Thursday, April 26, 2012

>Ambuja Cements

Realizations decline in peak construction season. Ambuja Cements saw its net
realizations decline by Rs90/ton in 1QCY12 despite a Rs10/bag increase in its key
markets, as the benefits of price increase were likely passed on to dealers in the form of
higher trade discounts. Inability to effect an improvement in realizations in the peak
construction season does not augur well for full-year earnings that will likely be
susceptible to higher input costs. Maintain SELL rating and target price of Rs150/share.

Sequential decline in realizations despite price hikes
ACEM reported revenues of Rs26.3 bn (19% yoy, 13% qoq), operating profit of Rs7.4 bn (22%
yoy, 77% qoq) and adjusted net income of Rs5.1 bn (25% yoy, 96% qoq) against our estimate of Rs28.3 bn, Rs7.3 bn and Rs4.6 bn respectively. Despite cement prices increasing by Rs10-12/bag over the past quarter, ACEM’s average realizations declined by Rs90/ton likely on account of higher dealer margins eating into the pricing benefits. Sharp sequential jump in profitability (53%) was largely aided by (1) decline in raw material cost and (2) leverage benefits of higher volumes. We note that reported net income of Rs3.1 bn includes prior-period depreciation of Rs2.8 bn as the company retrospectively changed its depreciation policy for captive power plants from SLM to WDV. We discuss key details of the result in a subsequent section.

Pricing discipline continues to remain precariously positioned
We further note that the under-utilization of capacities is likely to continue even in CY2012E
despite factoring 8% consumption growth. In our view, pricing discipline continues to remain
precariously positioned in the wake of (1) a weak demand environment coupled with a continued capacity overhang and (2) potential action by the Competition Commission of India (CCI) apart from the hefty penalty that could be levied in case of an unfavorable ruling.

Valuation indicating an optimistic scenario, ignoring potential regulatory risks; SELL
We maintain SELL on ACEM with a target price of Rs150. ACEM is currently trading at 9X
CY2012E EBITDA and EV/ton of US$186/ton on CY2012E production as against a replacement cost of US$110-120/ton. We note that the current market price implies 25% yoy growth in profitability in CY2012E on a multiple of 8.5X CY2012E EBITDA (see Exhibit 3), which in our view does not take cognizance of risk to earnings given (1) the continued demand-supply overhang and (2) threat of an unfavorable regulatory action. We note that our estimates factor sustenance of pricing discipline as well as demand revival (to an extent) as we build 6% and 13% growth in volumes and realizations and a corresponding 20% improvement in profitability in CY2012E.