CementAV030511

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India Equity Researc

Cemen

May 3, 2011

Cement Impending fall in utilization presents an obstacle

Sector Update Likely additions to capacity during FY12 may pull down capacity

utilization by c10% from the current c78% and could trigger a spell o

underperformance in cement stocks. This could snap the sectors threequarter long outperformance to the Nifty. The past nine quarter

reveal a striking correlation between a sequential rise in capacity

utilization and outperformance. We forecast capacity to rise by 7.5% in

FY12, while demand may grow at 8%. Another indicator of a likely

near‐term peaking in valuation is the rise in the EV/tonne close to the

top end of its range. We believe a potential correction could presen

an opportunity as the downside is restricted by valuations. We prefe

UltraTech Cement over ACC and Ambuja Cements for its lowe

valuation and the upward bias to its capacity utilization.

Capacity utilization likely to fall by c10% in 2H2011

We forecast grinding capacity utilization to decline from 80.6% in Apr11‐Jun1

to 71.1% in Jul11‐Sep11 and 71.3% in Oct11‐Dec11. Capacity addition for FY11f

FY13f is likely to grow at a CAGR of 8.2%. Consumption growth during the same

period is likely to increase by a CAGR of 8%. Hence, we forecast capacity

utilization for FY12f and FY13f to remain in the range of 75%‐76%. Capacity

addition during FY09‐FY11 grew at a CAGR of 16.3%, while consumption grew

at a CAGR of 10%. This led capacity utilization to decline from 88.3% in FY09 to

75.3% in FY11f.

Previous Cement underperformance correlates with fall in utilization

The performance of the Cement Index vis‐à‐vis the Nifty is correlated to the

changes in grinding capacity utilization. Better capacity utilization led to the

Cement Index outperforming the Nifty and vice‐versa. Hence, the impendingfall in utilization, after Jun11, raises the probability of underperformance.

Outperformance of past three quarters may reverse

Cement stocks outperformed the market during the past three quarters due to

capacity utilization increasing from 71.4% in Jul10‐Sep10 to 77.9% in Jan11

Mar11. The Cement Index outperformed the Nifty by 12% during this period

Based on the likely c10% drop in capacity utilization in 2H2011 and the

correlation between the Cement Index and the Nifty, we forecast the

outperformance of the past three quarters to reverse in 2H2011.

UltraTech Cement is our preferred pick over ACC and Ambuja Cements

UTCEM is likely to outperform its peers within the Cement Index. On EV/tonne

basis, UTCEM trades at a discount, at INR5,933, compared to ACC and ACEM

which trade at INR6,114 and INR7,722. However, capacity utilization for UTCEM

is likely to be 90.6% in FY12f, whereas ACC and ACEM it is likely to be 75.6%

and 81.5%, respectively. This restricts the downside in terms of valuations fo

UTCEM when compared to its peers. Broad‐based market correction is a risk to

our call as the Cement Index and EV/tonne valuation range of INR5,400

INR5,850 limit the downside in stocks.

ACC Hold

Current Market Price

Target Price

Bloomberg Code

Reuters code

Avg. Vol. (3m)

Avg. Val.(3m)(INRmn)

52‐wk H/L (INR)

MCAP (INRbn/USDmn)

Ambuja Cements Reduce


Target

PriceBloomberg Code

Reuters code

Avg. Vol. (3m)


52‐wk H/L (INR)

MCAP (INRbn/USDbn)

UltraTech Cement Add


Target Price

Bloomberg Code

Reuters code

Avg. Vol. (3m)(mn)


52‐wk H/L (INR)

MCAP (INRbn/USDbn)

Cement Index ‐ rolling EV/tonne (INR)

ACEM IN

GACM.BO

3.4

167 / 100

482

150

ACC.BO

403,368

416

202.8/ 4.6

1,080

UTCEM IN

ULTC.BO

166,149

1,197 / 820

ACC IN

1,066

1,144 / 695

140

229.1 / 5.1

171

283.1 / 6.4

1,033

1,178

2,500

3,750

5,000

6,250

7,500

Jan09 Jun09 Dec09 May10 Nov10 May11

Jimesh Sanghvi, +91 022 66842859

[email protected]

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India Equity Research Cement

Cement 2

Cement stocks likely to underperform as capacity utilization declines

The performance of the Cement Index vis‐à‐vis the Nifty is correlated to the changes in grinding capacity utilization.

Better capacity utilization led to the Cement Index outperforming the Nifty and vice‐versa. We forecast grinding

capacity utilization to decline from 80.6% in Apr11‐Jun11 to 71.1% in Jul11‐Sep11 and 71.3% in Oct11‐Dec11, assuming

average consumption growth of 8% in FY12. Hence, we forecast the Cement Index to underperform the Nifty for the

next six months on relative basis. Capacity addition is likely to grow in line with consumption growth for FY11f ‐FY13f.

Capacity utilization is likely to remain in the range of 75%‐76% for the next two years. The CAGR of 16.3% in capacity

addition over FY09‐FY11f led to utilization declining from 88.3% in FY09 to 75.3% in FY11f. Cement prices have also

been co‐related with the movement in capacity utilization, though at times with a lag of one month. On the back of a

drop in capacity utilization for the next six months, cement prices are likely to decline. We prefer UTCEM to both ACC

and ACEM as it trades at a discount in terms of valuations and is likely to operate its cement plants at a higher capacity

utilization compared to its peers.

Exhibit 1: Relative performance of cement index to grinding capacity utilization (%)

Jan09‐Mar09 Apr09‐Jun09 Jul09‐Sep09 Oct09‐Dec09 Jan10‐Mar10 Apr10‐Jun10 Jul10‐Sep10 Oct10‐Dec10 Jan11‐Mar11

Cement Index 20.5 34.8 16.4 1.4 15.6 ‐17.1 17.8 2.2 2.3

Nifty 2.1 42.0 18.5 2.3 0.9 1.2 13.5 1.7 ‐4.9

Relative 18.4 ‐7.2 ‐2.1 ‐1.0 14.7 ‐18.3 4.3 0.5 7.2

Capacity (mn tonnes) 54.2 57.0 58.4 61.28 63.7 67.4 68.0 69.7 71.2

Production (mn tonnes) 50.2 49.7 47.1 49.2 55.0 53.0 48.6 50.9 55.5

Capacity utilization (%) 92.7 87.2 80.6 80.3 86.3 78.7 71.4 73.0 77.9

EV/Tonne (INR) 3,655.6 4,756.4 5,641.3 5,301.0 6,046.3 5,844.0 5,601.6 6,32 4.8 5,762.7

Source: Cement Manufacturers Association, Avendus Research

Drop in capacity utilization to be a catalyst for underperformance

The performance of the cement index vis‐à‐vis the Nifty is correlated to the changes in grinding

capacity utilization. Better capacity utilization led to the Cement Index outperforming the Nifty and

vice‐versa. The drop in capacity utilization from 92.7% in Jan09‐Mar09 to 78.7% in Jul09‐Sep09 led to

the

9.3%

underperformance

of

the

Cement

Index

(7.2%

in

Apr09‐

Jun09

and

2.1%

in

Jul09‐

Sep09).

However, the Cement Index in absolute terms reported an increase during the same period due to

relatively low EV/tonne valuation of INR3,655 in Jan09‐Mar09.

Exhibit 2: Sensitivity in capacity utilization based on consumption growth (%)

Jan‐Mar11 Apr‐Jun11f Jul‐Sep11f Oct‐Dec11f Jan‐Mar12f

Capacity (mn tonnes) 71.2 72.7 76.4 76.8

Consumption (mn tonnes)

‐ growth of 10% 58.5 52.6 55.5 61.6

‐ growth of 8% 57.4 51.7 54.4 60.5

‐ growth of 6% 56.4 50.7 53.4 59.4

Capacity utilization (%) 78.7

Capacity utilization (%)

‐ growth of 10% 82.1 72.4 72.6 80.2

‐ growth of 8% 80.6 71.1 71.3 78.8

‐ growth of 6% 79.1 69.8 70.0 77.3


We forecast grinding capacity utilization to decline from 80.6% in Apr11‐Jun11 to 71.1% in Jul11‐Sep11

and 71.3% in Oct11‐Dec11f, assuming average consumption growth of 8% in FY12. We forecast the

Cement Index to underperform for the next six months on relative basis. On normalized basis, we

forecast the EV/tonne to remain in the range of INR5,400 (USD120) to INR5,850 (USD130), as seen in

the past. The EV/tonne traded below USD120 during Jan09‐Jun09 due to the global recession. Hence,

we do not foresee an absolute decline in the Cement Index.

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Cement 3

Capacity addition in line with consumption growth for FY11f ‐FY13f

We forecast cement production to grow at a CAGR of 8% during FY11‐FY13, in line with consumption

growth. Cement inventory is likely to remain unchanged during the period. Capacity addition for FY11f ‐

FY13f is likely to grow at a CAGR of 8.2%, with a CAGR of 8% in consumption growth. Hence, capacity

utilization is likely to remain in the range of 75%‐76% for the next two years. Capacity addition grew at

a CAGR of 16.3% during FY09‐FY11 compared to a CAGR of 10% in consumption. This led capacity

utilization to decline from 88.3% in FY09 to 75.3% in FY11f.

Exhibit 3: Industry capacity utilization

(mn tonnes) FY06 FY07 FY08 FY09 FY10 FY11f FY12f FY13f

Grinding capacity 157.7 165.9 175.7 205.3 240.4 276.3 297.1 323.6

% Increase 3.9 5.4 6.1 16.9 17.1 14.9 7.5 8.9

Cement production 141.8 155.1 168.3 181.4 201.0 208.0 224.6 242.6

% Increase 12.9 9.4 8.5 7.8 10.8 3.5 8.0 8.0

Grinding capacity utilization (%) 89.9 93.9 95.8 88.3 83.6 75.3 75.6 75.0


Drop in capacity utilization likely to be met by a decline in prices

Exhibit 4: Capacity utilization and Cement prices

64

74

84

94

104

Jan09 Apr09 Aug09 Dec09 Apr10 Aug10 Dec10 Mar11

210

225

240

255

270

Capacity utilization (%) Cement prices (INR/bag)


Cement prices have been co‐related to the movement in capacity utilization—as seen in Exhibit 4,

though there might be a lag of one month in certain cases. Based on our forecast of a decline in

capacity utilization, we forecast cement prices to decline over the next four months before stabilizing

by Sep11. This increases the uncertainty over near‐term earnings. Historically, cement prices have also

been weak in the Jul‐Nov period due to seasonal factors. The increase in cement prices during Jan11‐

Mar11 has also been due to a rise in input costs, mainly the cost of coal and freight.

UltraTech Cement likely to outperform ACC and Ambuja Cements

UltraTech Cement (UTCEM IN) is likely to outperform its peers within the Cement Index. UTCEM trades

at an EV/tonne of INR5,933 which is at a discount of c20% to Ambuja Cements (ACEM IN). ACC (ACC IN)

trades at an EV/tonne of INR6,114 which is at a marginal premium to UTCEM. However, capacity

utilization for UTCEM is likely to be 90% in FY12f, whereas ACC and ACEM are likely to operate at 75.6%

and 81.5%, respectively, during 2011. Higher capacity utilization and discounted valuations restrict the

downside in UTCEM’s valuations when compared to its peers.

UltraTech Cement: We assume an EV/tonne of INR5,714, which is the historical (between Apr06 and

Apr11) industry average EV/tonne and P/E of 11.3x. Applying these to our consolidated one‐year

forward rolling EPS and EV/tonne, we arrive at fair values of INR1,182 and INR1,174, respectively. Our

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Cement 4

Mar12 target price of INR1,178 is the average of the fair values based on the EV/tonne and P/E

methods. We have an Add rating on the stock.

ACC: We assume an EV/tonne of INR5,505, which is the historical (between Jan07 and Apr11) average

EV/tonne and a P/E of 12.5x. Applying these to our consolidated one‐year forward rolling EPS and

EV/tonne, we arrive at fair values of INR1,062 and INR1,070, respectively. Our Mar12 target of

INR1,066 is the average of the fair values based on the EV/tonne and P/E methods. We have a Hold

rating on the stock.

Ambuja Cements: We assume an EV/tonne of INR6,624, which is the historical (between Jan07 and

Apr11) average EV/tonne and a P/E of 12.0x. Applying these to our consolidated one‐year forward

rolling EPS and EV/tonne, we arrive at fair values of INR141 and INR139, respectively. Our Mar12 target

price of INR140 is the average of the fair values based on the EV/tonne and P/E methods. The stock

trades at an EV/tonne of USD168 (based on 2012 capacity) after the rally since mid‐Mar11. These

premium valuations are unsustainable, considering the surplus supply scenario in the cement industry.

We have a Reduce rating on the stock.

Exhibit 5: UTCEM ‐ One‐year forward EV/tonne (INR)

1,000

3,000

5,000

7,000

9,000

Apr06 Apr07 Apr0 8 Apr09 Apr10 Apr11 Ma r12

EV/t on ne Ave ra ge ‐ EV/tonne

Source: Capitaline, Avendus Research

Exhibit 6: UTCEM ‐ One‐year forward P/E (x)

2

7

12

17

22

Apr06 Apr07 Apr08 Apr09 Apr10 Apr11 Ma r12

P/E Avera ge P/E


Exhibit 7: ACC’s One‐year forward EV/tonne (INR)

2,000

4,500

7,000

9,500

12,000

Jan07 Jan08 Feb09 Feb10 Mar11 Mar12

EV/tonne Avera ge ‐ EV/tonne


Exhibit 8: ACC’s One‐year forward P/E (INR)

4

9

14

19

24

Jan07 Jan08 Feb09 Feb10 Mar11 Mar12

P/E Average P/E


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Cement 5

Exhibit 9: ACEM ‐ One‐year forward EV/tonne (INR)

2,000

4,500

7,000

9,500

12,000

J an0 7 Nov0 7 Se p0 8 Au g0 9 J un1 0 Ma y1 1 Ma r1 2

EV/tonne Ave ra ge ‐ EV/tonne


Exhibit 10: ACEM ‐ One‐year forward P/E (INR)

5.0

8.5

12.0

15.5

19.0

Ja n07 Nov07 Se p08 Aug09 Jun10 Ma y11 Ma r12

P/E Avera ge P/E


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Cement 6

Analyst Certification

I, Jimesh Sanghvi, Chartered Accountant, research analyst and author of this report, hereby certify that all of the views expressed in this document accurately reflect our personal

views about the subject company/companies and its or their securities. We further certify that no part of our compensation was, is or will be, directly or indirectly related to

specific recommendations or views expressed in this document.

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be taken as, the sole basis for an investment decision. The user assumes the entire risk of any use made of this information. Each recipient of this document should make such

investigation as he deems necessary to arrive at an independent evaluation, including the merits and risks involved, for investment in the securities referred to in this document

and should consult his own advisors to determine the merits and risks of such investment. The investment discussed or views expressed may not be suitable for all investors. This

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document.

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is

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providing

high‐

quality,

objective

and

unbiased

research

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investors.

To

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manage potential conflicts of interest and protect the integrity of our relationships with investing and corporate clients. Employee compliance with these policies is mandatory.

Any comment or statement made herein are solely those of the analyst and do not necessarily reflect those of Avendus.

Disclosure of Interest Statement (as of May 3, 2011)

Analyst ownership

of the stock

Avendus or its associate company’s

ownership of the stock

Investment Banking mandate with

associate companies of Avendus

ACC No No No

Ambuja Cements No No No

UltraTech Cement No No No

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