>Cement companies penalized by CCI on cartelization (CENTRUM)

The Competition Commission of India (CCI), on June 20, 2012, came out with its verdict on alleged cartelization by cement manufacturers and imposed hefty penalties on 10 cement manufacturing companies (ACC, Ambuja, Ultra Tech, JP Associates, India Cements, JK Cement, Century Textiles, Madras


Cements, Binani Cement and Lafarge India) for violation of Section 3 and 4 of the Competition Act 2002. The casewas referred to CCI by Builders’ Association of India on July 26, 2010.We had earlier stated in our reports that the investigation carried on by CCI imposes a regulatory risk to the sector and there were chances of CCI imposing penalty on the cement companies. The quantum of penalty levied by CCI varies between Rs11.4bn – Rs13.2bn for large players and Rs1.6bn- Rs4.8bn for mid-sized players. Though, as per Competition Act, the companies are required to deposit this penalty within 90 days of the ruling, they may appeal against this order in the Competition Appellate Tribunal (within a period of 60 days from the
receipt of the order) and get a stay order if the Tribunal decides.


We believe that the market had recently turned down the chances of imposition of penalties on the cement manufacturers as the judgment was long awaited and it was believed that it is difficult to prove cartelization in the case of cement companies due to involvement of large number of players here.


Cement stocks rallied between 10-15% in last two weeks against a 2% rally in broader indices on the expectation that the penalty by CCI will be amuted one. Apart from the penalties, we believe that pricing power of the cement companies could be at risk going forward as the utilization rate is expected to be lower in the next two years and at the same time, rising cost pressures could put earnings at risk. We expect the premium valuation of large players under our coverage to come down due to possible regulatory risks on the sector and maintain Sell rating on ACC, Ambuja and Ultra Tech. We have a Hold rating on Grasim Industries. We have a Buy rating on the mid-sized players under our coverage (India Cements, JK Cement, Orient paper & industries and Shree Cement) considering attractive valuations. However,we expect India Cements andJKCement to be underpressure for some time post this adverse ruling.


The findings of the Director General of CCI are summarized below:
 Top 12 companies ACC, Ambuja Cement, Ultra Tech, Jaypee Cement, India Cements, Shree Cement, Madras Cement, Century Cement, JK Cements, JK Lakshmi Cement, Binani Cement and Lafarge India Pvt Ltd control ~75% market share of cement in India. Therefore the focus of investigation was primarily on the top companies to investigate whether cementmanufacturers are engaged in anti-competitive practices.


 There has been a continuous divergence between the cement price index and the index price of various inputs like coal, electricity and crude petroleum and the gap has widened since 2000-01. The price of cement is rising faster than input prices.


 The price of cement has risen to Rs300/bag in March 2011 against Rs150/bag in 2004-05 whereas, during the same period, the cost of sales has increased by ~30%. It believes that the price of cement is independent of the cost of sales. The price of cement is changed frequently by all the companies, sometimes even twice
in a week.


 Even if the decision of price change is taken independently by different companies, the prices of competitors are monitored closely to respond to any price change made by them. The cost of production does not play an important role in the decision of pricing of cement except when there is substantial change in taxes or the cost of rawmaterial.
 The price is also affected by the price changes made by market leaders and the price of other players is regularly observed.


 Although, the companies claimed that the price is decided on market feedback, there was no formal or systematic mechanism or documentation system to substantiate the argument of reliance on market feedback for affecting price changes. The DG believed that the companies are having a centralized decision making system and the communications between dealers and the companies merely reflect the prices to be charged and not the reason or any data to show that there is more demand. The companies were also unable to explain how the demand ismeasured at a particular point of time.


 The DG also found that the coefficient of correlation of change in prices or the movement of prices of all the companies is positive and very close to each other (more than 0.5%) giving a strong indication of price parallelism. It believes that the price of the cement of different companies has moved in a particular direction in the entire country in a given period of time and hence, it believes that this price parallelism is indicative of price consulting among the companies.


 The examination of smaller players revealed that they simply follow the trend ofmajor players.


 According to DG, the cost of production varies from company to company; therefore, the price of individual companies must also vary. Therefore, it believes that the movement of price of all the companies in the same range and in the same direction is not possible unless there is prior consultation and discussion about the prices among them.



Our take and view on this judgment by CCI is as follows:

 Hefty penalty imposed on 10 cement players: Cumulatively, the penalty imposed on the 10 cement players (ACC, Ambuja, Ultra Tech, JP Associates, India Cements, JK Cement, Century Textiles, Madras Cements, Binani Cement and Lafarge India) stand at Rs63bn and ranges between 3-8% of current market cap for large players and 7-13% of current market cap for mid-sized players. Amongst the large players the highest penalty of Rs13.2bn (8.3% of current market cap) has been imposed on JP Associates and amongst mid-sized players JK Cement has been hit the most with a penalty of Rs1.3bn (12.5% of current market cap). Apart from the 10 cement players, CCI has also levied a penalty of Rs73mn (10% of total receipts for 2 years) on Cement Manufacturers Association citing that it has facilitated cartelization by providing platform to cement companies.

 Cement companies penalized on the basis of their profits and not on the turnover: CCI has calculated the penalty at 0.5x the net profit for FY10 (from May 20, 2009 as the enforcement provisions of the Act came into effect from this date) and FY11. In earlier instances (DLF, gas cylinder makers and aluminium phosphide tablet manufacturers), the commission had levied penalty based on the average turnover of last three years’ and on this basis the penalty on cement manufacturers would have been much lesser than the currently imposed penalties.

 Earnings could get impacted by 49-91% for coverage companies: The penalty imposed by CCI ranges between 49-91% of the profit for FY13E. Amongst bigger players under our coverage, the penalty imposed on ACC is 91% of its CY12 earnings. For JK Cement, the penalty is 63% of its FY13E earnings and for India Cements it stands at 49% of FY13E earnings. Amongst uncovered companies, Century Textiles has been affected the most and based on Bloomberg consensus’ estimates the penalty imposed is at 157% of its FY13E earnings, whereas, for JP Associates, the same is at 106%.

 Ruling likely to be challenged in Competition Appellate Tribunal (CAT): We believe that the ruling of CCI will be challenged in CAT considering historical evidences of other sectors. The companies may also move to the Supreme Court of India after an adverse judgment from CAT. As per the Competition Act, the companies may appeal against the CCI order in CAT within 60 days of receiving the order. Also, if the companies get a stay order fromthe CAT, they will not have to shell out the penalty immediately, which we believe is the most likely scenario. For instance, DLF got a stay order from CAT in November 2011 for the penalty imposed by CCI in August 2011 and the hearing in CAT is still going on.

 Pricing power of the companies could be at risk going forward: We believe that post this ruling, the pricing power of the cement companies could be at risk considering further regulatory issues and chances of CCI coming in action again in future at a time when the utilization rate of the industry is low and cost pressures are rising. It could also be difficult for the cement manufacturers to pass on the rise in input costs (expected increase in coal prices and freight costs in the near future) to consumers.

 Regulatory risk and future investigation fromCCI prevail: The ruing of CCI also points out to a “cease and desist” order to the companies and directs them that they should not involve in any activity related to agreement, understanding or arrangement on prices, production and supply of cement in the market. Though, the order does not warn the companies for a greater penalty in future, one of the senior members of CCI stated on the news channel (CNBC) that if the committee feels that the companies are forming cartel in future, theymay investigate again and impose heftier penalty on the companies (as per the Competition Act, CCI may impose penalty up to 3x of annual profits made out of cartel arrangement). The state government

may also put pressure on the cement manufacturers to cut the prices (for instance, Himachal Pradesh government asked cement companies to bring down the prices by Rs25/bag in January 2012) post this order.

 Maintain Sell on large players, valuation premium may erode: We maintain our Sell rating on large players under our coverage (ACC, Ambuja and Ultra Tech) considering rich valuations. The large three companies (ACC, Ambuja and Ultra Tech) are enjoying premium multiple (8-10x) to their historical valuations (7-8x) despite concerns on the earnings and deterioration in return ratios. We believe that further regulatory risks could erode the premium assigned to these companies and can dampen the investors’ sentiments. We have a Hold rating on Grasim Industries. We have a Buy rating on the mid-sized players under our coverage (India Cements, JK Cement, Orient paper & industries and Shree Cement) considering attractive valuations. However, we expect India Cements and JK Cement to be under pressure for sometimes post this adverse ruling.

RISH TRADER