>India Cement: Key Takeaways of Budget 2010 (MORGAN STANLEY)

We remain positive on the industry: We believe that demand/supply dynamics will remain favorable over the next few months, driven by strong demand momentum and our expectation of a modest increase in effective industry-wide capacity. We estimate that capacity utilization will inch higher, leading to increasing cement prices and potential earnings surprises. In our view, companies are in a position to pass on the impact of higher excise duty in the Budget, given current demand. We reiterate our Attractive industry view and OW ratings on Ultratech, Ambuja and ACC.

Key Budget highlights and likely impact:
• Increase in excise duty from 8% to 10%: This was in line with our and consensus expectations. Given the current demand/supply scenario, we believe companies will be able to pass this on. A couple of management comments in the press after the Budget (businessline) corroborate our view.

• Clean energy cess of Rs50/ton on both domestic and imported coal: This will have a marginal impact of around 50-60bps on EBITDA margins, if not passed on.

• These would be partly offset by a 250bps reduction in the surcharge on income tax, to 7.5%: This, in turn, leads to a lower overall tax rate of 33.2%, from 34% earlier.

Besides these, there are a few other highlights of the Budget that we believe are important for the industry.

Infrastructure focus – potential positive for demand: The government reiterated its focus on infrastructure
and rural development. Expenditure on initiatives that could result in increased cement consumption (see chart on page 2) has been raised relative to the previous year. While the impact of this is uncertain, in our view, it will provide an impetus for cement demand in the next 12 months. This makes us believe that our 10% demand growth assumption for F11e has upside risk.

Fuel price hike likely to lead to increased freight rates; likely to passed subject to demand-supply dynamics: In the Budget, the government restored a 5% import duty on crude oil, resulting in a per-liter increase of around Rs2-3 in petrol and diesel prices. As per general expectation, this is likely to be passed on by the transport companies. Given that freight comprises around 20-25% of total costs for cement companies, it would lead to an increase in total costs, resulting in some margin pressure if the companies did not pass it on. However, given our expectation of a balanced demand/supply environment over the next few months, we believe that the companies will be able to pass this on at least partially. Moreover, the impact is not likely to be seen before the Jun-10 quarter, in our view.

We believe that focus on infrastructure and rural employment bodes well for cement demand. The key policy changes are largely on expected lines and should broadly be margin-neutral in the near term, given our view that companies will pass on the impact of higher excise duty.

To read the full report: INDIA CEMENT