Q3FY2009 Cement earnings preview: dated January 07, 2009

Q3FY2009 Cement earnings preview Driven by the strong revival in dispatches in the last two months, cement volumes are estimated to have grown by 8.3% year on year (yoy) to 44.1 million tonne (MMT) in Q3FY2009 as against 40.8MMT in Q3FY2008. However, capacity in the same period increased by 19% to 51.51MMT, resulting in a decrease in the utilisation ratio, which is expected to drop to 86.4% in Q3FY2009 from 94.6% in Q3FY2008.  Overall, Sharekhan's cement universe is expected to register an 8.6% volume growth in Q3FY2009. Shree Cement, UltraTech Cement Company (UltraTech) and Orient Paper & Industries (Orient) are likely to report an impressive volume growth of 27.4%, 11.4% and 13% respectively for Q3FY2009 due to capacity addition. Sharekhan's universe is likely to register a 6.9% growth in its top line and a 23.5% decline in its earnings on a y-o-y basis. Shree Cement, Madras Cement, UltraTech and Orient are expected to post impressive sales growth of 23%, 18.3%, 16.8% anLoading…d 13.8% respectively due to capacity addition carried out by them. In terms of realisation, south-based companies are fetching healthy realisation whereas companies operating in the other regions are struggling to sustain their realisation. However, during the period under review the gross realisation of cement across the nation declined on the back of the pass-through of the benefit of the excise duty cut. The recently announced excise duty cut from 12% to 8% has translated into a reduction of Rs10 per 50kg bag. In response to the government's announcement, all the cement companies have reduced cement prices by Rs4-6 per 50kg bag. This means companies are still enjoying a benefit of Rs5 per bag. So going forward, this benefit of Rs5 a bag can act as a buffer for the cement companies. The adjusted profit after tax (PAT) of the companies in Sharekhan's universe is expected to decline by 23.5% because of a significant fall in the operating profit margin (OPM). The OPM is expected to decline by about 257 basis points to 1,328 basis points. Moreover, a sharp increase in the interest and depreciation charges due to capacity expansion will have an adverse impact on the bottom line of the cement companies.

Q3FY2009 Cement earnings preview: dated January 07, 2009

Q3FY2009 Cement earnings preview Driven by the strong revival in dispatches in the last two months, cement volumes are estimated to have grown by 8.3% year on year (yoy) to 44.1 million tonne (MMT) in Q3FY2009 as against 40.8MMT in Q3FY2008. However, capacity in the same period increased by 19% to 51.51MMT, resulting in a decrease in the utilisation ratio, which is expected to drop to 86.4% in Q3FY2009 from 94.6% in Q3FY2008.  Overall, Sharekhan's cement universe is expected to register an 8.6% volume growth in Q3FY2009. Shree Cement, UltraTech Cement Company (UltraTech) and Orient Paper & Industries (Orient) are likely to report an impressive volume growth of 27.4%, 11.4% and 13% respectively for Q3FY2009 due to capacity addition. Sharekhan's universe is likely to register a 6.9% growth in its top line and a 23.5% decline in its earnings on a y-o-y basis. Shree Cement, Madras Cement, UltraTech and Orient are expected to post impressive sales growth of 23%, 18.3%, 16.8% anLoading…d 13.8% respectively due to capacity addition carried out by them. In terms of realisation, south-based companies are fetching healthy realisation whereas companies operating in the other regions are struggling to sustain their realisation. However, during the period under review the gross realisation of cement across the nation declined on the back of the pass-through of the benefit of the excise duty cut. The recently announced excise duty cut from 12% to 8% has translated into a reduction of Rs10 per 50kg bag. In response to the government's announcement, all the cement companies have reduced cement prices by Rs4-6 per 50kg bag. This means companies are still enjoying a benefit of Rs5 per bag. So going forward, this benefit of Rs5 a bag can act as a buffer for the cement companies. The adjusted profit after tax (PAT) of the companies in Sharekhan's universe is expected to decline by 23.5% because of a significant fall in the operating profit margin (OPM). The OPM is expected to decline by about 257 basis points to 1,328 basis points. Moreover, a sharp increase in the interest and depreciation charges due to capacity expansion will have an adverse impact on the bottom line of the cement companies.

ndian Cement Sector - Is this the first sign of a pickup in real demand?

Deutsche Bank - Equity Research

* Sharp pickup in December 2008 demand - first signs of a revival?

Our channel checks with major cement producers suggest that cement dispatches in December 2008 were +12-14% yoy and +12-14% mom. More importantly, inventory levels for plants/dealers fell sharply and are close to zero for many plants.

What is likely pre-election spending by state governments (such as for a few big infrastructure projects and the renewal of many stalled projects) helped to boost demand. Shree Cements and Grasim are our top picks, though pure plays such as ACC and Ambuja Cement could do better near term.

* Restart of several big ticket projects; could be pre-election demand

Our talks with cement marketing companies and dealers suggest that demand has been boosted by state government project restarts including (a) the sewerage line project in Punjab; (b) the national irrigation project in Haryana and Andhra Pradesh; (c) roads, bridges and other infrastructure projects in Gujarat; (d) the concretization of roads in Delhi; and (e) offtake for the Bangalore Metro in Karnataka. This seems to be pre-election demand and is likely to sustain at least until May 2009. A few dealers remarked that a lot of infrastructure projects have restarted as current commodity prices make these projects look profitable for developers.


* Operating profits for cement companies could sustain over next few quarters

A 10-15% correction of average retail prices impacted ex-factory realization by only 5-7% as government had cut down excise duties. Our earnings estimates, assuming a further 5% drop in cement realisations and virtually constant energy costs, are 14-33% below consensus except for ACC and India Cements.

* Reiterate Buy on Grasim, Hold on ACC; Shree Cement is our top mid-cap
pick.

We have used a combination of bottom of cycle PE and DCF for valuations. Our cost of equity ranging from 13.1 for ACC to 13.8 for Ambuja ( risk free rate of 8.7%and beta of 0.8 to 1) with a terminal growth of 1-2%%. Our target price implies that cement stocks are at a discount to replacement value by 17 to 66% Our preferred picks are Grasim (TP Rs1,340 +9% upside potential) and Shree cement (TP Rs560 +15%upside potential).

We maintain Hold on ACC, Ultratech, India Cement and Ambuja.

Key downside risks are a collapse in demand and the bunching up of new capacities. Upside risk stems clearly from low fuel prices and delay in new capacities.

ndian Cement Sector - Is this the first sign of a pickup in real demand?

Deutsche Bank - Equity Research

* Sharp pickup in December 2008 demand - first signs of a revival?

Our channel checks with major cement producers suggest that cement dispatches in December 2008 were +12-14% yoy and +12-14% mom. More importantly, inventory levels for plants/dealers fell sharply and are close to zero for many plants.

What is likely pre-election spending by state governments (such as for a few big infrastructure projects and the renewal of many stalled projects) helped to boost demand. Shree Cements and Grasim are our top picks, though pure plays such as ACC and Ambuja Cement could do better near term.

* Restart of several big ticket projects; could be pre-election demand

Our talks with cement marketing companies and dealers suggest that demand has been boosted by state government project restarts including (a) the sewerage line project in Punjab; (b) the national irrigation project in Haryana and Andhra Pradesh; (c) roads, bridges and other infrastructure projects in Gujarat; (d) the concretization of roads in Delhi; and (e) offtake for the Bangalore Metro in Karnataka. This seems to be pre-election demand and is likely to sustain at least until May 2009. A few dealers remarked that a lot of infrastructure projects have restarted as current commodity prices make these projects look profitable for developers.


* Operating profits for cement companies could sustain over next few quarters

A 10-15% correction of average retail prices impacted ex-factory realization by only 5-7% as government had cut down excise duties. Our earnings estimates, assuming a further 5% drop in cement realisations and virtually constant energy costs, are 14-33% below consensus except for ACC and India Cements.

* Reiterate Buy on Grasim, Hold on ACC; Shree Cement is our top mid-cap
pick.

We have used a combination of bottom of cycle PE and DCF for valuations. Our cost of equity ranging from 13.1 for ACC to 13.8 for Ambuja ( risk free rate of 8.7%and beta of 0.8 to 1) with a terminal growth of 1-2%%. Our target price implies that cement stocks are at a discount to replacement value by 17 to 66% Our preferred picks are Grasim (TP Rs1,340 +9% upside potential) and Shree cement (TP Rs560 +15%upside potential).

We maintain Hold on ACC, Ultratech, India Cement and Ambuja.

Key downside risks are a collapse in demand and the bunching up of new capacities. Upside risk stems clearly from low fuel prices and delay in new capacities.

Cement Sector Update

Cost reliefs – sector due for re-rating

Cost reliefs – sector due for re-rating
Key Highlights

n Recent events like cut in central excise duty from 12% to 8%, 60% fall in prices of international coal from its July peaks, 70% fall in crude prices (relevant for packaging cost) and cut in diesel prices has significantly moderated the cost pressures witnessed by cement companies over last one year.

n We estimate that total cost of sales of cement to have come down by Rs461/ ton, i.e. a reduction of Rs23 per bag as compared to cost in Q2FY2009. Out of this Rs200/ton is the reduction on account of cut in excise duty rate and the balance is on account of reduction in cost of production.

n With cost of production likely to come down by Rs12.5/bag and cement prices softening by Rs4/bag, we estimate that profitability of cement companies to have improved by at least Rs8-10/bag i.e. Rs180-200 per tonne. Consequently we could see a significant 20% improvement in profitability of cement in Q42009 itself.

n In our earnings estimate for cement companies for FY2010 we had earlier estimated cement prices to drop by Rs20 per bag and cost of production to reduce by close to Rs5 per bag. However with recent events, even if cement companies were to cut prices by Rs20/bag, their EBIDTA margins in FY2010 might not drop significantly. For example average EBIDTA margin of top 5 pure play cement companies in our coverage might just drop by 120 bps yoy as against 440 bps drop expected earlier.

n We expect Ambuja Cement (CY2009 earnings upgrade of 26%), India Cement (FY2010 earnings upgrade of 32%), Ultratech Cement (FY2010 earnings upgrade of 33%) and Madras cement (FY2010 earnings upgrade of 31%), to be the biggest beneficiary of the recent moderation in cost pressures.

n Over past month cement stocks have underperformed broader market. We believe that the street has not yet factored in the significant improvement in profitability that cement companies could witness in Q42009 as compared to Q2209.

n We had been negative on the sector on account of sharp moderation in cement consumption and impending oversupply situation in FY2010. However we believe that the recent moderation in cost pressures has improved business fundamentals and on account of the same sector valuations which are close to multi year lows are due for re-rating. We expect Ambuja Cement, Ultratech Cement and India cement to outperform in near term.

Cement Sector Update

Cost reliefs – sector due for re-rating

Cost reliefs – sector due for re-rating
Key Highlights

n Recent events like cut in central excise duty from 12% to 8%, 60% fall in prices of international coal from its July peaks, 70% fall in crude prices (relevant for packaging cost) and cut in diesel prices has significantly moderated the cost pressures witnessed by cement companies over last one year.

n We estimate that total cost of sales of cement to have come down by Rs461/ ton, i.e. a reduction of Rs23 per bag as compared to cost in Q2FY2009. Out of this Rs200/ton is the reduction on account of cut in excise duty rate and the balance is on account of reduction in cost of production.

n With cost of production likely to come down by Rs12.5/bag and cement prices softening by Rs4/bag, we estimate that profitability of cement companies to have improved by at least Rs8-10/bag i.e. Rs180-200 per tonne. Consequently we could see a significant 20% improvement in profitability of cement in Q42009 itself.

n In our earnings estimate for cement companies for FY2010 we had earlier estimated cement prices to drop by Rs20 per bag and cost of production to reduce by close to Rs5 per bag. However with recent events, even if cement companies were to cut prices by Rs20/bag, their EBIDTA margins in FY2010 might not drop significantly. For example average EBIDTA margin of top 5 pure play cement companies in our coverage might just drop by 120 bps yoy as against 440 bps drop expected earlier.

n We expect Ambuja Cement (CY2009 earnings upgrade of 26%), India Cement (FY2010 earnings upgrade of 32%), Ultratech Cement (FY2010 earnings upgrade of 33%) and Madras cement (FY2010 earnings upgrade of 31%), to be the biggest beneficiary of the recent moderation in cost pressures.

n Over past month cement stocks have underperformed broader market. We believe that the street has not yet factored in the significant improvement in profitability that cement companies could witness in Q42009 as compared to Q2209.

n We had been negative on the sector on account of sharp moderation in cement consumption and impending oversupply situation in FY2010. However we believe that the recent moderation in cost pressures has improved business fundamentals and on account of the same sector valuations which are close to multi year lows are due for re-rating. We expect Ambuja Cement, Ultratech Cement and India cement to outperform in near term.