 10.9x FY16 EBITDA. Competitive position: STRONG Changes to this position: POSITIVE North India market favourably positioned for the recovery North India is a well-balanced cement market both in terms of demand-supply and retail-institutional client mix. Whilst utilisation levels have dropped to decadal lows of 78% in FY14, we expect a gradual recovery to ~85% by FY16, which should support pricing growth. Execution of large infrastructure projects like DMIC/DFC should catalyse institutional demand and hence we believe volume growth could surpass India s average growth of 7-10%. Shree cement being the market share leader in North India will be the prime beneficiary. Sharp volume growth despite macro adversities Shree s volumes grew at double the industry growth rate in FY14 (14.2% vs 7% in north India) backed by capacity expansions alongside ability to push volumes in the institutional segment given its cost competitiveness. The recent acquisition of the 1.5mn tonne grinding unit in Haryana and upcoming capacities unit in Rajasthan, Bihar and Chhattisgarh will ensure significantly higher volume growth than the industry as the cement demand cycle turns in India. Revising estimates to account for superlative volume growth We revise our volume growth estimate to 18.5% CAGR over FY14-16 (13.7% earlier) due to capacity additions in North (brownfield and grinding unit acquisition) and East (greenfield). We build in pricing growth of 9%/8% and unitary cost increase of 4%/5% in FY15/FY16, resulting in EBITDA/tonne of `1,113/`1,289 in FY15 and FY16, implying 42% EBITDA CAGR. We expect RoCE to improve to 22%/24% in FY15/FY16 as against 18.4% in FY14. Deserves premium valuation for superior RoCE and earnings growth Post the multiple re-ratings, Shree is trading at peak valuations of 10.0x FY16 EBITDA, a 50% premium to its historical average and in-line with larger brands like Ambuja. Superior RoCEs (22-24% over FY15-16, against 14-18% for the pan-india players) and EBITDA growth justify the higher multiple. Key risks: Unrestrained scale ambitions superseding capital efficiencies and delayed recovery in north India. Shree Cement BUY COMPANY INSIGHT SRCM IN EQUITY October 14, 2014 Key financials (` mn, unless specified) Y/E Mar (` mn) FY13 FY14 FY15E FY16E FY17E Operating Income (` mn) 55,901 58,873 76,162 93, ,315 EBITDA (` mn) 15,599 13,899 21,125 27,869 34,508 EBITDA margin (%) EPS (`) BPS (`) 1, , , , ,518.9 RoE (%) EV / EBITDA (x) Cement Recommendation Mcap (bn): `144/US$2557 6M ADV (mn): `147.3/US$2.4 CMP: ` 8,249 TP (12 mths): ` 9,158 Upside (%): 11 Flags Accounting: Predictability: Earnings Momentum: Catalysts Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. GREEN AMBER GREEN Cement demand recovery in north India in FY15 and FY16 Strong retail demand driving pricing discipline Market share gains of 200bps in FY16 with new capacity additions Performance 27,600 26,100 24,600 23,100 21,600 20,100 Oct-13 Dec-13 Sensex Source: Bloomberg, Ambit Capital research Analyst Details Feb-14 Apr-14 Jun-14 Aug-14 Nitin Bhasin Tel: nitinbhasin@ambitcapital.com Achint Bhagat Tel: achintbhagat@ambitcapital.com Shree Cement

46 Shree Cement North India - A favourable cement market North India (including Uttar Pradesh) is the largest cement-consuming region in India (market size of 70mn tonnes). The region has maintained a high level of capacity utilisation (above India s average throughout the last decade; see Exhibit 1). Despite significant capacity additions (11% CAGR over FY02-13), strong demand growth ensured that utilisation levels remained high. Cement consumption expanded at an 8% CAGR over FY02-13, with the maximum growth seen in states like Haryana, Rajasthan and Uttar Pradesh. Whilst cement demand growth remained subdued in FY02-05 at 6.8% CAGR (vs India s average of 7.5%), it recorded a 9% CAGR in FY05-13 (vs India s average of 8.5%). Cement demand in states such as Rajasthan and Haryana was led primarily by the IHB segment/rural housing demand. But the NCR region saw strong growth in cement demand due to increased investments in large infrastructure projects and higher residential and commercial real estate construction. CMA does not include Uttar Pradesh (UP) in North India. However, for our analysis, we include UP since Shree has meaningful despatches in western UP Exhibit 1: Cement volumes picked up post FY05 but have remained weak in recent times (mn tonnes) 75 13% Exhibit 2: Rajasthan, Haryana and UP saw strong growth in cement consumption (mn tonnes) State FY02 FY13 CAGR (FY02-13) Rajasthan % Delhi % FY02 FY03 FY04 FY05 FY06 FY07 FY08 North India Demand Source: CMA, Ambit Capital research FY09 FY10 FY11 FY12 FY12 FY13 10% 7% 4% North India volume growth Haryana % Punjab % Uttar Pradesh % Himachal Pradesh % Chandigarh % J&K % Uttarakhand % North India %. Given that state wise volume growth is not available since FY12, we exclude in from our analysis The exhibit below highlights that north India s GDP growth (7.9% CAGR over FY05-14) has been fairly strong and higher than India s average GDP growth over FY05-13, which explains the strong growth in cement demand. Furthermore, as shown in Exhibits 9 and 10, despite average construction GDP growth in north India (6.5% CAGR over FY05-13), the real estate GDP CAGR was extremely strong at 9.5% over FY05-13, which underpins the urban infrastructure growth in north India. Exhibit 3: North India GDP growth has been above India s average in most years (` bn) 14,000 12,000 10,000 8,000 6,000 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 North india GDP North India GDP growth India GDP growth ; Note: North India GDP includes Uttar Pradesh 12% 10% 8% 6% 4% GSDP growth in north Indian states State % of CAGR North FY05-13 India GDP UP 6.7% 32.1% Rajasthan 7.5% 16.8% Delhi 10.0% 16.2% Haryana 8.6% 13.8% Punjab 6.7% 11.8% Uttarakhand 12.7% 5.0% Himachal Pradesh 7.8% 3.2% Chandigarh 8.0% 1.2% North India 7.9% 100.0% Source: MOSPI October 14, 2014 Ambit Capital Pvt. Ltd. Page 46

47 Shree Cement Exhibit 4: Construction GDP growth was fairly strong, except in FY10 and FY11 Exhibit 5: Real estate GDP expanded strongly in north India, mainly in Delhi, UP and Haryana (` bn) (` bn) 1,300 14% 1,600 13% 1, % 10% 8% 6% 4% 1,400 1,200 1, % 9% 7% 500 2% 600 5% FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 North India Construction GDP growth (RHS) North India Real-estate GDP growth (RHS) Source: Data.Gov.in, Ambit Capital research. Note: State-wise GSDP break up is not available for FY14 Source: Data.Gov.in, Ambit Capital research. Note: State-wise GSDP break up is not available for FY14 Well placed to grow in a recovering economy We believe north India is well-positioned to grow in an economic up-turn, given: Balanced mix of retail-institutional demand: Not only is north India a large cement-consuming region (30% of India s consumption) but it also has a good mix of both retail and institutional demand. Whilst Rajasthan, Punjab and Haryana are primarily IHB markets, the NCR region is largely dependent on institutional clients due to high real estate and infrastructure construction. High industrialisation: North India (including UP) contributes to 26% of India s industrial GDP. Its high industrialisation compared with most other Indian regions makes it a favourable destination for corporate capex and infrastructure creation. Exhibit 6: North India forms 26% of India s industrial GDP (` bn) 14,000 13,000 12,000 11,000 10,000 9,000 8,000 FY09 FY10 FY11 FY12 FY13 FY14 26% 25% 24% 23% 22% 21% 20% North-Industrial GDP as a % of India's Industrial GDP Source: RBI, Ambit Capital research A freight-intensive region drawing large investments like DFC/DMIC North-west India is one of the most freight-intensive routes and hence large upcoming infrastructure projects like the Dedicated Freight Corridor (DFC) and the Delhi Mumbai Industrial Corridor (DMIC) are concentrated in north India. DFC and DMIC will aid cement consumption not only during the construction phase but also to support auxiliary consumption from growth in nearby regions. October 14, 2014 Ambit Capital Pvt. Ltd. Page 47

48 Shree Cement We believe cement demand in north India would at least grow in line with India s average growth of 7/10% in FY15/FY16, due to a recovery in institutional demand and stable retail demand in tier II/III cities. However, if the implementation of large infrastructure projects gathers steam, demand growth could be materially higher (note that over FY08-13 north India cement volumes grew 150bps higher than India s average). Utilisation level to improve gradually North India has maintained high capacity utilisation historically (>90% over FY02-10); however, a sharp increase in installed capacities (up 45% over FY09-12) has led to declining utilisation rates to 78% in FY13 vs 95% in FY09. We expect 15mn tonne capacity addition in the next two years (see the exhibit below) but despite that capacity utilisation would likely move up to 83% in FY16 as against 79% in FY14 (materially higher than India s average utilisation level of 73%. Exhibit 7: Utilisation level to improve with rising demand (mn tonnes) FY02 FY03 FY04 FY05 FY06 FY07 North India Capacity Cap. Util North India FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 North India demand Cap. Util India 110% 100% 90% 80% 70% Expect utilisation to increase to 83% by end FY-16 against 78% in FY14 Source: RBI, Ambit Capital research Regional Utilisation level could reach 85-90% by end-fy16 We believe that capacity utilisation can improve to 80-83%, assuming a volume growth of 7% in FY15 and 10% in FY16 (Scenario I). However if volume growth surprises positively and grows at 9%/12% in FY15/FY16, utilisation levels would increase to 87% by end-fy16 (Scenario II). Assuming a strong implementation of infrastructure projects alongside steady increase in retail demand and volume growth of 10%/15% in FY15/FY16, utilisation levels would increase to 90% by end- FY16 (scenario III), which would mean that pricing growth can be extremely strong in the region. Exhibit 8: positively Utilisation levels could reach 90% by FY16 if demand growth surprises Capacity utilisation-end FY16 Scenario I- 83% Scenario II-87% Scenario III- 90% 100% North India capacity utilisation 95% 90% 85% 80% 75% FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Scenario I Scenario III Scenario II Avg-utilisation- FY08-14 Source: CMA, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 48

49 Shree Cement Note in the sensitivity table below that capacity utilisation of the region would reach 91% if volume grows by 14% in FY16 and 12% in FY17 (and 7% volume growth in FY15). Note that we assume 23mn tonnes of incremental capacity addition over FY14-17 for the below analysis. Exhibit 9: Utilisation Volume growth in FY17 Sensitivity analysis of capacity utilisation by end-fy17 Source: CMA, Ambit Capital research Volume growth in FY16 6% 8% 10% 12% 14% 4% 78% 80% 81% 83% 84% 6% 80% 81% 83% 84% 86% 8% 81% 83% 84% 86% 87% 10% 83% 84% 86% 87% 89% 12% 84% 86% 87% 89% 91% Low fragmentation with 50% of the capacities controlled by top-3 players The fragmentation level is relatively low in north India, with 50% of the capacities controlled by the top-3 groups (i.e. Shree, UltraTech and Ambuja). Although Rajasthan is relatively more fragmented (only 58% of capacities controlled by the top- 3 groups, owing to several mid-sized players like JK Cement, JK Lakshmi Binani and Wonder Cement), the other producer states have extremely low fragmentation levels. ACC, Ambuja and UltraTech control most of the capacities in Punjab and Himachal Pradesh (HP). Fragmentation is relatively low in North India Exhibit 10: Fragmentation level is fairly low in north India Exhibit 11: Barring Rajasthan, >75% of capacities are controlled by the top-3 groups Capacity 61% 53% Share of Top-3 groups 50% 45% 21% Capacity 100% 98% Share of Top-3 groups 82% 59% 30 Central East North West South 0 PUNJAB HIMACHAL PRADESH UTTAR PRADESH RAJASTHAN High utilisation and low fragmentation could drive price hikes Given the high capacity utilisation rate, low fragmentation and low import from adjoining regions, we believe the scope of increasing prices is better in the north as compared to most other regions, even if the institutional segment is the dominant growth driver. However, as seen multiple times in the last two years, price hikes do not sustain alongside weak demand growth. The sharp price hikes in the last two quarters were driven by moderate demand growth and supply constraints, and prices have softened slightly in the last few weeks as demand growth moderated. The exhibit below highlights that pricing grows in times of high capacity utilisation and stable demand growth. As and when utilisation levels drop due to high capacity utilisation or poor demand growth, pricing growth would be limited. Hence, utilisation improvement will be a key driver of sustainable pricing growth. Pricing growth hinges on realisation improvement October 14, 2014 Ambit Capital Pvt. Ltd. Page 49

50 Shree Cement Exhibit 12: Pricing can sustain if utilisation levels improve 30% 105% 25% 20% 100% Rolling 3-yr capacity CAGR 15% 10% 5% 95% 90% Rolling 3-yr despatches CAGR Pricing growth 0% -5% -10% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 85% 80% Annual capacity utilisation (RHS) Source: CMA, Ambit Capital research State-wise primary data checks We spoke to dealers, distributors and managements of cement companies to gauge the demand and pricing growth in YTD FY15. Demand has improved marginally on a low base of last year but a major impetus in the region would require improvement in institutional demand which continues to be lacklustre. Whilst retail demand continues to be steady, it might weaken given the deficient monsoon this year. Price hikes in FY15 were supported to a large extent due to the shutdown of Binani s plant and prices have corrected marginally in recent months. Below is a summary of our state-wise discussions with dealers. Delhi/NCR: Cement demand has grown by 5-7% in 1HFY15, but real estate construction remains weak due to high real estate inventory. Institutional demand improved post the removal of the sand mining ban but softened in recent months (partially due to seasonality). Prices increased sharply during June-August 2014 but have corrected in September due to increasing inventory at the dealer level. Dealers believe that further price hikes will be tough to push through unless demand improves materially in 2HFY15. Haryana/Punjab: Retail demand is the key driver in these states, given the high dependence of agricultural production. Given that the monsoon was 30% deficient, farm income might suffer and so could retail cement demand. Prices remained fairly stable at `300/50kg bag. Rajasthan: This was one of the best-performing north India cement markets, primarily due to strong growth of retail demand and ongoing construction of large infrastructure projects like the Jaipur Metro. Cement prices increased to `300/50kg bag in July-August 2014 but reduced to `280/50bag in end-september. Western UP: Cement demand in western UP has grown by 6-7% in 1HFY15 mainly due to organised real estate construction in tier II/III cities. Dealers believe that demand can pick up sharply especially as IT/ITes service firms set up establishments in the region. Sharp hikes in the last six months have corrected in recent months The sharp increase in prices in north India in 1HFY15 has been primarily on two accounts: (1) improvement in utilisation rates post the resumption of sand mining and (2) lower supplies in the market due to the shutdown of Binani s plant for 3-4 months. Prices have corrected marginally in recent months and a sustainable increase hinges on demand recovery and pick up in utilisation rates. Mid-single digit demand growth, prices corrected with rising inventory with dealers Deficient monsoon could hamper retail demand in Haryana The fastest growing North Indian state in FY14 Commercial real-estate construction needs to revive for growth recovery October 14, 2014 Ambit Capital Pvt. Ltd. Page 50

51 Shree Cement Exhibit 13: Pricing movement over the last five years in north India (`/50 kg bag) Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Jun-12 Aug-12 Oct-12 Dec-12 Feb-13 Apr-13 Jun-13 Aug-13 Oct-13 Dec-13 Feb-14 Apr-14 Jun-14 Aug-14 North India avg Cement price India avg Cement price October 14, 2014 Ambit Capital Pvt. Ltd. Page 51

52 Shree Cement Upcoming infrastructure projects Exhibit 14: Upcoming key large infrastructure projects in NCR, Rajasthan and UP Project name NCR Cost (` bn) Delhi Metro Phase III 350 Delhi Jaipur Expressway 140 Status Out of the 2 new lines and 10 route extensions proposed for Phase III, Cabinet approvals have been obtained for 2 new lines and 5 line extensions totaling 140 km, with an estimated cost of `350 billion (US$5.4 billion). Construction has already begun on many of these projects. Whilst the project is stuck currently, the NHAI is considering fast-tracking the project by awarding it through the EPC route. Noida Metro 50 The Government has approved the metro; the metro link is likely to be commissioned by Rajnagar to UP gate 7 Recently announced; work is likely to begin in 6-10 months. Rapid Metro Gurgaon Phase II 21 Total NCR 568 Rajasthan Rewari to Vadodara (DFCC) 67 Khurja Bhaupur (DFCC) 33 Ghilot Industrial area 50 HPCL Barmer refinery 10 Phase II will add seven kilometres of double track, stretching south of Sikanderpur station along Golf Course Road, with 6 new stations. The construction work of Phase II will be completed by the end of Almost all the land required for the stretch has already been acquired and all the other statutory clearances have also been obtained. This contract is likely to be completed in four years. The World Bank has funded US$975 million for this stretch which is a Design-Build lumpsum contract that requires execution of the work within a time-frame of 4 years. The new industrial area, Ghilot, is going to be opened soon, as the area has got the environment clearance and other hurdles are also cleared. The 1,700-acre industrial area will have a dedicated zone for South Korean companies besides a Japanese zone. HPCL had registered 4,800 acres of land from the Rajasthan Government at a price of `300mn last week for the refinery. The refinery is likely to come up by Gomati Ka Chauraha (road) 10 Construction has begun; likely to be completed over the next 2 years. Lignite based power plant Barmer 50 Jaipur Bhilwara (road) 2 Agreement signed for 25 years. Raj West Power Ltd on 29 May 2006 put up a lignitebased power plant of 1,000 MW (8 units of 125MW each). Agreement signed on 12 July 2010 with M/s Jaipur Bhilwara Tollway Pvt Ltd and M/s Subhash Projects & Marketing Ltd. Work is in progress. Chomu to Mahala (road) 1 Financial bid received from M/s Unity Infra Projects Ltd; confirmation likely in 1-2 months Bikaner Suratgarh(road) 5 Financially closed; work to begin in a few months. Chittorgarh-Pratapgarh (road) 5 Financially closed; work to begin in a few months. Water Supply & Sewerage in Udaipur Water Supply & Sewerage System of Ajmer and Pushkar City Jalore Area Development Programme Drinking Water Supply & Sanitation Project Total Rajasthan 260 Uttar Pradesh (UP) 10 Feasibility report submitted; execution to begin in due time. 7 Feasibility report submitted; execution to begin in due time. 10 Implementation structure is under approval. Delhi-Saharanpur-Yamunotri Road 17 Work under progress Bareilly- Almora Road(up to Uttarakhand border) 4 Work under progress Varanasi-Shaktinagar 12 Work under progress Meerut-Karnal road 6 Work under progress Bara Thermal Power Project, Allahabad Karchana Thermal Power Project, Allahabad 115 LOI issued, shell company transferred to developer, and environmental clearance obtained. 76 LOI issued, shell company transferred to developer, and environmental clearance obtained. Jawaharpur Thermal Power Project 66 Activities to acquire the land have been initiated. Dopaha Thermal Power Project 100 Activities to acquire the land have been initiated. Yamuna Expressway Thermal Power Project 100 Activities to acquire the land have been initiated. Lucknow Metro 125 The metro has been approved; construction is likely to begin in January Total UP 621 Total- NCR, Rajasthan and UP 1,449 Source: Industry Sources, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 52

53 Shree Cement Focused on growing profitably Shree s focus on reinvesting for growth, maintaining operating and capital cost efficiencies, and entering fast-growing regions like East India, will ensure profitable growth as and when the cement demand cycle turns favourable in India. Whilst cement demand in India fell to a decadal low in FY14, Shree Cement continued to grow materially ahead of industry growth rates (14.2% in FY14 vs north India growth of 6-7%). Strong growth despite the adverse demand scenario vindicates its ability to gain market share, with rising capacities and a well-established distribution network (close proximity to key consumption centres). We believe the company will sustain superlative growth rates in the next 2-3 years, with increasing capacities in north India (through brownfield expansions and acquisitions) and entry in east India (grinding unit in Bihar and an integrated plant in Chhattisgarh). The chart below highlights that Shree s volume growth was the second highest in India over FY12-14; only Heidelberg grew higher than Shree (but its scale is materially lower. Exhibit 15: Shree was amongst the fastest growing cement manufacturers in FY14 Amongst the highest growing cement companies, despite materially higher scale than most regional peers 14.8% Volume CAGR FY % 7.7% 6.6% 6.5% 5.7% 5.3% 5.1% HEID Shree Mangalam Ramco JKLC Orient Industry OCL 2.6% 2.2% 0.9% ICEM UTCEM JKCE -0.1% Ambuja -0.5% -1.3% ACC Prism -4.1% -7.3% Jaypee Sagar. Note: ACC, Ambuja and Heidelberg are December-ending companies, whereas Shree is June-ending; we adjust the volumes to financial year to aid comparability Significant increase in market share; scope for further increase Shree s market share in north India has increased to ~17% in FY14 as against 12% in FY08, led by a 1.5x increase in installed capacity further aided by setting grinding units close to the major demand centres to optimise distribution. Shree has increased clinker capacity to 14mn tonnes (from 10mn tonnes in FY13) in Rajasthan. Post the addition of another 4mn tonne grinding unit in Rajasthan and the acquisition of a 1.5mn tonne grinding unit in Panipat (from Jaypee), its grinding capacity increased to 19mn tonnes. Given that the company has excess clinker capacity and solid distribution architecture, we believe it is well-placed to gain further market share in the coming years. Moreover, the company can add another grinding unit of 2mn tonnes given the surplus clinker capacity. Exhibit 16: Materially higher than industry volume growth 25% 20% 15% 10% 5% 0% Volume growth FY09 FY10 FY11 FY12 FY13 FY14 North India Shree India Exhibit 17:..aiding market share gains (mn tonnes) Increasing capacities through expansions/acquisitions to support market share gains FY08 FY09 FY10 FY11 FY12 FY13 FY14 Shree volume North India Market share (%) Source: CMA, Company, Ambit Capital research Source: CMA, Company, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 53

54 Shree Cement Well-entrenched cost competitiveness We had highlighted in our initiation dated 3 December 2013, Time to win away from home that Shree has the lowest cost of production and the lowest freight cost amongst Indian cement manufacturers. The company has shown exceptional cost management in the past by controlling fuel costs (the first Indian manufacturer to use petcoke), opting for higher blended cement production (PPC:OPC mix of 80:20) and splitting grinding units close to the demand centres to control distribution expenses. Not only are these competitive advantages sustainable in north India, but our channel checks also suggest that the company has taken adequate steps to ensure low-cost manufacturing in east India as well. Competitive mapping of north India cement players We have assessed Shree Cement s competitiveness vis-à-vis other north-based cement players on various financial parameters. Shree Cement ranks third in our competitive matrix (behind Ambuja and UltraTech). Although the company has the best cost of production (due to lower power and raw material costs) and market share (largest capacity and maximum market share gains in the last five years), it ranks below the pan-india players in terms of cost of sales and pricing. Exhibit 18: Ranking - Shree Cement is the third best player on our competitive matrix Companies Pricing Cost of production Cost of Sales Market share Overall Ranking UltraTech Ambuja Shree ACC JK Cement Mangalam JK Lakshmi Note: Shree s year-ending is June; ACC s and Ambuja s year-ending is December. Year-ending of all the other companies is March. Exhibit 19: Numbers behind our ranking Company Realisation (`/tonne) FY13 CAGR (FY08-13) Cost of production as a % sales Avg FY13 (FY08-13) Cost of sales as a % of sales Avg FY13 (FY08-13) Capacity (mn tonnes) Market share volume CAGR (FY08-13) UltraTech 4, % 53.4% 54.7% 23.4% 20.4% % Ambuja 4, % 51.9% 50.4% 22.7% 22.3% % Shree 4, % 51.0% 45.7% 21.4% 22.5% % ACC 4, % 56.3% 55.5% 24.8% 20.1% % JK Cement 3, % 52.1% 50.9% 28.6% 28.6% % Mangalam 3, % 52.8% 53.7% 28.6% 24.6% % JK Lakshmi 3, % 54.9% 55.2% 24.3% 22.1% %. Note: Shree s year-ending is June; ACC s and Ambuja s year-ending is December. Year-ending of all the other companies is March. Explanation for the parameters used in our competitive mapping Pricing Ambuja ranks the best given its premium positioning in north India We use grey cement realisation (excluding clinker sales) as a benchmark to judge the pricing power/market mix of the players. Ambuja Cement ranks the best on this metric, owing to its premium realisations across the north Indian states. Shree Cement fairs poorly on pricing, as its prices are 5-10% lower than larger brands such as Ambuja, UltraTech and ACC. October 14, 2014 Ambit Capital Pvt. Ltd. Page 54

55 Shree Cement Cost of production: Shree s superiority driven by lower power and fuel costs We assessed the players on cost of production to gauge their cost competitiveness. We ascertain the cost as a percentage of sales due to the different OPC:PPC mix. Shree and Ambuja Cement are superior on this metric. Whilst Shree is largely in line to its peers in terms of raw material and employee costs, its cost savings are driven by lower power and fuel costs. Cost of sales: Shree is marginally higher than pan-india peers We compared the players on selling costs, which includes freight and marketing and distribution. Whilst Shree is far superior to its peers on freight costs (explained in the section below), Shree s other selling costs are materially higher than its peers at ~10% of sales as against 2-5% for other peers. The management highlights that this is on account of its multi-brand strategy, which requires investments for building all the three brands individually (separate dealers, marketing teams, etc), unlike other peers that have to spend only on one brand. The management has mentioned in previous annual reports that the advertising cost per tonne of Shree Cement is the highest in the industry. Market share: Shree is the largest player with the highest market share We ascertained market share on the basis of capacity and five-year volume CAGR. Not only is Shree Cement the largest player in India, but its volume growth has also been significantly higher than its other peers and also higher than the north India region as a whole (14% CAGR over FY08-13 as against 4-5% for other players and 9% for north India). The company has the highest market share (18%) in north India. Limitations to our analysis a) UltraTech s, Ambuja s and ACC s numbers include the performance for all pan- India operations and they cannot be segregated for North India. b) Our competitive mapping exercise considers that ~60% of the capacities are in North India, as the requisite details are not publicly available for the others. c) We have included miscellaneous expenditure as a part of the cost of production since the nature of the cost item is not determinable. Please refer to our initiating coverage note, Time to win away from home, for a detailed break-down of Shree competitive advantages. Highly efficient capital deployment Moreover, we highlight that Shree has a history of efficient capital deployment and the lowest cost per unit of capacity addition amongst the top-5 cement companies in India. Exhibit 20: Shree s capacity expansion costs have been the lowest in the industry Particulars Capacity Addition (mn tonnes) (1) Weights (2) Integrated Grinding Integrated Grinding Wtd. Capacity addition (1) X (2) Combined Wtd Cost cost per tonne (` mn) (` mn) (FY02-13 Grinding Capacity (mn tonnes) Clinker Capacity (mn tonnes) (` mn) FY06 FY13 FY06 FY13 Madras ,956 6, ACC ,404 5, ACEM ,105 5, Shree ,638 4, UltraTech ,544 7, Note: We assign a weight of 1.0x to an integrated plant and 0.4x to a grinding unit. We exclude power addition by Shree Cement and Madras Cement in our capex cost calculation. Note that UltraTech s clinker and grinding capacity includes Samruddhi Cement s capacity. October 14, 2014 Ambit Capital Pvt. Ltd. Page 55

56 Shree Cement Growing in size; entering new regions Shree Cement has outlined an aggressive expansion plan of doubling its cement capacity by FY18. The company s ongoing capacity expansion will take its cement capacity from 17.5mn tonnes in FY14 to 21.5mn tonnes in FY15 and 24mn tonnes in FY16. Acquisition of Jaypee s Panipat plant is an intelligent move Shree Cement has signed an agreement to acquire Jaypee s 1.5mn tonne grinding unit in Panipat, Haryana, for `3.6bn (implying a valuation of US$40mn/tonne). We believe that the deal would be value-accretive for Shree, due to the better use of its clinkerisation capacity (14mn tonnes by end-fy15 vs own grinding capacities of 15.5mn tonnes in North India); further, the acquisition cost is in line with Shree s historical capacity expansion costs (US$50/tonne). We believe that this acquisition is in line with the company s strategy of moving closer to the target markets and the plant would improve the company s presence in the north India market and reduce the lead distance in the Punjab and Haryana markets (the management estimates savings of `200/tonne on sales from this unit). Exhibit 21: Shree s capacity addition history and upcoming additions Acquisition of Jaypee s plant will improve Shree s footprint in North India (mn tonnes) Brownfield expansion in Ras Grinding unit in Khushkhera Grinding unit in Suratgarh and Laksar Grinding unit in Jaipur Ras line IX Ras line X with 4mn tonne grinding Bihar grinding unit + Jaypee Chhattisgarh Panipat integrated acquisition plant FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Grinding capacity Clinker capacity Foray into east India and then in central, west and south India The company has already commissioned a grinding unit in Bihar and will commission an integrated cement plant in Chhattisgarh (2.5mn tonnes; likely to be commissioned in early-fy16).the company already has identified land in Karnataka and Madhya Pradesh for capacity expansions post the completion of expansions in east India. Entry in East India to diversify geographical presence Exhibit 22: Shree s upcoming capacity addition plans Capacity Cement Capacity (mn tonnes) Clinker capacity (mn tonnes) Investment (` mn) Status Ras Unit IX ,500 Commissioned in FY14 Ras Unit X ,500 Commissioned in FY15 Bihar Grinding Unit Chhattisgarh Integrated plant ,000 Commissioned in FY ,000 To be commissioned in early FY16 Jaypee, Panipat 1.5-3,600 Acquired in FY15 Total ,600 ; Note: EIA reports filed by the company October 14, 2014 Ambit Capital Pvt. Ltd. Page 56

57 Shree Cement Self-sufficiency in funding capex Given Shree s scale, the company can internally generate funds to meet its capex requirements, not only in the next 3-4 years (as it doubles capacity) but also in the long term. We believe that the company will generate CFO of `487bn over FY15-25 and FCF of `337bn assuming the capacity increases to 39mn tonnes by FY25. Furthermore, surplus cash positions the company well to scout for inorganic growth opportunities, with several companies struggling to run operations with their weakened balance sheet. We believe that the company will have significant cash surplus even after re-investing in capex (`87bn by FY20), which could be used to pay dividend/share buy-backs in the future. Exhibit 23: Self-sufficiency in funding capex needs (` bn) (mn tonnes) FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 CFO FCF Capacity (RHS) Exhibit 24: Cash as a percentage of capital employed could reach as high as 50% by FY20 (` bn) FY12 FY13 FY14 FY15 FY16 FY17 FY18 FY19 FY20 Cash Cash as a % of CE 50% 45% 40% 35% 30% 25% 20% October 14, 2014 Ambit Capital Pvt. Ltd. Page 57

58 Shree Cement Revision in estimates Volumes surprised positively in FY14; expect superlative growth to continue Whilst we had expected muted volume growth in FY14, given the extremely weak demand in north India, Shree Cement surprised us positively by posting a volume growth of 14% vs 6-7% in north India. Alongside the expected recovery in north India cement volumes, enhanced grinding capacities, adequate clinker availability and entry in east India will enable strong volume growth in the next two-three years. We believe Shree will be able to gain market share especially when institutional demand will likely be a major driver (as its lower production costs enables it to offer better rates to institutional clients). Volume and realisation growth assumptions: We expect volume growth of 21% in FY15 and 16% in FY16 (vs 14% in FY14). Our volume growth expectation hinges on the successful and timely commissioning of capacities in Rajasthan and east India (Shree has a history of timely additions) and continued market share gains. We build in realisation growth of 9% in FY15 and 8% in FY16. In the power segment, we expect sales to remain flat in FY15 and decline marginally in FY16, as power capacity would incrementally be used to meet captive needs. We expect power EBITDA to increase to `2bn in FY15 and `2.1bn in FY16 as against `1.7bn in FY14. We expect volume growth of 21% in FY15 and 16% in FY16 (vs 14% in FY14) Exhibit 25: Upcoming capacities to drive market share gains, and better realisations with pricing growth (mn tonnes) FY08 FY09 FY10 FY11 FY12 Volume (LHS) Realisation (ex-freight) FY13 FY14 FY15E FY16E 5,500 4,500 3,500 2,500 1,500 Exhibit 26:..to drive strong revenue growth in FY15/FY16 Expect sharp EBITDA growth with higher volumes and improving realisation We build in only a marginal 3.5%/3% increase in operating costs in FY15/FY16 driven largely by savings in power and fuel costs, although we build in a 5%/4% increase in unitary freight costs in FY15/FY16 respectively (over and above the 14% increase in FY14). Our estimates imply EBITDA/tonne of `1,230/`1,397 in FY15/FY16 (42% EBITDA CAGR over FY14-16). FY17E Realisation (`/tonne) (` bn) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E Cement Power YoY growth (RHS) 60% 50% 40% 30% 20% 10% 0% -10% We build in only a marginal 3.5%/3% increase in operating costs in FY15/FY16 Exhibit 27: Improvement in EBITDA to be driven by realisation growth and steady costs 1,700 1,500 1,300 1, (`/tonne) FY08 FY09 FY10 FY11 FY12 Unitary EBITDA (LHS) FY13 FY14 FY15E FY16E FY17E EBITDA margin (%) Exhibit 28: Unitary EBITDA expansion alongside higher volumes to drive significant EBITDA and PAT growth FY08 (` bn) FY09 FY10 FY11 FY12 EBITDA FY13 PAT FY14 FY15E FY16E FY17E October 14, 2014 Ambit Capital Pvt. Ltd. Page 58

59 Shree Cement Continue to re-invest for growth; RoCE to recover with strong EBITDA growth We expect the company to re-invest `27bn in capacity expansions in the next two years (66% of CFO) to ramp up capacities in Rajasthan and east India. We believe that the sharp improvement in EBITDA/tonne will drive a significant improvement in RoCEs to 23.7%/25% in FY15/FY16 vs 16.4% in FY14 and the five-year average of 17%). Exhibit 29: Expect the company to re-invest 66% of CFO for capacity expansions over FY14-16 Exhibit 30: growth the sharp improvement in EBITDA/tonne will drive a significant improvement in RoCEs to 23.7%/25% in FY15/FY16 vs 16.4% in FY14 RoCE/RoE to recover given sharp EBITDA FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E CFO FCF Capex/CFO (RHS) 120% 100% 80% 60% 40% 20% 0% (x) FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E GB turnover (LHS) RoCE RoIC (%) October 14, 2014 Ambit Capital Pvt. Ltd. Page 59

60 Shree Cement Change in assumptions Exhibit 31: Detailed financial assumptions (` mn unless mentioned otherwise) Assumptions (new) Assumptions (old) Change (%) Comments FY15E FY16E FY15E FY16E FY15E FY16E Cement sales % 8.6% Expect strong sales in FY15 and FY16 with commissioning of new capacities and acquisition of Jaypee's plant in Haryana. Capacity utilisation (%) bps -195 bps Power sales (kwh) 2,109 1,873 2,531 2, % -25.8% Per tonne analysis Cement Realisation 4,030 4,364 3,919 4, % 3.7% Operating costs 2,917 3,052 2,807 2, % 4.7% EBITDA 1,113 1,289 1,112 1, % 8.5% Financials (` mn unless specified) Net Revenues 76,162 93,398 75,787 86, % 8.3% We reduce power sales estimate to account for lower sales in FY14. Expect steady growth in cement realisation with a recovery in India's cement demand and entry in the high-realisation East India market. Increase in realisation estimate is on account of higher-than-expected realisation in 3QFY14. Increase in operating costs is on account of factoring in higher-than-earlier freight costs. Change in unitary EBITDA is largely driven by upward revision of realisation and lower power and fuel costs. Increase in revenue is a function of higher volume and Cement Revenues 69,209 87,061 65,663 77, % 12.5% realisation growth. We reduce power sales and realisation estimates, resulting in Power revenues 6,953 6,338 10,124 8, % -28.6% lower power revenues. EBITDA 21,125 27,869 22,829 26, % 5.6% Cement EBITDA 19,110 25,725 18,631 21, % 17.7% Power EBITDA 2,015 2,144 4,198 4, % -52.8% EBITDA margin (%) bps -76 bps EBIT margin (%) 22% 23% 24% 24% -2 bps -1 bps Higher cement EBITDA is a function of upward revision in realisations. Overall EBITDA declines in FY15 on account of a significant reduction in power EBITDA. Adjusted PBT 16,402 21,791 17,889 20, % 6.7% Reduction in PBT estimates is on account of lower Power EBITDA. Adjusted PBT margin (%) bps -36 bps Tax 3,280 4,794 3,578 4, % 6.7% We model a tax rate lower than the maximum marginal rate Tax Rate (%) bps 0 bps due to MAT credits. Adjusted PAT 13,122 16,997 14,311 15, % 6.7% Change in PAT is in line with PBT change. Adjusted PAT margin (%) bps -28 bps EPS (`) % 6.7% Capex 14,561 12,207 11,124 12, % -1.4% Gross Block turnover bps 7 bps FCF 2,927 10,864 7,788 10, % 6.1% Increase capex for `3.6bn paid for acquisition of Jaypee's cement plant, and hence, CFO generated is lower. RoCE Better operational performance is leading to better bps 122 bps profitability in the next two years. Target price 9, Our DCF-based target price increases materially, as we revise 46% our volume growth estimate to factor in increased capacities. Exhibit 32: Sensitivity of EPS and EBITDA in FY15 and FY16 to change in realisation Change in realisation (` per bag) FY15 FY16 Change from Base case (EBITDA) Change from Base case (EPS) EBITDA EPS EBITDA EPS FY15 FY16 FY15 FY , , % 12.2% 17.2% 16.6% 14 19, , % 5.7% 7.9% 7.7% 18 (base) 21, , % 0.0% 0.0% 0.0% 22 22, , % -4.4% -5.9% -5.7% % -8.9% -11.7% -11.3% October 14, 2014 Ambit Capital Pvt. Ltd. Page 60

61 Shree Cement Ambit vs consensus Exhibit 33: Our estimates are significantly higher than consensus Particulars Consensus Ambit Divergence Comments Revenue (` mn) FY ,257 76,162 7% Our estimates are higher than consensus as we expect further market share gains with enhanced capacities FY ,838 93,398 10% EBITDA (` mn) FY ,728 21,125 13% Our EBITDA estimates are higher than consensus due to our expectation of pricing recovery in North India FY ,926 27,869 16% PAT (` mn) FY ,393 13,122 26% Higher PAT growth than consensus is on account of higher EBITDA and better interest FY ,139 16,997 20% and depreciation recovery Source: Bloomberg, Ambit Capital research Recent revision in consensus estimates Consensus revenue estimates have been revised upwards by 3.3% for FY15 and 9.1% for FY16 and consensus EBITDA estimates by 2.5% for FY15 and 14% for FY16. From the lows in March 2014, consensus revenue estimates for FY15 and FY16 have been upgraded by 6.2% and 9.4% and EBITDA estimates by 12.1% and 20.8%. With the latest upgrades, the consensus is building in revenue growth of 21% in FY15 and 19% in FY16. Assuming that the realisation jump should be at least 6% p.a., the implied volume CAGR is 13-14%, which is materially lower than our estimates of 17%. It appears to us that there is some room for further upgrades, as the present estimates are building in 13-14% volume CAGR assuming a 6% pricing CAGR; given Shree s capacity additions in north and east and market leadership in north India, we believe its volume CAGR could be 15-18%, implying 2-5% upgrades for volumes, and hence higher upgrades for revenues. Moreover, if Shree uses the spare cash on the books for inorganic expansions (as seen in the recent acquisition of Jaypee s 2mn tonne grinding unit in Panipat), its volume growth expectations could be reset further, as it will have excess clinker capacity in FY16 and it can acquire 1-2mn tonnes to make the most of the opportunity. Whilst industry dynamics do not indicate an upside risk to 6% pricing CAGR, production/pricing discipline can take prices anywhere! EBITDA margin: Consensus is building in a fairly high EBITDA margin of 26.4%/28.3% in FY15/FY16 respectively; assuming a 14% volume CAGR does not imply more than `200/tonnes (~20%) expansion in unitary EBITDA. The leading market participants are indicating that unitary EBITDA should be higher than this level two years out. We believe further margin improvement hinges on realisation growth as the room to reduce costs are limited. Consensus revenue estimates for FY15 and FY16 have been upgraded by 6.2% and 9.4% and EBITDA estimates by 12.1% and 20.8% in the last 6 months Exhibit 34: Significant upgrades to consensus revenue Exhibit 35: and EBITDA estimates in recent months 73,000 Revenue (` mn) 87,000 19,000 EBITDA (` mn) 24,000 71,000 69,000 67,000 65,000 Jan-14 Feb-14 Mar-14 Apr-14 May-14 FY15 Jun-14 Jul-14 Aug-14 FY16 Sep-14 84,000 81,000 78,000 75,000 18,500 18,000 17,500 17,000 16,500 16,000 Jan-14 Feb-14 Mar-14 Apr-14 May-14 FY15 Jun-14 Jul-14 Aug-14 FY16 Sep-14 23,000 22,000 21,000 20,000 19,000 Source: Bloomberg, Ambit Capital research Source: Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 61

62 Shree Cement Valuations At a premium but justified! With multiple re-ratings in three years, Shree now trades at 10.0x FY16 EBITDA (11.5x based on consensus EBITDA), an 60% premium to its five-year average, a 40-50% premium to mid-cap India cement companies and only a marginal discount to pan- India players like UltraTech. We believe that the company deserves premium multiples, as not only has its scale increased materially, but it has also maintained exceptional capital allocation and superlative RoCE/RoE. We believe it will maintain superlative earnings growth and profitability in the future as well (see the table below). The premium enjoyed by the larger players is based on their pan-india presence/brand, but we believe that Shree in a few years would also have multi-region exposure, starting with east, then central and south. We admit that Shree s brand is not as strong as the national players and it sells at a discount, but its materially better capital allocation, rising scale and profitable growth adequately make up for a slightly lesser brand. Our DCF-based target price of `9,158 implies `12,285 FY16 EV/tonne and 10.6x FY16E EBITDA. DCF valuation `9,158/share We value Shree Cement using a DCF methodology wherein EBITDA margin, working capital turnover and capital expenditure are the key variables controlling the valuation. Furthermore, we use a free cash flow to equity methodology given that Shree is a cash surplus company. We undertake a combined valuation for the cement and the power segment, due to the combined costs and inter-segmental transactions. We value the stock at `9,158/share which implies 10.6x FY16 EV/EBITDA. The assumptions underlying our valuation are: Volume and realisation estimates: We estimate 18% cement volume CAGR over FY14-16, given steady retail demand growth, recovery in the investment cycle driving institutional demand alongside the company gaining market share with upcoming capacities. We model a 9.1% volume CAGR over FY14-25E, higher than our longterm industry growth expectation of 8%. We believe Shree will grow ahead of the industry, as the company will likely add capacities pan-india and gain market share in new regions. We assume a capacity utilisation rate of 85-90% over FY14-24 given the company s presence in favourable markets such as north India and expansions in underpenetrated markets such as east India. Whilst realisations drop marginally in FY14, we expect a 9% increase in FY15 and an 8% increase in FY16. We estimate realisation CAGR of 6% over FY Shree now trades at 10.0x FY16 EBITDA (11.5x based on consensus EBITDA), a 60% premium to its five-year average, a 40-50% premium to mid-cap India cement companies and only a marginal discount to pan-india players like UltraTech. Exhibit 36: Expect sharp volume growth in the next two years followed by high single-digit growth Exhibit 37: We build in 5% long-term pricing growth mn tonnes (`/tonne) 40 8, , , , ,000 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25 October 14, 2014 Ambit Capital Pvt. Ltd. Page 62

63 Shree Cement Margin and operating cash flows: After a marginal decline in unitary EBITDA in FY14, we expect significant improvement in the next three years (18% CAGR over FY14-17E), as realisation improves and a significant cost inflation is offset by lower power and fuel costs. Post FY17, we expect unitary EBITDA to increase at 8% and we taper the growth to 5% by FY25. Factoring in these assumptions, our estimated EBITDA CAGR is 15% and CFO CAGR is 14.2% over FY16-25E. Capex and FCF: Shree is adding 10mn tonnes of capacity over FY14-16, entailing an investment of ~`33.5bn. With the management s pursuit of pan-india expansions, we expect the company to add 15mn tonnes of incremental capacity over FY16-25, reinvesting 35% of the CFO (`135bn) over FY14-24E as against the 72% re-investment rate over FY We expect the company to generate FCF of `285bn over FY % WACC and 4% terminal growth: We assume a WACC of 14.0%, 50bps higher than pan-india players, given Shree s smaller scale and size. Our terminal growth rate is 4% is in line with the estimate for the other cement companies. Exhibit 38: FCFE profile low FCFE will likely increase as capacities are commissioned Exhibit 39: DCF-based value of `9,137/share (` mn) 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E PV of FCFE (LHS) RoCC WACC 35% 25% 15% 5% PV of the forecasting period up to FY24 (` bn) 122 Terminal Value (` bn) 169 Add: Cash 28 Implied equity value (` bn) 318 Implied equity value (` per share) 9,158 Sensitivity analysis Our base-case valuation assumes volume growth of 21% and realisation growth of 9% in FY15. Note that the changes in our FY15 estimates lead to a change in our forward estimates as the base changes. Exhibit 40: Base-case valuation of `9,158/share DCF Value Change in realisation growth (FY15) Change in volume growth FY ,401 8,480 8,560 8,639 8, ,695 8,777 8,859 8,941 9, ,989 9,074 9,158 9,243 9, ,284 9,371 9,458 9,544 9, ,578 9,667 9,757 9,846 9,936 October 14, 2014 Ambit Capital Pvt. Ltd. Page 63

64 Shree Cement Cross-cycle valuation A significant increase in the scale of the business and improvement in profitability resulted in multiple re-ratings of Shree Cement s stock over the last three years. Moreover, strong volume growth in FY14, despite the adverse demand scenario led to further expansion in Shree s EV/EBITDA multiples. Shree is currently trading at 11.6x FY16 consensus EBITDA and `11,538 FY16 EV/tonne, at a 60% and 65% premium to its five-year averages. Note that the above-mentioned EV/tonne includes the thermal power assets, adjusting for which the EV/tonne is `10,788. Whilst Shree is trading broadly in-line with larger brands like Ambuja on FY16 consensus EBITDA, it is justified given superior RoCE (22-24% in FY15-16 as against 14-17% of Ambuja in CY14-15), superior capital deployment and higher growth visibility. We do not see scope for a material re-rating from hereon and the stock price hinges largely on strong EBITDA expansion (41% EBITDA CAGR over FY14-16). Note that our EBITDA estimates are 16% higher than consensus in FY16. Shree is trading broadly in-line with larger brands like Ambuja on FY16 consensus EBITDA, it is justified given superior RoCE Exhibit 41: After multiple re-rating Shree is trading at peak EV/EBITDA Exhibit 42: Shree is trading at a 65% premium to its fiveyear average EV/EBITDA (X) (X) 14,000 12,000 10,000 8,000 6,000 4,000 0 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 2,000 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11 Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 One-yr fwd EV/EBITDA 5-yr ave EV/EBITDA One-yr fwd EV/tonne 5-yr ave EV/tonne Source: Company, Bloomberg, Ambit Capital research Source: Company, Bloomberg, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 64

65 Shree Cement Relative valuation - In the big league now With multiple re-ratings in three years, Shree is currently trading at a 30-40% premium to other regional players; we believe Shree deserves the premium to other mid-cap cement companies as not only does it have higher scale, but has also shown superior capital allocation and industry-leading profitability. The company s discount to pan-india brands like UltraTech and Ambuja has narrowed materially and it now trades at a 10% discount to UltraTech and in-line with Ambuja (as against a 20-25% discount earlier). As shown in Exhibit 45, Shree s historical RoCE has been materially higher than its peers, and we expect the company to maintain superlative RoCE in the future which justifies the higher multiple. Moreover, rising scale alongside entry into newer region and more importantly continuing efficiencies will increasingly make Shree the preferred cement stock for investors, providing further support to trading multiples; we believe there is a high likelihood that Shree trades at a material premium to Ambuja on EV/EBITDA within the next 1-2 years. Exhibit 43: Shree is trading in line with Ambuja and at a 10% discount to UltraTech on EV/EBITDA Exhibit 44: Shree is trading at a 20% premium to Ambuja on EV/tonne (X) Apr-09 EV/EBITDA Sep-09 Feb-10 Jul-10 Dec-10 May-11 Oct-11 Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Sep-14 Ambuja Shree UltraTech (X) 18,000 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 EV/Tonne May-11 Oct-11 Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Ambuja Shree UltraTech Sep-14 Source: Company, Bloomberg, Ambit Capital research Source: Company, Bloomberg, Ambit Capital research Exhibit 45: Shree Cement s RoCE is materially higher than its peers Post-tax RoCE (%) FY09 FY10 FY11 FY12 FY13 FY14 FY15E FY16E FY17E UltraTech Ambuja ACC Shree Ramco Source: Company, Bloomberg, Ambit Capital research. October 14, 2014 Ambit Capital Pvt. Ltd. Page 65

66 Key catalysts Faster-than-expected demand recovery: Sharper-than-expected demand would aid volume growth but more importantly keep prices stable. We believe the factors that can drive a quicker demand recovery could be on-track execution of large infrastructure projects like DFC and DMIC. Further reduction in international coal/ pet coke prices: With all major input costs increasing materially in recent times, low international coal/pet coke prices have cushioned Shree s profitability to a certain extent. Shree s profitability, if international coal prices weaken further, will improve in the coming quarters. Successful launch in east India: As Shree expands outside north India, the key thing to note will be the success in new regions, as future volume growth is dependent on it. With east India likely to see continued sharp growth in cement demand, market share gains in these markets would result in higher volume growth. Risks Break down of pricing discipline: Fading volume growth and likely market share gains by the small- and mid-sized players have resulted in recent pricing discipline (as they follow the larger players). However, a delayed recovery in retail demand can lead to an intensifying fight for market share and hence the price wars could accentuate. This poses a major risk, as the profitability decline could be sharper especially with a significant increase in costs. INR depreciation: INR depreciation will offset the impact of lower international coal prices, resulting in higher coal costs and sharper decline in unitary EBITDA. Furthermore, the diesel price increase could also be higher if the INR depreciates further. Increase in international coal prices: Coal prices have declined substantially over the last months due to the slowdown in China. However, coal prices face an upside risk if coal imports increase in China. Misallocation of capital: Shree is likely to generate significant CFO over the years despite factoring in high re-investment rates. Poor capital allocation decisions of the management could erode profitability. CCI penalty: The Competition Commission of India (CCI) has imposed a fine of `3,970mn (10% of end-fy13 net worth) on Shree Cement, alleging its involvement in cartelisation. If this liability materialises, 50% of its FY14 PAT will be wiped out. Reliance shifting pet coke gasifiers for synthetic gas: Reliance plans to shift eight of its existing gasifiers from pet coke to produce synthetic gas for the plastic industry. If this happens, ~6mn tonnes of the pet coke capacity (>50% of overall capacity) will cease to exist. Shree Cement is the largest procurer of pet coke from Reliance and it gets bulk discounts of 2-5%. Hence, if Reliance discontinues pet coke production, Shree Cement s fuel costs will likely increase. Forensic accounting Exhibit 46: Explanations for flags on the cover page Segment Score Comments Accounting Predictability Earnings Momentum GREEN AMBER GREEN Shree Cement In our forensic accounting of 374 companies, Shree Cement ranks 64 th. It also is the fourth-best cement company based on our accounting checks. The only concern on Shree is around volatile depreciation rates which however can be explained from the WDV method that the company follows. Shree Cement has always made timely announcements of capacity expansions and has in most cases not surprised negatively. However, the company s annual reports, unlike many larger and smaller peers, provide a very detailed view about the management s approach to its business. FY15 and FY16 consensus estimates have seen material upgrades in recent months as pricing and demand improved in north India. October 14, 2014 Ambit Capital Pvt. Ltd. Page 66

67 Shree Cement Balance sheet Year to March (` mn) FY13 FY14 FY15E FY16E FY17E Total Networth 38,436 46,407 57,699 71,733 87,751 Loans 12,882 12,882 11,882 10,882 9,882 Deferred tax liability (net) (938) (938) (938) (938) (938) Sources of funds 50,381 58,352 68,644 81,678 96,697 Net block 17,820 18,154 23,609 32,076 39,781 Capital work-in-progress 1,333 7,533 12,000 9,552 7,946 Investments 22,033 22,033 22,033 22,033 22,033 Cash and bank balances 3,694 6,506 5,361 11,120 18,857 Sundry debtors 3,147 2,742 3,547 4,350 4,998 Inventories 5,305 5,645 7,303 8,700 9,996 Loans and advances 7,717 7,258 9,390 11,515 13,231 Other current assets Total Current Assets 19,862 22,151 25,601 35,685 47,083 Current Liabilities 9,617 10,484 13,563 16,633 19,111 Provisions 1,050 1,036 1,036 1,036 1,036 Current liabilities and provisions 10,666 11,520 14,599 17,668 20,147 Net current assets 9,195 10,631 11,002 18,017 26,936 Miscellaneous expenditure Application of funds 50,381 58,352 68,644 81,678 96,697. Income statement Year to March (` mn) FY13 FY14 FY15E FY16E FY17E Revenue 55,901 58,873 76,162 93, ,315 yoy growth -5% 5% 29% 23% 15% Total expenses 40,302 44,974 55,037 65,530 72,807 EBITDA 15,599 13,899 21,125 27,869 34,508 yoy growth -5% -11% 52% 32% 24% Net depreciation 4,356 4,356 4,640 6,187 7,984 EBIT 11,243 9,542 16,485 21,682 26,524 Interest and financial charges 1,931 1,292 1,242 1,141 1,041 Other income 1,883 1,849 1,159 1,251 1,525 Adj PBT 11,195 10,100 16,402 21,791 27,008 Provision for taxation 1,155 1,238 3,280 4,794 6,752 Consolidated adj PAT 10,040 8,862 13,122 16,997 20,256 yoy growth 59% -12% 48% 30% 19% Consolidated reported PAT 10,040 8,862 13,122 16,997 20,256 EPS basic (`) EPS diluted (`) DPS (`) October 14, 2014 Ambit Capital Pvt. Ltd. Page 67

68 Shree Cement Cash Flow statement Year to March (` mn) FY13 FY14 FY15E FY16E FY17E PBT 11,194 10,100 16,402 21,791 27,008 Depreciation 4,356 4,356 4,640 6,187 7,984 Others (1,820) Interest paid (net) 1,931 1,292 1,242 1,141 1,041 CFO before change in WC 15,662 15,748 22,284 29,119 36,034 Change in working capital (644) 1,376 (1,516) (1,255) (1,182) Direct taxes paid (2,410) (1,238) (3,280) (4,794) (6,752) CFO 12,598 15,886 17,488 23,070 28,100 Net capex (8,935) (10,891) (14,561) (12,207) (14,083) Net investments (16,511) Interest received CFI (2,696) (10,891) (14,561) (12,207) (14,083) Proceeds from borrowings (8,761) - (1,000) (1,000) (1,000) Change in share capital Interest & finance charges paid (2,236) (1,292) (1,242) (1,141) (1,041) Dividends paid (690) (891) (1,830) (2,963) (4,237) CFF (9,817) (2,183) (4,072) (5,104) (6,279) Net increase in cash 84 2,812 (1,145) 5,759 7,738 Opening cash balance 218 3,694 6,506 5,361 11,120 Closing cash balance 302 6,506 5,361 11,120 18,857 FCF 3,663 4,994 2,927 10,864 14,016, Ratio Analysis Year to March (%) FY13 FY14 FY15E FY16E FY17E EBITDA margin RoCE RoE P/E (x) P/B(x) EV/EBITDA(x) EV/Tonne 20,769 17,908 12,917 11,290 10,489 Valuation Parameter Year to March (%) FY13 FY14 FY15E FY16E FY17E P/E (x) P/B(x) Debt/Equity(x) Net debt/equity(x) (0.3) (0.3) (0.3) (0.3) (0.4) EV/Sales(x) EV/EBITDA(x) EV/Tonne 20,769 17,908 12,917 11,290 10,489, October 14, 2014 Ambit Capital Pvt. Ltd. Page 68

69 Recovery hopes priced in Resolution of South India s unique growth restricting challenges alongside economic recovery in India, should drive strong cement volume growth in the region. Ramco, being the regional leader (both brand and scale) stands to be a major beneficiary of the demand and pricing recovery. Whilst we expect strong EBITDA growth (41% CAGR) over FY14-16, we believe post the recent rally the valuations are demanding. The stock is trading at 9.0x FY16 EBITDA (25% premium to 5-year averages), in-line with ACC (which has pan-india presence and superior RoCEs). We turn SELLers; our TP of `283, implies justified 8.5x FY16 EBITDA for a relatively low RoCE franchise. Competitive position: STRONG Changes to this position: POSITIVE On the path to a long-awaited recovery in south India We believe that the unique growth restricting challenges in south India would abate with political stability in the states. The Andhra Pradesh split could drive significant volume growth with the resumption of stuck infrastructure projects, large new project announcements and capex related to the new state capital formation. Volume growth in Karnataka and Kerala is growing in mid-single digits mainly driven by retail and institutional demand recovery could provide an added impetus. Tamil Nadu remains the only worry due to declining retail demand (owing to widespread drought and poor rainfall). Irrespective of demand growth, pricing recovery hinges on discipline South India constitutes 24% of overall cement sales in India (30% in FY09) and can catapult India s cement demand growth rate. However, even if volumes in the region grow at an extremely high rate of 16% for FY16 and FY17, utilisation will remain low (71% in FY17) and hence production/pricing discipline holds the key for realisation growth. Positive sentiment and stress on small players could support discipline (as seen in 1HFY15) and hence we expect realisation growth of 11%/8% in FY15/FY16. Ramco, the best play on demand recovery, BUT Undeniably, Ramco with its scale and brand leadership remains a strong play on volume recovery in south India. We build in 9.6%/7% volume/realisation CAGR over FY15-18 and steady cost increases of 4-5% in each year, implying 21% EBITDA/tonne CAGR over FY We expect Ramco to generate `27bn/11bn CFO/FCF and RoCE of % (vs 4.5% over FY15-17). However, Ramco s scale build up ambitions could restrict RoCE expansion. positives are priced in! Ramco trades at 9.1x FY16 EBITDA, a 28% premium to its five-year average of 7.1x. Current valuations are expensive and not justified by low RoCE of 7-11% over FY15-17E. Post the recent re-rating, its valuation discount to Ambuja and Shree has narrowed significantly (trades in line with Ambuja but an unjustified 10% discount to Shree vs 50% discount earlier) despite poor operating performance and inferior capital allocation/governance. Key financials Ramco Cement SELL COMPANY INSIGHT TRCL IN EQUITY October 14, 2014 Y/E Mar (` mn) FY2013 FY2014 FY2015E FY2016E FY2017E Operating Income (` mn) 38,454 36,835 43,238 52,061 61,253 EBITDA (` mn) 10,217 5,630 8,387 11,231 14,527 EBITDA margin (%) EPS (`) RoCE (%) EV/EBITDA (x) EBITDA/tonne (x) 6,972 6,625 6,224 6,224 5,976 Cement Recommendation Mcap (bn): Rs144/US$2.6 6M ADV (mn): Rs100.3/US$1.6 CMP: Rs312 TP (12 mths): Rs283 Downside (%): 9 Flags Accounting: Predictability: Earnings Momentum: Catalysts Ambit Capital and / or its affiliates do and seek to do business including investment banking with companies covered in its research reports. As a result, investors should be aware that Ambit Capital may have a conflict of interest that could affect the objectivity of this report. Investors should not consider this report as the only factor in making their investment decision. AMBER AMBER AMBER Poor pricing discipline leading to lower realisations Delayed demand recovery dragging our FY15/FY16 volume growth expectations lower RoCE compression with planned expansion in Andhra Pradesh Performance (%) 29,000 27,000 25,000 23,000 21,000 19,000 Source: Bloomberg, Ambit Capital research Analyst Details Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Sensex Achint Bhagat achintbhagat@ambitcapital.com Nitin Bhasin nitinbhasin@ambitcapital.com Ramco

70 Ramco Cement South India- Overcoming challenges South India is a large cement market (25% of India s consumption) with a strong institutional and retail client base, owing to the industrially developed and high per capita income states. However cement demand has been extremely weak in the region in the last four years (1% CAGR over FY10-14 vs 6% CAGR for non-south regions), due to: (1) political instability in states like Andhra Pradesh and Karnataka and (2) weak industrial growth owing to the iron ore mining ban in Karnataka and the drought in Tamil Nadu. Moreover, a significant increase in installed capacities led to a sharp decline in utilisation rates, propelling price wars and leading to rising despatches outside the region. Note that utilisation levels in south India dropped to 58% in FY14 as against 97% in FY07. Exhibit 1: Demand deceleration and sharp decline in capacity utilisation in recent years South India accounts for 25% of India s consumption % % 80% 65% 50% FY01 FY02 FY03 FY04 FY05 FY06 FY07 (mn tonnes) FY08 FY09 FY10 FY11 FY12 FY13 FY14 Consumption Utilisation (RHS) Source: CMA, Ambit Capital research Recent developments raise hopes of a recovery Industry participants hope that cement demand will recover in south India, as the region is overcoming its unique challenges, especially due to the split of Andhra Pradesh into Telengana and Seemandhra and a stable majority Government in Karnataka. We believe that volumes will recover materially as infrastructure projects revive and the new capital of Seemandhra (Vijayawada) is developed; however, we believe that this would take 2-3 quarters at least and volume growth will be visible from FY16 onwards. Moreover, drought and political unrest in Tamil Nadu could delay a recovery in the state, pulling demand growth lower in south India. Based on discussions with the managements of cement companies, our state-wise demand growth expectations are as follows: Andhra Pradesh: A few quarters before growth kick-starts Andhra Pradesh s cement market size has shrunk to 14mn tonnes from the peak level of 20mn tonnes (in FY09). Institutional demand remains extremely weak, as irrigation projects have stalled, infrastructure developers are starved of funds, no new projects are being awarded and the contractors for ongoing public infrastructure projects (irrigation, roads, etc) have not been paid. Note that the state has 34 stuck irrigation projects with an outlined investment of `1.5trn, which could revive under a stable state administration. Pricing has been extremely volatile over the last 18 months, as low capacity utilisation and poor demand have led to frequent price wars. Prices reached as high as `300/50kg bag in November 2013; however, it declined to `200/50kg bag by March 2014 but post the Central Elections prices reached peak levels of `320/50kg bag during July-September October 14, 2014 Ambit Capital Pvt. Ltd. Page 70

71 Ramco Cement What will be the impact of the Telengana and Seemandhra split? AP has been reeling under political agitation for the last four years, which has slowed down infrastructure growth materially in the state. The split of the state into Telengana and Seemandhra has raised hopes of a recovery in infrastructure growth not only through a revival of stuck projects but also through new announcements like: (a) the Vizag-Chennai Industrial Corridor (expected investment of over `1,000bn), (b) developing Kakinada as a hardware manufacturing hub, and (c) building a smart city in Krishnapatnam in the Nellore district of Andhra Pradesh as part of the Chennai-Bangalore Industrial Corridor. Moreover, the development of Vijayawada as the new state capital (investment in airport, public infrastructure, etc) and also improving sentiment driving housing construction (property transactions recorded 28% growth in Hyderabad post the split) could keep demand fairly strong in the coming years. The president of the Confederation of Real Estate Developers, Mr T Rajasekhar Rao, believes that, The cities that are expected to emerge as realty hotspots in the new state are Vizag, Guntur and even Tirupati. Chittoor, Anantapur and Nellore too might see some development. However experts argue that it would take another 6-10 months for the execution to pick up post which it would start reflecting in cement volume growth. For more details on the Andhra Pradesh market refer to our monthly dated 3 April 2013 (click here). Case study: Splits of Bihar, Uttar Pradesh and Madhya Pradesh Historical data suggests that the split of Bihar (into Jharkhand), Uttar Pradesh (into Uttarakhand) and Madhya Pradesh (Chhattisgarh) has augured well both from an industrial growth perspective as well as from a cement demand perspective. Note in Exhibits 2 and 3 below that the GDP growth rates post the split have been materially higher vs the GDP growth rates before the split in each of the three states. Exhibit 2: The growth pre-split was materially lower than. Years (pre-split) State Pair 1 State Pair 2 State Pair 3 JH BI UT UP CH MP Average Growth over and Source: Planning Commission, media articles, Ambit Capital research; Note: JH Jharkhand, BI Bihar, UT Uttar Pradesh, CH Chhattisgarh, MP Madhya Pradesh Exhibit 3: the growth post the split Years (post-split) State Pair 1 State Pair 2 State Pair 3 JH BI UT UP CH MP NA Average since Source: Planning commission, media articles, Ambit Capital research; Note: JH Jharkhand, BI Bihar, UT Uttar Pradesh, CH Chhattisgarh, MP Madhya Pradesh Split of AP into Telengana and Seemandhra could revive cement demand through infrastructure construction October 14, 2014 Ambit Capital Pvt. Ltd. Page 71

72 Tamil Nadu: Poor infra execution; drought hurting retail Cement demand in Tamil Nadu (TN) has declined by 1-2% in YTD FY15, as the execution of infrastructure projects in the last two years has been poor and large announced projects like the monorail remain slow-moving. Most of the districts in TN have faced severe drought and poor rainfall in the last two years, which have led to a slowdown in demand from the retail client base (~80% of overall demand). Furthermore, sand unavailability for large parts of the year also hindered construction activities. Industry participants do not expect any major growth in the next 8-10 months. However, the management believes the only bright spot is that pricing may find support, as no new capacities are coming up in TN and if demand in AP recovers, despatches from this state would decline. For more details on the TN cement market refer to our monthly dated 05 July 2013 (click here). Ramco Cement Most of the districts in TN have faced severe drought and poor rainfall in the last two years, which have led to a slowdown in demand from the retail client base Karnataka: Mild recovery, but still a long way to go Industry participants highlight that demand has improved in Karnataka (6-7% growth in YTD FY15) after the stable majority government. Whilst real estate construction remains tepid in Bangalore, it has remained fairly strong in other cities like Mangalore. Companies expect steady demand growth of 5-6% next year; however, a major growth impetus requires a pick-up in infrastructure construction. For more details on the Karnataka cement market refer to our monthly dated 05 June 2013 (click here). Companies expect steady demand growth of 5-6% next year; however, a major growth impetus requires a pick-up in infrastructure construction Kerala: Retail segment, the key driver Demand was negatively impacted in Kerala due to heavy rainfall in the first six months of FY14. Demand recovered from November 2013 onwards, as the monsoons receded and retail demand started picking up. The management highlights that 90% of the client base in Kerala is retail and Ramco is the strongest brand with a market share of 20%. Dealer checks suggest that Ramco is the oldest brand in the market and the company s efficient distribution, penetration in key regions, and better-than-peer incentive structure makes it the strongest brand in the state. Demand was negatively impacted in Kerala due to heavy rainfall in the first six months of FY14. Maharashtra: Institutional segment bouncing back Given the relative ease of entry, companies based in south India (which are running at abysmally low utilisation levels) have aggressively increased despatches to Maharashtra; within south India, Karnataka (the Gulbarga cluster) has historically had high despatches to Maharashtra; however, dispatches from AP for the last 1-2 years have increased meaningfully due to a continued slowdown in their primary markets. Strong demand growth in Maharashtra can also improve capacity utilisation in south India. Volume growth was extremely weak in Maharashtra during FY14; however, we hear that institutional demand has started picking up in large markets, like Mumbai and Pune, as sand availability has improved. Cement prices have reached `330/50 kg in Maharashtra in September from the lows of `260/50 kg bag in July, as south India players maintained production discipline. October 14, 2014 Ambit Capital Pvt. Ltd. Page 72

73 Ramco Cement Exhibit 4: Summary of demand characteristics, recent performance and outlook of states in and around south India State Market Size (mn tonnes) FY09 FY14 CAGR FY09-14 Andhra Pradesh % Karnataka % Tamil Nadu % Kerala % Maharashtra % Source: CMA, Industry Research, Ambit Capital research Characteristics Recent performance Outlook The largest cement producer in India and a highly fragmented market with no clear leaders. A large exporter to adjoining states like Maharashtra and Orissa and influences pricing in these states. A large institutional-dominated cement market; it houses two limestone clusters (Gulbarga - mainly for despatches in Maharashtra; Yerraguntla - for despatches in south Karnataka and Tamil Nadu). Birla Super (UltraTech) is the biggest brand. The largest cement market in south India dominated by retail clients. Ramco and India Cements are the biggest brands. Pricing remains stable, as concentration of capacities and retail clientele confers pricing power to the incumbents. A small but premium market. Ramco is the biggest brand with a 20% market share. 90% of the sales are in the retail segment. The largest cement market in India (mainly institutional), supplied largely from south India and Gujarat-based manufacturers. More than 30 brands are available in the market. Volumes have been declining for the last three years with political issues hampering growth. Volume growth has picked up to 5-6% in FY14 post the formation of the stable majority government. Severe drought in most regions has led to a 1-2% decline in volumes in FY14. Heavy monsoons led to poor performance till 1HFY14 but volumes grew by 6-7% post that. Demand has been weak as institutional demand remained poor in key cities. Some improvement seen in recent months post the lifting of the sand mining ban. Proposed split of the state in Telengana and Seemandhra would have positive long-term impact but near-term outlook remains unenthusiastic. Volume growth is likely to be steady driven by rising infrastructure and real estate construction in tier-ii cities. Retail demand likely to be low given poor farm output due to the drought conditions. Demand is likely to be steady driven primarily by retail clients. Demand growth hinges on recovery of investment cycle and institutional demand in large consumption centres. Scenario analysis: Impact of a recovery in south India? South India currently constitutes 24% of overall sales in India (down from a peak of 30% in FY09). Strong growth in the south in FY06-09 (11.5% CAGR as against 7.7% in the rest of India) was a key reason for the sharp cement consumption growth in India. Note that sales growth in south India has slowed down from FY10 onwards, materially pulling down India s average growth rates. Exhibit 5: The strongest cement growth period in India was driven by exceptional growth in south India 30.0% 20.0% YoY Change South India drove strong growth in India during FY % 0.0% -10.0% FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13* India South India India- ex South India Source: CMA, Ambit Capital research Whilst retail demand is likely to be steady, we believe that the cement volume growth impetus in India hinges on a recovery in institutional demand, which has declined in the last two years. A probable recovery of the investment cycle post the Central Elections should improve infrastructure construction, as the execution of stuck infrastructure projects picks up. South India, a large but downtrodden region, will play a major role in driving the growth of the Indian cement industry (as seen historically). South India influences October 14, 2014 Ambit Capital Pvt. Ltd. Page 73

74 pricing not only within the region but also in large west India states like Maharashtra (Karnataka and AP are the main suppliers to Maharashtra). A volume recovery in south India would reduce despatches (at aggressive prices) to nearby regions, improving pricing in these states. We assess the impact of a poor, moderate and a strong recovery in south India and its impact on the Indian cement industry. In all the three cases, we assume that India (ex-south) would grow at 5% in FY15 and 7% in FY16. Scenario 1 (poor recovery) 100bps lower growth than India (ex-south) over FY15 and FY16 Assuming south India grows 100bps lower than the rest of India for the next two years, overall demand growth in India would be 4.8% in FY15 and 6.8% in FY16. Capacity utilisation would improve only marginally (90bps) and prices could continue to remain under pressure. Scenario 2 (moderate recovery) 100bps higher growth than India (ex-south) over FY15 and FY16 We believe this scenario is highly possible, as infrastructure spending could revive (after declining for the last three years) post the Central Elections and state elections in AP. If south India grows 100bps higher than the rest of India for the next two years, overall demand growth in India would be 5.2% in FY15 and 7.2% in FY16. Capacity utilisation would improve by ~170bps and whilst prices would fail to grow materially, they could remain stable. This is our base-case assumption. Scenario 3 (strong recovery) 300bps higher growth than India (ex-south) over FY15 and FY16 We believe this scenario would require an infrastructure demand recovery across south India and a pick-up in retail demand in states like Tamil Nadu. Furthermore, assuming south India grows 200bps higher than the rest of India for the next two years, overall demand growth in India would be 5.7% in FY15 and 7.7% in FY16. Capacity utilisation would improve by ~2,500bps and prices hikes can be sustained. Exhibit 6: Scenario analysis on a demand recovery in south India Scenario 1 (poor recovery) Scenario 2 (moderate recovery) (Base Case) Ramco Cement Scenario 3 (strong recovery) Volume (mn tonnes) growth Volume (mn tonnes) growth Volume (mn tonnes) growth FY14* FY15 FY16 FY15 FY16 FY14* FY15 FY16 FY15 FY16 FY14* FY15 FY16 FY15 FY16 India % 6.8% % 7.2% % 7.7% South India % 6.0% % 8.0% % 10.0% India- ex-south India % 7.0% % 7.0% % 7.0% Source: Industry Participants, CMA, Ambit Capital research As shown in the exhibit below, in a poor or moderate recovery in south India, volume growth in India would remain lower/in line with the last five-year average; however, a strong recovery would result in slightly higher growth than the last five-year average. Exhibit 7: Demand growth to be lower/in line than the five-year average in case of a poor-to-moderate demand recovery in south India 12% 10% 8% 6% 4% 2% 0% Volume growth in India under various scenarios in South FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 Poor Moderate Strong average (FY09-13) Source: CMA, Ambit Capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 74

75 Ramco Cement A long way before utilisation reaches optimal levels Although capacity expansions are likely to slow-down in the next 2-3 years, we believe that utilisation levels would remain low given the significant over-capacity in the region. Note in the scenario table below that even if we assume production growth of 16% in the region for FY16 and FY17 (and 7% in FY15), utilisation level remains sub-optimal at 71%. Exhibit 8: Despite strong growth, utilisation would remain sub-optimal Utilisation Demand growth in FY17 Source: CMA, Ambit Capital research Demand growth in FY16 8% 10% 12% 14% 16% 8% 61% 62% 63% 65% 66% 10% 62% 63% 65% 66% 67% 12% 63% 65% 66% 67% 68% 14% 65% 66% 67% 68% 69% 16% 66% 67% 68% 69% 71% Even if we assume production growth of 16% in the region for FY16 and FY17 (and 7% in FY15), utilisation level remains suboptimal at 71%. Three lynchpins for a pricing recovery The pricing decline in the last two years has been on account of a sharp decline in utilisation rates and the irrational pricing behaviour of the smaller players fighting for market share. We believe three requisites of a pricing recovery would be: (1) a demand recovery driving utilisation level, (2) slowdown in capacity additions, and (3) better discipline from the smaller players. The exhibit below highlights that declining capacity utilisation in the last few years has led to poor pricing growth. However, limited capacity additions and a demand recovery could lead to an improvement in pricing in the coming years. Pricing growth hinges on demand recovery, slow-down in capacity addition and discipline from smaller players Exhibit 9: Demand growth to be lower/in line with the five-year average in case of a poor-to-moderate demand recovery 40% 30% 20% 10% 0% 100% 90% 80% 70% Rolling 3-yr capacity CAGR Rolling 3-yr despatches CAGR Pricing growth -10% -20% FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 60% 50% Annual capacity utilisation (RHS) Source: CMA, Ambit Capital research Limited capacity additions in main consumption centres As per the announced capacity expansion plans of cement companies, ~12mn tonnes is likely to be added in south India in the next two years. Whilst we believe that Dalmia Cement s and Orient Cement s capacity expansion plan in on track, the others could see delays. Furthermore, except for Chettinad s 3.5mn tonne capacity expansion in Tamil Nadu, all the capacities are coming up in Karnataka, which is largely meant for despatches in Maharashtra. Hence, we do not see rising supply pressure in key markets from new capacities in the next few years. October 14, 2014 Ambit Capital Pvt. Ltd. Page 75

76 Ramco Cement Exhibit 10: Capacity addition is likely to be limited Company State Capacity (mn tonnes) Year Type Status Dalmia Bharat Karnataka 2.5 FY15 Greenfield Integrated unit The capacity has already seen some delays, likely to be operational in early FY15 Orient Cement Karnataka 1.2 FY15 Greenfield Integrated unit As per the management, the expansion is on track Chettinad Tamil Nadu 3.5 FY16 Chettinad Andhra Pradesh 1.5 FY16 Brownfield expansion at integrated plant Brownfield expansion at integrated plant No clarity on the same No clarity on the same Zuari Karnataka 1 FY16 Greenfield Integrated cement plant Likely to be delayed Zuari Karnataka 2 FY16 Greenfield Integrated cement plant Likely to be delayed Total 11.7 Source: Company filings, Ambit Capital research Production discipline vital for a pricing recovery The price wars during the last months have been a function of the irrational behaviour of the smaller players (certain players were selling at marginal cost) to gain market share. As seen historically (Dec 2010-Aug 2012), pricing can grow despite weak demand growth if production and pricing discipline are maintained. Furthermore, new entrants like Jaypee and JSW Cement also distorted pricing in the region. Exhibit 11: Pricing growth hinges on production discipline Source: Industry Participants, Ambit capital research October 14, 2014 Ambit Capital Pvt. Ltd. Page 76

77 Ramco Cement Stress of small players could support pricing Note that the balance sheet of the smaller south Indian companies have materially deteriorated in FY14, with several companies struggling to meet their interest commitments from EBITDA. Furthermore, the debt/equity of the smaller players has increased to near-distress levels. In addition to poor demand and rising costs, weak pricing has led to a sharp drop in profitability of the players. Industry experts believe that the current poor profitability will make operations unviable for the smaller players that would be induced to maintain production discipline to survive. Given that costs have limited room to decline, a sustained increase in prices is the only resort for these companies. In the exhibit below, we would like to highlight companies like Sagar Cement, Andhra Cement, KCP, Anjani Portland and Kakatiya Cement. In FY14, these companies interest expense ate into most of the EBITDA, their pre-tax RoCEs were in the low single digits, and their debt/equity was more than 1.0x (for most of them). We highlight that several other smaller companies are facing a similar (or even a worse financial situation); however, we have excluded them from the analysis below, given the limited publicly available financial data for these companies. Exhibit 12: Smaller players profitability has reached unsustainable levels in FY14 A marketing head of one of the largest cement brand in south India highlighted, Not only small players but larger players like Jaypee are facing significant financial stress and it is in their interest to not reduce pricing. He expects rising consolidation in the south India cement industry, as the current level of profitability is not viable to run operations for a 1-2mn tonne cement manufacturer at sub-50% utilisation levels. Anjani s acquisition is a step towards that. Company Interest/EBITDA RoCE (EBITDA/Capital Employed) Debt/Equity (x) FY11 FY12 FY13 FY14 FY11 FY12 FY13 FY14 FY11 FY12 FY13 FY14 Ramco Cement 21% 16% 17% 27% 15% 21% 21% 11% Chettinad Cement 12% 13% 17% 16% 30% 35% 29% 24% India Cements 32% 34% 38% 58% 7% 14% 13% 7% Sagar Cements 38% 27% 45% 104% 18% 27% 14% 5% Andhra Cements -81% 29% -24% -72% -3% 4% -3% -1% K C P 10% 18% 21% 68% 21% 28% 21% 7% Keerthi Indus 32% 22% -615% 165% 9% 30% -1% 4% Kakatiya Cement 3% 0% 0% 0% 8% 25% 20% 9% Anjani Portland 62% 50% 63% 79% 15% 21% 17% 8% We believe that the combined bargaining power of the top-three cement groups (Ramco, Chettinad and India Cement) can improve, given the financial duress of the smaller companies. Furthermore, in case of a stronger-than-expected retail demand growth, the larger companies would be able to push for price hikes. Hence, we build in realisation growth of 11% in FY15 and 8% in FY16. Building operational efficiencies We had highlighted in our initiation note, Waiting to build (click here) that Ramco enjoys higher-than-industry realisation and has the lowest production cost amongst south Indian companies. However, the company s cost of sales is amongst the highest in south India due to high lead distances (transportation to far-off markets like east India and exports outside India). Recent efficiency enhancing measures Improve proximity: The management highlights that the company is focused on improving logistics infrastructure and it would add grinding capacities close to the demand centres and fly ash sources. As per the management, there are significant savings of fly ash procurement costs if the grinding unit is located close to fly ash surplus locations. For instance, Ramco pays `700/tonne for fly ash at its integrated cement plant in Andhra Pradesh (alongside inward transportation cost), whereas the company procures fly ash at negligible costs in West Bengal and Vishakhapatnam. The company could add grinding units in other east India states like Orissa or even in October 14, 2014 Ambit Capital Pvt. Ltd. Page 77

78 Ramco Cement south India (close to Chennai) to improve proximity to the target markets and reduce fly ash cost. Beneficiation plant in Tamil Nadu: The company has recently commissioned a limestone beneficiation plant at its Tamil Nadu capacity which would likely increase limestone life to 100 years from 30 years currently. In low-grade limestone, the silicon dioxide content is fairly high (up to 30%), which is either rejected or Ramco has to buy high-quality, sweetener grade of limestone with 8% silicon dioxide and blend it with low-grade limestone for use. Beneficiation would reduce the company s dependency on imported limestone. Furthermore, there are certain by-products of the beneficiation process which can be sold commercially. but capital misallocation risk continues We had highlighted in our initiating coverage note on Ramco Cement dated 3 September 2013, Waiting to build, that the company s RoCE has historically lagged its peers due to materially lower asset turnover. The company has historically operated at sub-optimal utilisation levels (average utilisation levels of 68% over FY02-14 as against % for pan-india peers and Shree Cement). Moreover, the capacity addition cost of the company has also been higher than most peers. We expected capacity utilisation to start improving as demand recovers in south India, given the limited capacity expansion plans, barring a 1mn tonne grinding unit in Vizag. However, recent media articles suggest that Ramco is planning to set-up a greenfield plant in Andhra Pradesh at an investment of `15bn (could go up to `30bn). Ramco already has ample capacity in AP (3.5mn tonnes) which is operating at 50% capacity utilisation; we fail to understand the need to commit capital this early into the demand recovery in an excess capacity region. The management previously highlighted that they will expand in east and west India but not south India. As per media articles, Ramco is planning to set-up a greenfield plant in Andhra Pradesh at an investment of `15bn (could go up to `30bn) Exhibit 13: Ramco s utilisation has been lower than 75% for 8 out of last 11 years (mn tonnes) FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 Capacity utilisation (LHS) (%) Dotted line implies 75% utilisation level Revision in estimates The changes to our estimates are mainly to account for improving volume growth and pricing outlook for FY15 and FY16. Here is the rationale for our basic assumptions for the next two years: Volume: We expect a volume growth of 6.8% in FY15 (on a low base of FY14), as we expect a mild recovery in south India alongside higher sales in east India. We expect a sharp volume growth of 12% in FY16 and 10% in FY17, as we expect a stronger volume growth in south India (as its unique political and economic concerns abate) and market share gains in non-south India states. Realisation: We expect a realisation growth of 11% in FY15 and 8% in FY16 (after a 6% decline in FY14). This would imply a `31/50kg bag increase in FY15 and `21/50kg in FY16 (after declining by `20/50kg bag in FY14). We assume that smaller players will likely be more disciplined on pricing in FY15 and FY16 and support pricing to reduce losses. Note that prices increased by `40/50kg bag in FY12 and `15/50kg bag in FY13 despite no material change in volumes. October 14, 2014 Ambit Capital Pvt. Ltd. Page 78

79 Ramco Cement Exhibit 14: Recovery in volumes and sharp pricing growth Exhibit 15:..would drive revenue growth in the next two years (mn tonnes) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E Volume Realisation (RHS) Realisation-ex freight (RHS) FY17E (`/tonne) 6,000 4,500 3,000 1,500 (` bn) FY08 FY09 FY10 FY11 FY12 FY13 FY14E FY15E FY16E FY17E Revenue YoY growth (RHS) 30% 20% 10% 0% -10% Operating costs: We expect a 4.4% YoY increase in unitary operating costs in FY15. Whilst we expect a 5-6% increase in raw material, transportation and other direct expenses, we expect only a 2% increase in power and fuel costs, as international coal prices remain weak. We build in 5% increase in unitary costs in FY16. Unitary EBITDA: We expect a 43.3% EBITDA/tonne CAGR over FY14-16 (after declining by 43% in FY14); our assumption hinges on strong realisation growth, as pricing discipline improves in south India. Profitability: We expect RoCEs to improve to 6.0% and 8.5% in FY15 and FY16, respectively vs 6.4% in FY14. The profitability improvement will be driven by EBITDA growth alongside limited capex investment. Furthermore, capital employed turnover will likely improve to x (from 0.6x in FY14), as the capacity utilisation level picks up. CFO, capex and FCF: We expect the company to generate `38bn CFO over FY15-17 (74% of EBITDA), reinvest `19.2bn for capacity expansions, leading to FCF of `18.8bn over FY Note that we have not factored in capex for the greenfield plant in AP, pending official confirmation and time-lines from the company. Exhibit 16: EBITDA growth to be driven by higher volumes and recovery in EBITDA/tonne Exhibit 17: Higher CE turnover and better margins will drive profitability improvement (`/tonne) 1,400 1,200 1, FY08 FY09 FY10 FY11 EBITDA FY12 FY13 FY14E FY15E FY16E FY17E EBITDA margin (RHS) 40% 35% 30% 25% 20% 15% FY08 FY09 FY10 FY11 FY12 FY13 CE turnover (X) RoE(%) (RHS) FY14E FY15E FY16E FY17E RoCE (%) (RHS) October 14, 2014 Ambit Capital Pvt. Ltd. Page 79

80 Ramco Cement Exhibit 18: Change in estimates/ Assumptions New Assumptions Old Assumptions Change (%) Comments FY15E FY16E FY15E FY16E FY15E FY15E Cement sales % 1.3% We keep our volume growth estimates unchanged. We expect 6.5% volume growth in FY15 led by mild Capacity utilisation (%) bps 0 bps recovery in South India and higher sales in East India. We expect a stronger recovery in FY16 and hence factor in a sharp 10% volume growth Power sales (kwh) % 0.0% Per tonne analysis Cement Realisation 4,557 4,921 4,431 4, % 2.8% Realisation decline is on account of lower base of FY14 (poorer than expected realisation in the last two quarters). We keep our growth estimates unchenged (10% realisation growth in FY15 and 8% realisation growth in FY16) Operating costs 3,784 3,960 3,669 3, % 2.9% Decline in operating costs is on account of lower power and fuel costs given ongoing weakness in international coal prices EBITDA 832 1, , % -2.8% Financials (` mn unless specified) EBITDA/tonne decline is on account of lower realisations Net Revenues 43,238 52,061 42,844 50, % Change in revenue is on account of above-mentioned 2.9% change in realisation estimates EBITDA 8,387 11,231 8,859 11, % Decline in Unitary EBITDA is resulting in decline in -1.4% absolute EBITDA EBITDA margin (%) bps -94 bps Adjusted PBT % Change in PBT estimates is on account of change in -2.8% EBITDA estimates Adjusted PBT margin (%) bps -70 bps Tax 1,071 1,902 1,227 1, % -2.8% Adjusted PAT 2,384 4,233 2,732 4, % -2.8% On account of changes in estimates as highlighted Adjusted PAT margin (%) bps -48 bps above EPS (`) % -2.8% Capex 4,001 5,169 4,047 5, % -0.9% We assume capex for Vishakhapatnam expansion (` WC Turnover bps -80 bps 3600 mn), 60MW of additional captive power capacity (` 550 mn) and assuming acquisition of land and FCF 3,329 2,942 2,883 3, % -8.1% mining lease Source: Ambit Capital Research Ambit vs consensus Note that our FY16 revenue, EBITDA and PAT estimates are 6%, 9% and 11% higher than consensus, respectively. We are building in a sustained hike in realisations in south India, assuming that small players in the region should likely support pricing (despite low utilisation levels), given their weak balance sheets (refer to page 8). Note that in FY12 and FY13 (years of strong pricing discipline despite weak demand), consensus EBITDA estimates were revised upwards by 56% and 46%, as sustained prices resulted in better-than-expected EBITDA. Consensus EBITDA estimates for FY15 have been reduced by 6% and increased by 4% for FY16 since April 1, Current consensus estimates imply 25% EBITDA CAGR over FY14-16 (vs our expectation of a 33% CAGR). Exhibit 19: Our FY16 estimates are higher than consensus, as we expect better pricing growth Particulars Consensus Ambit Divergence Comments Revenue (` mn) FY ,493 43,238 4% Our revenue estimates are higher than consensus, as we expect higher realisation growth with pricing discipline would support price hikes. FY ,539 52,061 7% EBITDA (` mn) FY2015 7,739 8,387 8% Our EBITDA estimates are materially higher than consensus in on account of better realisation driving unitary EBITDA growth amid stable costs. FY ,296 11,231 9% PAT (` mn) FY2015 2,446 2,384-3% FY2016 4,151 4,233 2% Consensus EBITDA estimates for FY15 have been reduced by 6% and increased by 4% for FY16 since April 1, 2014 Higher than consensus PAT in FY16 is a function of higher EBITDA. October 14, 2014 Ambit Capital Pvt. Ltd. Page 80

81 Ramco Cement Exhibit 20: Consensus estimates were revised upwards by 56% in FY12 and Exhibit 21: 46% in FY13 as strong pricing discipline resulted in better-than-expected EBITDA (` mn) FY12 EBITDA 10,000 (` mn) FY13 12,000 EBITDA 9,000 11,000 8,000 10,000 7,000 9,000 6,000 5,000 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Consensus Jun-11 Aug-11 Oct-11 Actual Dec-11 Feb-12 Apr-12 8,000 7,000 Apr-11 Jun-11 Aug-11 Oct-11 Dec-11 Feb-12 Apr-12 Consensus Jun-12 Aug-12 Oct-12 Actual Dec-12 Feb-13 Source: Bloomberg, Company, Ambit Capital research Exhibit 22: Consensus EBITDA estimates have been reduced by 6% for FY15 8,400 8,100 7,800 7,500 (` mn) Source: Bloomberg, Company, Ambit Capital research Exhibit 23: and increased by 4% for FY16 (` mn) 10,400 10,100 9,800 7,200 Apr-14 May-14 Jun-14 Jul-14 FY15 EBITDA Aug-14 Sep-14 9,500 Apr-14 May-14 Jun-14 Jul-14 Aug-14 FY16 EBITDA Sep-14 Source: Bloomberg, Company, Ambit Capital research Source: Bloomberg, Company, Ambit Capital research Strong play on south India recovery but too expensive We maintain that Ramco Cement will be a key beneficiary of demand revival in south India, given a strong brand and distribution with capacities spread out across major demand centres. However, we believe that post the recent stock price run-up (50% since April 1, 2014), there is little room for further upsides. The stock is trading at 9.0x one-year forward EBITDA, a 30% premium to its five-year average of 7.1x, which we find difficult to justify, especially when seen in light of the low RoCEs of 6.5%/9.3% in FY15/FY16E. Our DCF-based target price of `283 implies 8.5x FY16 EBITDA, still at a 20% premium to historical averages. Note that Ramco is currently trading in-line with ACC, though ACC has superior RoCEs, almost double the capacities and better market exposure. On an EV/tonne basis, Ramco trades at `6,224 FY16 EV/tonne (US$105; assuming USD-INR at `60 and without adjusting for wind power assets), a 40% premium to its five-year averages. We believe that the current valuations are rich and risky for a player overly concentrated in an overcapacity region like south India that is susceptible to price wars. Moreover, if the company goes ahead with its expansion in AP, it would compress RoCEs further for the next 2-3 years. October 14, 2014 Ambit Capital Pvt. Ltd. Page 81

82 Ramco Cement Exhibit 24: Ramco is trading at a 60% premium to its fiveyear average consensus EBITDA (X) Exhibit 25: Ramco is trading at a 40% premium to its fiveyear average EV/tonne (`) 7,000 6,000 5,000 4, ,000 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 One-yr fwd EV/EBITDA 5-yr ave EV/EBITDA One-yr fwd EV/tonne 5-yr ave EV/EBITDA Source: Bloomberg, Ambit Capital research Exhibit 26: DCF-based valuation of `283/share Source: Bloomberg, Ambit Capital research Exhibit 27: PVFCF profile over FY15-25 PV of the forecasting period up to FY25 (` bn) 36 Terminal Value (` bn) 59 Enterprise value (` bn) 95 Less: net debt at Mar-15 (` bn) 28 5,000 4,000 3,000 2,000 1,000-20% 17% 14% 11% 8% 5% Implied equity value (` bn) 67 FY16E FY17E FY18E FY19E FY20E FY21E FY22E FY23E FY24E FY25E Implied equity value (` per share) 283 Source: Bloomberg, Ambit Capital research PV of FCFF (LHS) RoIC WACC Source: Bloomberg, Ambit Capital research Not available at a discount anymore! One of the reasons for our previous BUY recommendations on Ramco was a sharp discount to companies like Shree and Ambuja, but now the discount has narrowed significantly. Ramco trades in line with Ambuja and a marginal discount to Shree as against a discount of 25-35% discount to SRCM and ACEM, two quarters back. We believe that Ramco deserves to trade at a higher discount, given poor capital efficiency as compared to SRCM and ACEM. Exhibit 28: Ramco is trading at comparable valuations to Ambuja and a 10% discount to Shree on EV/EBITDA (X) Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 May-11 EV/EBITDA Oct-11 Source: Bloomberg, Ambit Capital research Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Ambuja Shree Ramco Sep-14 Exhibit 29: Ramco is trading at a 30% discount to Shree and Ambuja on EV/tonne basis (X) 14,000 12,000 10,000 8,000 6,000 4,000 2,000 Apr-09 Sep-09 Feb-10 Jul-10 Dec-10 EV/Tonne May-11 Oct-11 Source: Bloomberg, Ambit Capital research Mar-12 Aug-12 Jan-13 Jun-13 Nov-13 Apr-14 Ambuja Shree Ramco Sep-14 October 14, 2014 Ambit Capital Pvt. Ltd. Page 82

83 Ramco Cement Key catalysts Poor pricing discipline: Our realisation estimates hinge on a strong pricing environment, as the weaker players bargaining power reduces. However, if pricing is not disciplined, realisations will fail to grow, resulting in continuing decline in profitability. INR depreciation: Given that the INR depreciation offsets the impact of lower international coal prices, INR weakening would result in higher coal costs and sharper decline in unitary EBITDA. Furthermore, the diesel price increase could also be higher if the INR depreciates further. Increase in international coal prices: Coal prices have declined substantially over the last months due to the slowdown in China. However, coal prices face an upside risk if coal imports increase in China. CCI penalty: The Competition Commission of India (CCI) has imposed a fine of `2,586 mn (11% of end-fy14 net worth) on Ramco Cement, alleging its involvement in cartelisation. If this liability materialises, the entire PAT of FY15 will be wiped out. The company has deposited 10% of the penalty. Risks Faster-than-expected demand recovery: Whilst we expect only a moderate demand growth in FY15, a stronger-than-expected demand recovery would result in higher volume growth. We believe the factors that can drive a quicker demand recovery could be higher-than-expected GDP growth and sharp increase in postelection infrastructure construction. Resolution of south India s challenges: We believe that cement demand could revive sharply if the current problems, like political instability in Andhra Pradesh, power shortage and poor government spending, are addressed. Higher-than-industry volume growth: Market share gains led by recent capacity additions would result in higher-than-industry volume growth and improvement in utilisation levels. Market share gain in east India: Ramco Cement is in the early stages of building a brand in West Bengal. Given that volume growth is likely to be high in east India, market share gain in these markets would result in higher volume growth. Furthermore, with the Vizag grinding unit likely to be completed by early- FY15, the company can increase volumes in other east India states such as Orissa. Exhibit 30: Explanation of our flags on the cover page Segment Score Comments Accounting Predictability Earnings Momentum Source: Ambit Capital research AMBER AMBER AMBER In our forensic accounting analysis, amongst the seven cement companies, Ramco Cement ranks 5 th primarily due to its low gross block turnover and high contingent liabilities as a percentage of net worth. The company has almost always reported high CFO/EBITDA and low volatility in other income and miscellaneous expenditure as a percentage of sales. Ramco Cement has always made timely announcements of its capacity expansions, plans/intentions and has rarely surprised in a significantly positive or negative manner. The company does not hold concalls/meetings with analysts on a regular basis or provide additional inputs apart from the statutory requirement. Furthermore, the company s sudden allocation towards CSR raises concerns. FY15 and FY16 EBITDA estimates have seen marginal upgrades over the past three months; however, the same has been the case for most of the cement companies, as pricing improved. October 14, 2014 Ambit Capital Pvt. Ltd. Page 83

84 Ramco Cement Balance sheet Year to March (` Mn) FY13 FY14 FY15E FY16E FY17E Share capital Reserves and surplus 23,470 24,582 26,604 30,221 35,705 Total Networth 23,708 24,820 26,842 30,459 35,943 Loans 26,671 29,288 29,788 29,788 29,788 Deferred tax liability (net) 7,164 7,373 7,373 7,373 7,373 Sources of funds 57,542 61,481 64,004 67,620 73,103 Net block 47,797 46,411 47,150 48,486 50,004 Capital work-in-progress 1,480 3,542 2,373 2,872 5,209 Investments 887 2,834 2,834 2,834 2,834 Cash and bank balances ,053 2,617 3,154 Sundry debtors 3,028 3,040 3,198 3,708 4,195 Inventories 5,948 6,618 6,397 7,560 8,726 Loans and advances 5,035 5,557 5,331 6,419 7,552 Total Current Assets 14,550 15,616 16,979 20,303 23,628 Current liabilities and provisions 5,299 6,922 6,648 8,190 9,886 Net current assets 9,251 8,694 10,331 12,113 13,742 Application of funds 57,542 61,481 64,004 67,620 73,103 Income statement Year to March (` Mn) FY13 FY14 FY15E FY16E FY17E Revenue 38,454 36,835 43,238 52,061 61,253 yoy growth 18% -4% 17% 20% 18% Total expenses 28,237 31,205 34,851 40,830 46,726 EBITDA 10,217 5,630 8,387 11,231 14,527 yoy growth 7% -45% 49% 34% 29% Net depreciation 2,806 3,063 3,117 3,334 3,553 EBIT 7,411 2,568 5,270 7,897 10,973 Interest and financial charges 1,796 1,881 1,986 2,003 2,003 Other income Adj PBT 5,887 1,543 3,456 6,134 9,302 Provision for taxation 1, ,071 1,902 2,884 Adj PAT 4,042 1,377 2,384 4,233 6,418 yoy growth 5% -66% 73% 78% 52% Reported PAT 4,037 1,377 2,384 4,233 6,418 EPS (`) DPS (`) October 14, 2014 Ambit Capital Pvt. Ltd. Page 84

85 Ramco Cement Cash Flow statement FY13 FY14 FY15E FY16E FY17E PBT 5,882 1,543 3,456 6,134 9,302 Depreciation 2,806 3,063 3,117 3,334 3,553 Others (8) (143) (171) (240) (332) Interest paid (net) 1,760 1,781 1,986 2,003 2,003 CFO before change in WC 10,440 6,244 8,387 11,231 14,527 Change in working capital (2,277) (1,085) 15 (1,218) (1,091) Direct taxes paid (1,148) (377) (1,071) (1,902) (2,884) CFO 7,014 4,781 7,331 8,111 10,552 Net capex (3,993) (5,379) (4,001) (5,169) (7,408) Net investments Interest received CFI (3,828) (5,405) (3,830) (4,929) (7,077) Proceeds from borrowings 40,342 30, Change in share capital 0 - (15) (0) (0) Interest & finance charges paid (1,760) (1,781) (1,986) (2,003) (2,003) Dividends paid (692) (279) (347) (616) (934) CFF (2,885) 528 (1,848) (2,619) (2,937) Net increase in cash 301 (96) 1, FCF 3,021 (598) 3,329 2,942 3,143, Ratio Analysis Year to March (%) FY13 FY14 FY15E FY16E FY17E Revenue growth 17.6 (4.2) EBITDA growth 7.4 (44.9) PAT growth 5.0 (65.9) EPS norm (dil) growth 5.0 (65.9) EBITDA margin EBIT margin Net margin RoCE RoIC RoE Valuation Parameter Year to March FY13 FY14 FY15E FY16E FY17E P/E (x) P/B(x) Debt/Equity(x) Net debt/equity(x) EV/Sales(x) EV/EBITDA(x) EV/tonne (`) 6,857 6,518 6,123 6,123 5,878 EV/tonne (US$) October 14, 2014 Ambit Capital Pvt. Ltd. Page 85

86 Ramco Cement Institutional Equities Team Saurabh Mukherjea, CFA CEO, Institutional Equities (022) Research Analysts Industry Sectors Desk-Phone Nitin Bhasin - Head of Research E&C / Infra / Cement / Industrials (022) nitinbhasin@ambitcapital.com Aadesh Mehta, CFA Banking / Financial Services (022) aadeshmehta@ambitcapital.com Achint Bhagat Cement / Infrastructure (022) achintbhagat@ambitcapital.com Aditya Bagul Consumer (022) adityabagul@ambitcapital.com Aditya Khemka Healthcare (022) adityakhemka@ambitcapital.com Ashvin Shetty, CFA Automobile (022) ashvinshetty@ambitcapital.com Bhargav Buddhadev Power Utilities / Capital Goods (022) bhargavbuddhadev@ambitcapital.com Dayanand Mittal, CFA Oil & Gas / Metals & Mining (022) dayanandmittal@ambitcapital.com Deepesh Agarwal Power Utilities / Capital Goods (022) deepeshagarwal@ambitcapital.com Gaurav Mehta, CFA Strategy / Derivatives Research (022) gauravmehta@ambitcapital.com Karan Khanna Strategy (022) karankhanna@ambitcapital.com Krishnan ASV Real Estate (022) vkrishnan@ambitcapital.com Pankaj Agarwal, CFA Banking / Financial Services (022) pankajagarwal@ambitcapital.com Paresh Dave Healthcare (022) pareshdave@ambitcapital.com Parita Ashar Metals & Mining / Oil & Gas (022) paritaashar@ambitcapital.com Rakshit Ranjan, CFA Consumer / Retail (022) rakshitranjan@ambitcapital.com Ravi Singh Banking / Financial Services (022) ravisingh@ambitcapital.com Ritesh Gupta, CFA Midcaps Chemical / Retail (022) riteshgupta@ambitcapital.com Ritesh Vaidya Consumer (022) riteshvaidya@ambitcapital.com Ritika Mankar Mukherjee, CFA Economy / Strategy (022) ritikamankar@ambitcapital.com Ritu Modi Automobile (022) ritumodi@ambitcapital.com Sagar Rastogi Technology (022) sagarrastogi@ambitcapital.com Sumit Shekhar Economy / Strategy (022) sumitshekhar@ambitcapital.com Tanuj Mukhija, CFA E&C / Infra / Industrials (022) tanujmukhija@ambitcapital.com Utsav Mehta Technology (022) utsavmehta@ambitcapital.com Sales Name Regions Desk-Phone Sarojini Ramachandran - Head of Sales UK +44 (0) sarojini@panmure.com Deepak Sawhney India / Asia (022) deepaksawhney@ambitcapital.com Dharmen Shah India / Asia (022) dharmenshah@ambitcapital.com Dipti Mehta India / USA (022) diptimehta@ambitcapital.com Hitakshi Mehra India (022) hitakshimehra@ambitcapital.com Nityam Shah, CFA USA / Europe (022) nityamshah@ambitcapital.com Parees Purohit, CFA UK / USA (022) pareespurohit@ambitcapital.com Praveena Pattabiraman India / Asia (022) praveenapattabiraman@ambitcapital.com Production Sajid Merchant Production (022) sajidmerchant@ambitcapital.com Sharoz G Hussain Production (022) sharozghussain@ambitcapital.com Joel Pereira Editor (022) joelpereira@ambitcapital.com Nikhil Pillai Database (022) nikhilpillai@ambitcapital.com E&C = Engineering & Construction October 14, 2014 Ambit Capital Pvt. Ltd. Page 86

87 Ramco Cement Explanation of Investment Rating Investment Rating Expected return (over 12-month period from date of initial rating) Buy >5% Sell <5% Disclaimer This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of Ambit Capital. AMBIT Capital Research is disseminated and available primarily electronically, and, in some cases, in printed form. Additional information on recommended securities is available on request. Disclaimer 1. AMBIT Capital Private Limited ( AMBIT Capital ) and its affiliates are a full service, integrated investment banking, investment advisory and brokerage group. AMBIT Capital is a Stock Broker, Portfolio Manager and Depository Participant registered with Securities and Exchange Board of India Limited (SEBI) and is regulated by SEBI 2. 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