Myirisbreport.myiris.com/NFASIPL/SHRCEMEN_20111208.pdf · Rock solid Production discipline should keep pricing high and lift stocks to mid-cycle valuation Contrary to much of the

Rock solid

Production discipline should keep pricing high and lift stocks to mid-cycle valuation

Contrary to much of the Street’s view, we expect Indian cement stocks will continue to strengthen, thanks to production discipline and large producers not chasing market share irrationally.

Asset-based valuation is more stable than an earnings-based approach, in our view. We look at mid-cycle EV to replacement cost to determine fair value.

We initiate coverage on six stocks, with a non-consensus Buy on Ambuja and the highest TPs on the Street for Shree and Grasim.

Key analysis in this anchor report includes:

• A detailed look at sources of cement demand, including rural housing, organised urban real estate and infrastructure construction.

• Breakdown of cement manufacturing costs and industry profitability at various utilization levels.

• How the cost structure affects producers’ ability to maintain production discipline.

• Our valuation method based on mid-cycle EV to replacement cost.

EQUITY RESEARCH

AN

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December 8, 2011

Research analysts

India Construction Materials

Aatash Shah - NFASL [email protected] +91 22 4037 4194

Vineet Verma - NSFSPL [email protected] +91 22 4053 3675

See Appendix A-1 for analystcertification, important disclosures and the status of non-US analysts.

India cement

India cement

CONSTRUCTION MATERIALS

EQUITY RESEARCH

ANCHOR REPORT: Rock solid

Production discipline should keep pricing high and lift stocks to mid-cycle valuation

December 8, 2011

Non-consensus view: Profitability and ROCE to improve We expect the strong performance of cement stocks to continue, thanks to pricing discipline in the sector. We think that bearish Street views are mistaken as they might be extrapolating the current low capacity utilization to a fall in cement prices and hence a decline in profitability. On the contrary, we find cement producers have already displayed discipline in terms of supply matching demand and are taking price hikes through. We believe this discipline will continue as they favour profitability over market share gains. This should lead to EBITDA/tonne improving towards the up-cycle levels by FY14F, which would act as a launching pad for ROCE once demand picks up and capacity utilization increases.

Demand pick up in FY14F; large capacity additions only in case of profitability According to our bottom-up demand analysis, we believe demand growth is unlikely to move lower from here, while a pick-up could start in 2HFY13F and continue into FY14F on the back of the stable growth in unorganised housing, higher investment in infrastructure and government spending around upcoming elections. Our analysis of capacity additions by company suggests a worst-case utilization rate of 78% in FY14F with potential upside risk, as unless profitability improves, some capacity could be delayed or shelved.

Cement companies likely to trade at mid-cycle multiples Unlike the consensus view, which has been impacted by low capacity utilization and believes that the sector will enter a down-cycle, we believe that return ratios will continue to remain at mid-cycle levels and will trend towards up-cycle levels when utilization moves up over the longer term. In this situation, we believe stocks should trade at mid-cycle levels in terms of their asset-based valuation multiples. We favour a mid-cycle EV to the replacement cost multiple methodology to value the stocks.

Ambuja and Shree our top picks; Neutral on ACC and UTCEM We initiate coverage on six companies with a non-consensus Buy on Ambuja, Buys on Shree Cements and Grasim with the highest target prices on the Street, and non-consensus Neutrals on ACC and Ultratech. We also initiate coverage on India Cements with a non-consensus Neutral. We prefer companies that have non-southern India exposure given the large and persistent overcapacity in the southern region.

Fig. 1: Stocks for Action – Buy Ambuja, Shree and Grasim

Source: Nomura estimates. Prices are as of 2 December 2011.

Anchor themes

We believe production discipline in the sector is likely to continue, enabling companies to increase pricing and maintain mid-cycle ROCE while moving towards upcycle profitability. Demand should bounce back in FY14F, while capacity utilization should bottom out in FY13F.

Nomura vs consensus

We are largely in line with consensus on earnings, but consensus is ascribing the down-cycle rather than the mid-cycle multiple.

Research analysts




Tickers Price Rating PT Upside (%)Ambuja Cement ACEM IN Equity 160.6 BUY 186 16%Shree Cement SRCM IN Equity 2,131.6 BUY 2,933 38%Grasim GRASIM IN Equity 2,451.4 BUY 3,014 23%UltraTech UTCEM IN Equity 1,176.7 Neutral 1,259 7%ACC ACC IN Equity 1,214.0 Neutral 1,155 -5%India Cements ICEM IN Equity 75.6 Neutral 80 6%

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

Nomura | India cement December 8, 2011

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Contents

4 Investment summary

4 We initiate coverage on the sector with a non-consensus positive view

4 Production discipline to continue

4 Demand – Bust in FY12F, robust in FY14F

5 Capacity – In the worst case, utilization to improve in FY14F

5 Cost increases likely to be moderate

5 Profitability likely to move up toward up-cycle levels

6 Regional favoritism – we prefer non-south exposure

6 Valuation methodology – we prefer asset-based methodology

6 Where are we different from consensus

7 Risks to our view

8 Our view on cement company stocks and valuation methodology

9 Valuation methodology

11 Where are we different from consensus

14 The history behind the mystery

17 Demand – Bust in FY12F; robust in FY14F

17 Why did demand growth suddenly collapse when GDP growth was reasonably strong? Is there actually a strong correlation with GDP growth?

21 How are the demand drivers likely to perform over the next two-three years?

34 Capacity – Piling on the tons

34 What are the upcoming plans of various cement players in terms of capacity addition? What does the capacity utilization picture look like for the next three years?

39 Cost of production – Not likely to repeat past trend

39 How are key costs likely to move from current levels?


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46 Cement pricing – Up, up, but not away

46 The most important question – Will production discipline break?

50 Will production discipline break if the cost of production declines?

50 Will production discipline break if demand shows a sharp spurt?

50 Risks to our view on production discipline

52 Ambuja Cements

62 Shree Cement

71 Grasim Industries

77 UltraTech Cement

85 ACC

93 India Cements

102 Appendix A-1


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Investment summary

We initiate coverage on the sector with a non-consensus positive view

We have a positive view on the India cement sector, driven by our belief that: 1) the current maturity and discipline among producers will persist; 2) demand growth is likely to bounce back in 2HFY13F; 3) FY14F will be driven by increased investment in infrastructure and government spending before the state and central elections; and 4) there will be a likely improvement in capacity utilization in FY14F even after assuming worst-case capacity additions; while 5) cost increases are likely to be moderate in the medium term due to the weak global macro conditions.

We believe these factors should lead to increasing profitability in terms of EBITDA/ton toward up-cycle levels and the sustenance of return ratios at mid-cycle levels over the next two years. In our view, this should allow cement stocks to trade at mid-cycle asset-based valuation multiples.

We initiate coverage on Ambuja Cements (ACEM IN) with a non-consensus Buy rating, Shree Cements Ltd. (SRCM IN) with a Buy rating and the highest target price on the Street, Grasim Industries (GRASIM IN) with a Buy rating and again the highest target price on the Street, and ACC Ltd. (ACC IN), Ultratech Cement Ltd. (UTCEM IN) and India Cement Ltd. (ICEM IN) with non-consensus Neutral ratings.

Production discipline to continue

Continued production discipline, we believe, will be the key to the fortunes of the industry over the next two years. While we recognize the scale of overcapacity in the industry, we believe producers will continue to avoid a price war. In our opinion, it is better to be profitable on lower volume than to make losses on momentarily higher volume and finally record larger losses on lower volume. We believe that cement companies have learned the lessons of FY02-03 and 2QFY11 well, when companies broke production discipline, fought on price and ended up making losses or very low profits. Companies have realised that fighting on price in a fragmented market is a lose-lose situation, while maintaining production discipline is a win-win scenario. There is no win-lose scenario in this industry, where competitors will be quick to cut prices to maintain market share.

Our view is based on four factors:

• Cement is a price-inelastic commodity; cutting prices will not increase demand

• Market share cannot be gained in an environment where everybody has surplus capacity, only profits can be lost

• Losses will occur throughout the industry if a manufacturer tries to be too adventurous

• The top six players control more than 50% of the industry

We believe cement manufacturing firms will have a profitability-targeting strategy in terms of EBITDA/ton to ensure that the ROCE on new plants (replacement cost) is maintained at the very least at 12% (equal to the weighted average cost of capital at D:E of 1:1) in the medium term. Currently, at the average level of profitability in the industry, the ROCE is closer to 10.5%. We believe cement firms thus realize the need to increase their profits and profitability to make their new expansions viable before thinking of market share gains. We expect prices to increase at a CAGR of 6.5-7.0% in FY13F-FY14F.

Demand – Bust in FY12F, robust in FY14F

Cement demand growth was less than 5% in FY11 and is likely to record another year of below 5% growth in FY12F. We believe this is a cyclical slowdown in terms of growth driven by decreased government spending on housing and infrastructure in the past two years, and demand growth is unlikely to fall from these levels, in our view. At the


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moment, demand is at a level where it will be supported by the rock-steady demand from unorganized and self-constructed rural housing, which is likely to continue, growing at a rate of 7.5% p.a, according to our estimates. We foresee the situation improving partly in FY13F and mainly in FY14F as investments in infrastructure bounce back while government spending improves given the spate of state elections slated for FY13F and FY14F, along with the general elections in FY14F. Within this report we provide a bottom-up analysis of cement demand. We foresee cement demand growing at 4% in FY12F, 8.1% in FY13F and 10.9% in FY12F. We also provide an analysis suggesting why cement demand growth has, at best, a tenuous linkage with GDP demand growth and its components, which is also unlikely to hold true every year – something that goes against popular opinion.

Capacity – In the worst case, utilization to improve in FY14F

We have done a company-wise study of upcoming cement capacity and have estimated upcoming capacity additions in each year and region to FY14F. From our analysis, we expect effective capacity additions to slow from the very high levels seen in FY10 and FY11, but to still remain historically high at 26mnT in FY12F and 28.5mnT in FY13F, before falling in FY14F to 16.5mnT. In our view, some of this cumulative 71mnT of capacity addition could be delayed or shelved if profitability fails to pick up. Keeping this in mind, we believe our capacity addition estimates are possibly the worst case, and our capacity utilization estimates of 75% for FY12F, 74% for FY13F and 78% for FY14F could have potential upside risks. We believe our utilization estimate of 78% for FY14F is among the lowest on the Street. At the same time, we believe that a utilization range of 80-85% is likely to be the ‘new normal’ for the industry, and a 90%+ level may not be seen for many years.

Cost increases likely to be moderate

While costs, especially those for coal and freight, have increased rapidly over the past two years, we expect cost increases, if any, to be moderate in the medium term as the weak global macro environment starts impacting global commodity prices. Though Coal India did increase prices for linkage coal in March 2011 by 30%, international coal prices have already come off from their FY11 peaks of by about 18% in USD terms while in INR terms they are flat vs. the past year levels. With the global macro environment weakening and growth in China also set to slow, according to our China economics team, we believe coal prices are unlikely to move up from current levels. Petcoke, which is used by Shree Cements, has seen its price move down as Europe, which is the chief user of petcoke, is in the doldrums. If power and fuel costs, which account for almost 30% of overall costs for cement companies, remain flat, overall cost increases should remain slow, in our view. Risks, though, do exist on raw material cost and freight costs, as the approval of a new mining bill could lead to a doubling of royalty payments on limestone, while any increase in diesel prices could lead to an increase in freight costs – though visibility on this remains low. We expect the cost of production to increase at a CAGR of 6% over FY13F-FY14F.

Profitability likely to move up toward up-cycle levels

Profitability for most companies in terms of EBITDA/ton is currently trending near up-cycle levels, and with gradual price hikes should move to up-cycle levels by FY13F-FY14F. Return ratios in terms of ROCEs, though, would still be subdued at mid-cycle levels given the lower capacity utilization. Once growth in terms of cement demand kicks in by FY14F, the up-cycle levels of profitability would provide a launching pad for the ROCEs to move up to the up-cycle levels too. If profitability levels do not move, the anticipated capacities will not come through, leading to higher capacity utilization in the industry and for existing players, which itself has the potential to increase profitability and return ratios on older capacities, though over a longer time period.


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Regional favoritism – we prefer non-south exposure

Excess capacity and capacity utilization are problems mainly faced by the southern region, and to an extent the western region, whereas other regions are still showing healthy utilization levels, in our view. Cement from the southern region could only be transported in sizeable quantities to Maharashtra in the western region and Orissa and Chhattisgarh in the eastern region. Hence, manufacturers from the south cannot disturb the competitive situation in most of the north, central or eastern regions. Also, with increasing freight costs, a difference of only INR750/ton could make it remunerative for players in the south to sell into other regions. This difference does not exist at all today. In fact, prices in the south are currently the highest in the country, though we believe they are likely to get discounted a bit in the future. Essentially, manufacturers located in the north, central, east and Gujarat in the west are isolated from the excess capacity in the south. We prefer non-south exposure as risks to production discipline are the highest in the south. Ambuja Cement and Shree Cements, on which we have a bullish view, have no exposure to the south.

Valuation methodology – we prefer asset-based methodology

In our opinion, valuing a cyclical commodity industry or company based on earnings would be difficult given the volatility in earnings. Earnings are far more dependent on the price than on the volume of the commodity being sold, and while it isn’t difficult to predict the volume, it is much tougher to predict prices. When the dynamics of the sector are likely to change in terms of the stage of the cycle, earnings estimates usually get revised significantly due to the non-linear impact on the price of the commodity. This makes earnings-based multiples irrelevant, in our view.

In our opinion, for such an industry the asset-based valuation methodology works best in smoothing out the volatility and providing a more stable value for the company. It is still important to recognise the stage of the cycle while providing the asset-based valuation.

We prefer to value the companies on an EV/ton basis using a premium or discount of the EV/ton to the replacement cost. We believe the sector’s return ratios are in the mid-cycle range and we offer mid-cycle EV to replacement cost multiples adjusted for the one –year forward ROCE vs. the mid-cycle ROCE levels to value the companies. We believe replacement costs have gone up substantially over the past 10 years driven by the increase in the cost of equipment, land and the addition of power plants and logistics infrastructure to the mix in the past three-four years. We estimate the current replacement cost to be USD130/ton, or INR6,250/ton at INR48/USD.

Where are we different from consensus

Consensus is largely negative on the sector, driven by its concerns over low capacity utilization and the belief that low utilization will bring cement prices down, while cement stocks’ valuations are not building this in.

We believe consensus is focusing too much on low capacity utilization in the southern region and ignoring companies’ profitability in terms of EBIDTA/ton, which is trending closer to up-cycle levels, or return ratios, which are at mid-cycle levels. The consensus belief that prices are likely to fall because of low utilization is flawed, in our view, because low utilization leads to supply matching demand, and as long as this is the case, prices should not fall and should stay at lower levels.

The Street believes that capacity will keep getting added while profitability goes lower. We think that a chunk of the planned capacity additions will not materialise if the profitability of cement companies fall from here, as new capacity will not be viable at all. The consensus expects costs to keep rising in line with the previous two years, while we believe cost increases will moderate over the next two years.

In addition, the consensus view is that return ratios will remain low in comparison with the FY06-FY09 boom period. We believe that these are mid-cycle levels and value the stocks accordingly. The Street seems to be confused with regard to the current stage of


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the cycle, as it assumes capacity utilization to bottom in FY13F and move up in FY14F while projecting earnings which are mid-cycle, in our view, but offer down-cycle multiples based on earnings.

Risks to our view

• The sustenance of the accusation of cartelization against cement companies: If the production discipline and supply matching demand are considered by the authorities as “cartelization” by cement manufacturers, there could be fines in the offing for cement companies, and this could affect our view on the sector. While there have been allegations of cartelization against cement firms almost every other year, they have been difficult to prove in an industry with 50 different players and the absence of any super-normal profits.

• A breakdown in production discipline: In case there is a surprise breakdown in production discipline, cement prices are likely to fall, in our view, impacting profitability across the board, especially in the south.

• Slower-than-anticipated demand growth: If the investments in infrastructure continue to remain slower than normal over the next two years too, demand would be lower than our estimates, and so would utilization rates.

• Higher than anticipated capacity additions: While we believe we have taken into account the worst case capacity additions estimated till FY14F, if the additions turn out to be higher than our estimates, capacity utilization may head even lower, impacting our view.

• A sharp increase in cost: In case cost, especially that of coal and freight, increases sharply, profitability may not improve to our estimated levels and could be a risk to our view.


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Our view on cement company stocks and valuation methodology Based on our analysis, we initiate coverage on the sector with a positive view. The key points which make us positive are:

• Demand growth is going through a cyclical downturn and is quite possibly at a level where it will be supported by the significantly steady demand from unorganized and self-constructed rural housing. The slowdown should last for FY12F and partly through FY13F before picking up in 2HFY13F and FY14F, in our view, as investments in the country restart. India has never witnessed two consecutive years of sub-5% growth in cement demand, and we think a third year of low growth is extremely unlikely.

• Production discipline is unlikely to break down, as current profitability levels are close to the up-cycle levels and manufacturers are unlikely to take any risk on this in an environment where cost has put severe pressure on them. The difference between the situation in FY02-03 and today is that overcapacity is far more severe and further capacity is still coming through, while demand growth is weaker. In FY02-03 some manufacturers could afford to be adventurous knowing that the capacity utilization situation would reverse itself in a year’s time through the growth in demand and no significant capacity being added. Today, any attempt to be adventurous would likely lead to a sharp and possibly elongated downturn, which no manufacturer can afford. Maintaining status quo is the win-win strategy, in our view.

• Capacity utilization is a problem, mainly in the southern region and to an extent in the western region, whereas other regions are still showing healthy utilization levels. Cement from the southern region can only be transported in sizeable quantities to Maharashtra in the western region and Orissa and Chhattisgarh in the eastern region. Hence, manufacturers from the south cannot disturb the competitive situation in most of the north, central or eastern regions. Also, with increasing freight costs, only a difference of INR750/ton and upward could make it remunerative for players in the south to sell in other regions. This difference does not exist at all today. In fact, prices in the south are currently the highest in the country, though probably likely to get discounted a bit in future. Essentially, manufacturers located in the north, central, east and Gujarat in the west are isolated from the excess capacity in the south.

• Our estimates for capacity addition in the next three years are, in our opinion, at the worst-case levels, as there could be delays or even the shelving of a few projects that could turn out to be unviable. In our opinion, either profitability levels have to move up from here or manufacturers will realize that their new capacity addition plans are unviable. If profitability levels do not move, the anticipated capacity will not all be realized, leading to higher capacity utilization in the industry and for existing players, which by itself has the potential to increase profitability and return ratios on older capacities.

• Costs have increased substantially for cement companies over the past two years, leaving them with no choice but to increase prices in the face of low demand. Over the next years we expect cost increases to be moderate, given the global macro environment, especially for coal and other fuel. The slower growth in cost should enable cement manufacturers to focus on increasing their profitability rather than just increase prices to play catch-up with cost, in our view.

• Profitability for most companies is currently trending near up-cycle levels and with gradual price hikes should move to up-cycle levels by FY13F-FY14F. Return ratios in terms of ROCEs, though, could still be subdued at mid-cycle levels given lower capacity utilization. Once growth in terms of cement demand kicks in by FY14F, the up-cycle levels of profitability would provide a launching pad for the ROCEs to move up to up-cycle levels, too.

• Replacement cost or cost of setting up a new capacity keeps moving up every year, making existing capacities more attractive for new entrants.

• Cement companies are cash rich and in the current macro environment we believe being cash rich is likely to earn extra brownie points from investors. Cash is generally a burden only during the up-cycle when investing it in the business would generate higher returns.


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Valuation methodology

In our opinion, valuing a cyclical commodity industry or company based on earnings would be incorrect given the volatility in earnings. Earnings are far more dependent on the price of the commodity than the volume of the commodity being sold and while it is not difficult to predict the volume, it is much tougher to predict prices.

When the dynamics of the sector are likely to change in terms of the stage of the cycle, earnings estimates usually get revised drastically due to the non-linear impact on the price of the commodity. This makes earnings-based multiples irrelevant, in our view. Also what most analysts tend to forget is that for a commodity company, earnings multiples are usually at their highest when the company is at the bottom of the cycle supported by the discount to the asset value and multiples tend to move down as the cycle improves. When the company is at the top of the cycle, multiples tend to be on the lower side again, restricted by the premium to the asset value.

In our opinion, for such an industry, the asset-based valuation methodology works best in smoothing out the volatility and providing a more stable value for the company. It is still important to recognise the stage of the cycle while providing the asset-based valuation.

We prefer to value the companies on an EV/ton basis using a premium or discount of the EV/ton to the replacement cost. To calculate the multiple to the replacement cost, we look at the historical multiples across the cycles and based on the current cycle of the industry, we use the average multiple in a similar cycle in history. To recognise at which point in the cycle is the industry in, we compare the expected return ratios (ROCE) of the companies vs. their historical ROCEs across cycles. The average of the up-cycle and down-cycle ROCEs gives us the mid-cycle ROCEs. To derive a more accurate multiple to the replacement cost, we then adjust the multiple by the ratio of the one-year forward ROCE to the average ROCE during a similar cycle, thus bringing an element of earnings into the picture but not making the valuation completely dependent on earnings.

Fig. 2: Hypothetical example of valuation methodology

Source: Nomura estimates

Our view on the current stage of the cycle Since FY01 the sector has gone through a down-cycle between FY01-FY05 and then an up-cycle between FY07-FY10 with mid-cycle levels in FY06 and FY11. We believe that the expected ROCEs of the cement companies under our coverage compare very well with the mid-cycle ROCE level.

in INR/ton

FY13F ROCE (a) 32%

Average up-cycle ROCE (b) 30%

Average down-cycle ROCE [c] 14%

Average mid-cycle ROCE (d) 22%

Average up-cycle EV/ton multiple to prevailing replacement cost (e) 1.70

Ratio of 1 yr fwd ROCE to average up-cycle ROCE (f=a/b) 1.07

Target EV/ton to replacement cost multiple (g=e*f) 1.81

Current replacement cost (h) 6,250

Target EV/ton (i=g*h) 11,333

Conclusion: Company is in an up-cycle


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Fig. 3: ROCE over the cycle

Source: Company data, Nomura research

Based on this, we believe that the companies deserve to trade at the mid-cycle EV to replacement cost multiples and value the companies accordingly. The calculation of the replacement cost per ton becomes crucial here and we calculate it as below based on our interaction with equipment suppliers and cement companies. This is the cost it would take for a new cement plant to be set up from scratch.

Fig. 4: Calculation of current replacement cost per ton

Note: Calculated at INR48 to 1USD

Source: Industry data, Nomura estimates

We believe replacement cost has gone up substantially over the past 10 years, driven by the increase in the cost of equipment, land, and the addition of power plants and logistics infrastructure to the mix in the past three-four years.

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Interest during construction 15 720

Others 8 384

Total only for cement plant 110 5,280

Power plant 12 576

Logistics infrastructure 8 384

Total investment 130 6,240


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Fig. 5: Increase in replacement cost

Source: Industry data, Nomura estimates

Where are we different from consensus

Consensus is largely negative on the sector driven by its concerns on the low capacity utilization and its belief that the low utilization will bring cement prices down while cement stocks’ valuations are not building this in. Where are we different?

• We believe consensus is focusing too much on the low capacity utilization in the southern region and ignoring the profitability in terms of EBIDTA/ton of the companies which is trending closer to the up-cycle levels or the return ratios which are at mid-cycle levels.

• Consensus’ belief that prices are likely to fall because of low utilization is flawed, in our view, because low utilization leads to supply matching demand, and as long as this is the case, prices cannot fall and stay at lower levels. While we do not expect cement prices to show a runaway increase from here, prices could definitely move up enough for cost increase to be covered at the very least as has been the case in the past 1.5 years.

• Consensus believes that capacities will keep getting added while profitability goes lower. As explained above, we think that a chunk of the planned capacities will not come up if the profitability of cement companies fall from here, as new capacities will not be viable at all. Giving the example of falling profitability and the large addition of capacity in FY11 is incorrect as the capacities were at a fairly advanced stage of construction and the lower level of profitability was only a year old.

• Consensus expects costs to keep rising in line with the previous two years, while we believe cost increase will moderate in the next two years.

• Consensus expects return ratios to remain low in comparison with the FY06-FY09 boom period. We believe that these are mid-cycle levels and value the stocks accordingly.

• Consensus seems to be confused with regard to the stage of the cycle, as it forecasts capacity utilization to bottom in FY13F and move up in FY14F, while projecting earnings that are in the mid-cycle, in our view, but are offering down-cycle multiples.

The charts below show how consensus EPS estimates and target prices have changed for each of the companies since their 3QFY11/4QCY10 results. Consensus has consistently increased its target prices for ACC, ACEM and UTCEM without changing its view, while for ICEM it has brought down the target price while upgrading the stock. Consensus is most negative on ACC and ACEM, where it has increased the target price without changing its earnings estimates, suggesting a move towards mid-cycle valuations.

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Fig. 6: Consensus EPS estimates for ACC

Source: Bloomberg, Nomura research

Fig. 7: Consensus target prices and ratings for ACC


Fig. 8: Consensus EPS estimates for ACEM


Fig. 9: Consensus target prices and ratings for ACEM


Fig. 10: Consensus EPS estimates for UTCEM


Fig. 11: Consensus target prices and ratings for UTCEM


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13

Fig. 12: Consensus EPS estimates for SRCM


Fig. 13: Consensus target prices and ratings for SRCM


Fig. 14: Consensus EPS estimates f r ICEM


Fig. 15: Consensus target prices and ratings for ICEM


Fig. 16: Consensus EPS estimates for Grasim


Fig. 17: Consensus target prices and ratings for Grasim


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14

The history behind the mystery Large cement capacity addition in FY10 and FY11… Over the past couple of years, cement manufacturing capacities have sprung up in India at an unprecedented pace, driven by the high demand and capacity utilization witnessed between FY04-09. Capacity has increased by 90 mnT or c.42% of the existing year-end capacity in FY09. With capacity utilization reaching 97% between FY07-FY09, cement firms across the board felt the need to expand, especially looking at the 8%-10% growth rate in demand. With capacities taking two-four years to set up, most of the expansion plans saw the light of the day only in FY10-FY11 and the last leg of those expansion plans will come on line in FY12-FY13.

Fig. 18: Trend in capacity addition vs. utilisation level

Source: CMA, Nomura research

…just as demand growth takes a tumble The demand for cement in India had averaged around the 9%-mark since FY03 till FY10 and it is said that cement demand growth in India usually averages about 1.25x the GDP growth in the country (we shall question this link later in the report). In FY11, to everybody’s surprise, demand growth fell to just 4% y-y and has refused to budge, registering only a 3.5% growth y-y in 1HFY12. Considering that GDP growth has been healthy at 8.5% in FY11 and is expected to be 7.4% in 1HFY12, these growth rates are not in sync for the past 1.5 years now. The addition to demand has been just 12.3 mnT or 6.1% of the FY10 demand levels in the past 18 months.

Fig. 19: Growth in cement demand


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So, cement prices collapsed? Wrong Traditionally, when capacity surplus has been high in the system, cement prices have fallen following a fight to maintain market share, though newer capacities do remain underutilised. This situation was last witnessed during the down-cycle of FY01-FY03, when prices fell 10%-15% as capacity additions were to the tune of almost 27% of the earlier prevailing capacity in FY00. This led to some firms, especially in South India, reporting losses.

This time it’s different. While prices did fall significantly in 2QFY11 (INR50-60 per bag was the fall in prices), manufacturers were quick to flip back the pages and revise their lessons of FY01-03. Call it as manufacturers’ ‘maturity’ or an ‘informal arrangement’, but production was quickly cut to bring it in line with demand. Capacity utilization is now at decade lows and would head lower if demand does not recover. This production discipline, though, helped prices to recover not only the earlier losses but also reach close to their peaks. This ‘maturity’ has also been forced onto the manufacturers due to the increasing production cost for cement.

Fig. 20: Trend in capacity utilisation vs. cement realisation


Cost increase is pinching pockets, limiting the profitability to mid-cycle levels The cost of cement production grew by ~60% between FY01 and FY09, and since then has grown by 15% till FY11. The overall cost of production has increased by c.INR 340/MT of cement since FY09. The increased cost has been primarily driven by fuel and freight costs as prices of coal have increased while freight costs have been driven by the increase in diesel prices and wages. A key factor has also been the lower availability of linkage coal in India leading to the higher dependence on costly imports and shortage of railway wagons leading to a shift towards expensive road transport. Raw material cost has also gone up due to higher royalties and power companies charging for fly-ash, which earlier used to be supplied at negligible cost.

The increase in cement prices, thus, has gone more towards maintaining profitability rather than increasing it.

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Fig. 21: Trend in COP, EBITDA per tonne and ROCE

Source: Company data, Nomura estimates

The mysterious outperformance of cement stocks despite the average scenario Frontline cement stocks have outperformed the BSE Sensex by 15%-32% over the past one year and are close to their life-time highs, while consensus has remained negative on the names on expectation of lower profitability levels, bleak demand growth outlook and the fear of production discipline breaking down.

Fig. 22: YTD relative performance of cement stocks vs. BSE


Fig. 23: Consensus FY13 (or CY12) EPS change


Read on for the solution to this mystery To get to the bottom of why cement stocks are trading at current valuations and whether they are justified or not, we asked several questions/raised points, which are answered/analysed in this report. Some of the key questions are below:

• Why did demand growth suddenly collapse when the GDP growth was reasonably strong? Is there actually a strong enough correlation with GDP growth?

• How are demand drivers likely to perform in the next three years?

• What are the upcoming plans of various cement players in terms of capacity addition?

• The most important question – Will the production discipline break?

• How are key costs likely to move from current levels?

• What is the appropriate valuation methodology?

• Where do we see the stocks moving from here?

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17

Demand – Bust in FY12F; robust in FY14F

Why did demand growth suddenly collapse when GDP growth was reasonably strong? Is there actually a strong correlation with GDP growth?

Cement volume growth in FY11 was extremely weak at 4% y-y, and in 1HFY12 the weakness continued, with only a 3.5% y-y growth. Considering that GDP growth in FY11 was 8.5% and our economists expect 1HFY12 GDP growth to be a still healthy 7.4%, this anemic growth goes against the generally accepted statement that cement demand grows in tandem with GDP growth and the average demand to GDP growth multiplier is 1.25.

Clearly, anecdotal evidence suggests that the infrastructure and real estate segments in India have slowed down significantly in the past 1.5 years. We looked at the annual growth in the aggregate revenue of companies in the sectors which are consumers of cement viz. construction firms and property developers. The growth in revenue for these firms typically translates to an increase in construction activity and hence cement consumption. There has been a slowdown in FY11 for both the sectors vs. the growth rates witnessed in FY05-08. Though the growth rate for property developers seems to have recovered in FY11, FY12 is likely to see a dip again, noticing the 1HFY12 performance.

Fig. 24: Aggregate revenue growth for cement consuming sectors

Note: Data for 34 construction firms and 16 property developers

Source: Ace Equity, Nomura research

The major consumer of cement in India, though, is the unorganised sector, including self-constructed housing, mainly in rural India. Data is unavailable with regard to this segment of cement consumption, but we look at two large rural housing programmes for the poor, Indira Awas Yojana and Indirramma Housing, run by the central government and by the state of Andhra Pradesh as a proxy for rural housing development. Both these programmes witnessed slower pace of housing completion in FY11. For Indirramma, FY12 does not appear to have gotten off to a bright start and completions are likely to be the same as in FY11. Each rural house of 250sqft constructed under the Indirramma scheme consumes two tons of cement, and this scheme was a significant contributor to cement consumption, to the extent of 9% in FY09 in Andhra Pradesh, which consumes almost 10% of India’s cement. In FY11, this demand would have declined by 2.6mnT over FY09, lopping off almost 1.3ppt from cement demand growth over two years. If we look at Indira Awas Yojana and consider similar usage of cement per house, the reduction in demand in FY11 was about 1.4mnT, which would have taken out another 0.75% from cement demand growth. For FY12, the central government is not targeting any growth in houses to be completed over FY11.

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Fig. 25: Housing completion under government schemes

Source: Ministry of Rural Development, AP State Housing Corporation, Nomura research

While self-constructed housing would have grown given the growth in rural income, given the high level of stock in the country, growth rates are unlikely to be high in this segment. With the number of households in India growing at ~1.6% per annum as per the Census of India 2011, this would be the base growth rate for houses constructed in India apart from the homeless getting accommodated and replacement/size enhancement of old homes. We would not expect the growth in overall housing stock to exceed 2.5% per annum. But within this, ‘pucca,’ or brick/cement/concrete constructed housing, would be much higher. As per the Census of India 2001, the growth rate in pucca houses in India was 4.3% between FY91-FY01. Given the much better growth in the economy, both urban and rural in the past decade, the growth in the stock of pucca houses would have picked up significantly and in our opinion would have been an average 6% between FY01-FY11.

Thus, cement consumption in self constructed housing in India possibly grew at 7% y-y in FY11 and 1HFY12 and contributed 50% to overall cement demand, in our view, overall cement demand grew by 3.5% y-y. But, 1.25% of this growth was taken away by the slowdown in government constructed housing. The aggregate revenue of infrastructure, construction and urban real estate space in our sample space grew by 13.5% in FY11. Accounting for a 7% inflationary impact on revenue, real growth in revenue would have been 6.5%, and with ~35% of cement consumption coming from this segment (infrastructure, construction & urban real estate), overall cement demand in FY11 grew by 2.3%. Thus, it is no surprise that cement demand in India grew by just ~4% in FY11 and continues to grow at a similar level in FY12.

Fig. 26: Approximate contribution to cement demand growth in FY11


Correlation analysis of cement demand growth with GDP growth & its components Does cement demand growth actually have a high correlation with GDP growth in India? Logically, it may seem that it should, but we think the relationship is tenuous at best and need not hold true every year.

We have run a correlation analysis of GDP growth rates and cement demand growth over the past 20 years and have found that on a one-to-one basis, there is actually no correlation between the two. When we consider GDP growth leading cement demand

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19

growth by a year, we see a better correlation, but it is still quite weak. We also look at the correlation with the various components of GDP growth in India that could impact cement demand such as growth in the ownership of real estate, construction, agriculture and gross fixed capital formation (GFCF). Again, the results are disappointing. The results in terms of the coefficient of determination, which is measured between 0 and 1, are provided below. The closer the number to 1, the better the correlation between the two variables.

Fig. 27: Correlation of cement demand growth with GDP and its components since FY91

Source: CMIE, CMA, Nomura research

Now this correlation data improve significantly if we look at the data since FY03, especially for the components, but in some cases cement demand seems to be leading the economic growth rates.

Fig. 28: Correlation of cement demand growth with GDP and its components since FY03


Clearly, agriculture growth is no determinant for cement demand, suggesting that rural housing’s dependence on higher agricultural production is not very high and poor monsoons will not impact cement demand growth which was witnessed in FY09, when despite a bad drought in India cement demand still grew at 8%.

The linkage with the ownership of real estate, construction and GFCF has increased with cement demand growth lagging them by a year, but the linkage is still not very strong.

Cement demand correlated with… Coefficient of determinationCement growth leading/lagging

GDP growth 0.13 One year lag

Ownership of real estate 0.01 No lead or lag

Construction 0.05 One year lag

Agriculture 0.09 One year lag

Gross fixed capital formation 0.10 One year lag

Cement demand correlated with… Coefficient of determinationCement growth leading/lagging

GDP growth 0.21 One year lead

Ownership of real estate 0.47 One year lag

Construction 0.36 One year lag

Agriculture 0.02 One year lead

Gross fixed capital formation 0.41 One year lag


20

Fig. 29: GDP and GFCF growth vs. cement demand growth


We then try to smooth out the volatility by looking at the three-year rolling average growth rates and checking the correlation. The correlation with GDP growth improves significantly if we look at the smoothed out data points, especially since FY03.

Fig. 30: Correlation of three-year moving averages of cement demand growth and GDP and its components


Fig. 31: Three-year moving average of GDP and GFCF growth vs. cement demand growth


While the correlation using the moving average has improved, it was only significantly strong post FY03. The correlation with the components of the GDP still remains weak. Clearly, over a three-year period cement demand growth may move in tandem with the GDP growth but the relationship need not hold true every year, as per our analysis.

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We also take a look at the multiples of cement demand growth to GDP growth over the past 20 years. Anecdotally, it is said that the average multiple is 1.25x. We find this multiple to be very volatile on a year-to-year basis, but again when looking at the three-year moving average, the volatility gets significantly smoothened out. Looking at this analysis, we notice that the multiple has reduced since FY03. Between FY91 and FY03, the average multiple was 1.33x and between FY04-FY11, the multiple declined to 1.05x, suggesting that the incremental growth in GDP was largely led by non-cement consuming sectors.

Evidently, continuing to assume a multiple of 1.25x to that year’s GDP growth rate to forecast cement demand growth would be erroneous, in our view, given the higher growth capability of the services sector in India vs. the construction sector. The multiple should actually be in the range of 1-1.1x to the three-year average GDP growth rate.

Fig. 32: Multiples of three-year moving average of cement demand growth and GDP growth


How are the demand drivers likely to perform over the next two-three years?

Doing a bottom-up analysis for cement demand is difficult given the absolute lack of data regarding its consuming industries. We still attempt to provide colour on how these segments are likely to perform in future and what could be the resultant impact on cement demand.

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Fig. 33: Contribution of each segment to cement demand


Unorganised and rural housing and ancillaries Data regarding self-constructed and rural houses in India are unavailable, and hence we can only make an estimate regarding cement consumption and growth from this segment. As we have explained in the previous section of this report, cement demand growth does not seem to be very well linked with the growth in agricultural production and hence the performance of the monsoon is unlikely to impact demand for cement in a significant manner. This is what we witnessed in FY09-FY11, where despite a drought in FY09, cement demand grew by 8% while despite good monsoons in FY11, cement demand grew by just ~4%.

At the same time, construction of a home, apart from the need, is purely driven by the income of a person and the wealth effect, both of which have increased in India and are likely to continue so in the future, as well.

If we take rural income, two-thirds of people in rural India, as per the Planning Commission of India, have their income linked to the farm. Crop prices have increased significantly over the past three years, while the government has hiked the Minimum Support Price (MSP) for various crops at a CAGR of 12% over the past four to five years.

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Fig. 34: Increase in minimum support price (MSP) for various crops

Source: Press Information Bureau

Farm income has increased substantially, and we believe this trend is likely to continue as state governments aim to appease farmers ahead of elections in various states and the general elections in India in 2014. As an example, the Uttar Pradesh government hiked the sugarcane procurement price by 17% in November 2011 ahead of the elections in the state in early 2012. Cotton farmers in Maharashtra are campaigning for a 100% increase in the MSP. On the anvil are a hike in the MSP for jute and a further hike for wheat. There are 12 states heading for elections in the next two years.

Fig. 35: States heading for elections in the next two years

Source: Election Commission of India, Nomura research

As far as the wealth effect is concerned, the primary increase in wealth for people in rural and small-town India came from the increase in land prices over the past five-six years. In our view, land prices in India have gone up three to five times across the country, fuelled by the demand for land by real estate developers and industry. This has enabled farmers cash in on their existing attractively located land holdings and buy larger tracts of land in interior locations and possibly even construct larger and better quality housing.

We would expect this wealth effect from land price inflation to continue in the future given the Indian government’s focus on resolving the land acquisition problem by providing a fair deal to land owners through the Draft Land Acquisition and Resettlement and Rehabilitation Bill, 2011. If this draft bill is passed by the Parliament in its current form, it could increase the cost of land acquisition by four to five times from current levels,

Commodity 2010-11 2011-12 Y-Y hike 2 years 3 years 4 years 5 years

Paddy 1,000 1,080 8.0% 6.6% 8.3% 13.8% 13.2%

Coarse Cereals 880 980 11.4% 8.0% 5.3% 13.0% 12.7%

Maize 880 980 11.4% 8.0% 5.3% 12.1% 12.7%

Wheat 1,120 1,285 14.7% 8.1% 6.0% 6.5% 11.4%

Barley 780 980 25.6% 14.3% 13.0% 10.8% 11.6%

Gram 2,100 2,800 33.3% 26.1% 17.4% 15.0% 14.1%

Arhar (Tur) 3,000 3,200 6.7% 18.0% 27.3% 19.9% 17.8%

Moong 3,170 3,500 10.4% 12.6% 11.6% 19.8% 18.2%

Urad 2,900 3,300 13.8% 14.4% 9.4% 18.0% 16.8%

Masur (Lentil) 2,250 2,800 24.4% 22.4% 14.4% 13.3% 12.6%

Sugarcane 108 139 29.1% 3.5% 19.4% 14.4% 11.6%

Cotton 2,500 2,800 12.0% 5.8% 3.8% 11.7% 9.6%

Groundnut-in-shell 2,300 2,700 17.4% 13.4% 8.7% 14.9% 12.2%

Rapeseed/Mustard 1,850 2,500 35.1% 16.9% 11.0% 8.6% 7.8%

Sunflower Seed 2,350 2,800 19.1% 29.1% 19.3% 16.7% 13.3%

Soyabean 1,400 1,650 17.9% 10.6% 6.9% 16.0% 12.9%

Safflower 1,800 2,500 38.9% 23.1% 14.9% 10.9% 9.5%

Copra 4,450 4,525 1.7% 0.8% 7.3% 5.7% 4.7%

Sesamum 2,900 3,400 17.2% 9.2% 7.3% 21.1% 16.9%

Nigerseed 2,450 2,900 18.4% 9.8% 6.4% 23.7% 18.9%

Average 16.8% 12.1% 10.3% 13.5% 12.1%

CAGRPrice (INR/quintal)

2012 2013

Gujarat Madhya Pradesh

Uttar Pradesh Rajasthan

Punjab Karnataka

Uttarakhand Chattisgarh

Goa Jammu & Kashmir

Manipur

Himachal Pradesh


24

including the provision of rehabilitation benefits and allowances. This bill provides for resettlement benefits even for livelihood losers who do not own land. In our opinion, this could provide a significant boost to the wealth of people in the semi-urban and rural areas of the country. Even if the provisions of the bill are diluted following protests by the industry, the benefits would still be substantial, in our view.

We believe that helped by continuing income increase and the rise in wealth, there would be a substantial increase in self-constructed housing and ancillary activities in semi-urban and rural India. As explained earlier, the growth in the number of households in India is 1.6% per annum as per the Census of India, 2011. This would be the base rate at which the number of houses would grow in India, in our view. Apart from this, the homeless getting accommodated and replacement/size enhancement of old homes should also lead to increased demand for housing to the extent of 2.5% per annum. The growth in pucca housing would be much higher, though. As per the Census of India 2001, the growth rate in pucca houses in India was 4.3% between FY91-FY01. Given the income increase and wealth effect discussed above, the growth in the stock of pucca houses would have picked up significantly post FY01 and, in our opinion, would have grown by an average of 6% between FY01-FY11 and growing at 7-8% in the latter part of the decade.

The stock of pucca houses as per the Census of India, 2001 was 55.43mn vs. the total number of households of 193.6mn. Based on this and an average 6% growth in pucca houses in FY01-FY11 and 7% growth in FY12F-FY14F, we forecast an indicative demand for cement in the next three years from self constructed housing. This is not an accurate forecast given the high amount of estimation required for historical data.

Fig. 36: Indicative cement demand forecast from unorganised housing

Source: Census of India, 2011, Nomura estimates

These numbers also tie-in with the frequently quoted figure by media, industry and analysts of housing contributing 60% of the demand for the cement in India. The above figures give us 55% of our estimated cement demand for FY12 coming from the unorganised housing segment.

In a nutshell, we believe that the cement demand from the unorganised housing segment will grow at approximately 7% per annum in the next three years. We believe that this segment forms a base for cement demand in India and if the other drivers of cement stay flat, cement growth in India will still be around 3.5%.

Organized real estate The organised real estate segment in India has been volatile since the global financial crisis of 2008, with construction slowing down in FY09 and picking up only towards the end of FY09. While 2HFY09 and 1HFY10 were healthy for sales and construction, since then the increase in prices and mortgage rates has reduced sales volume and also impacted construction. Tight liquidity for developers and the shortage of labour have also impacted the construction pace over the past one year, in our view.

We look at the construction in India’s urban real estate in the top six cities in the past three years and forecast for the next three years. We assume a cement demand of

No. of pucca houses in FY01 (mn) 55.4

CAGR between FY01-FY11 6.5%

No. of pucca houses in FY11 (mn) 104.0

Growth in FY12-FY14F 7.0%

Incremental houses in FY12F 7.3



Average area of each house (sqft) 850

Cement usage per sqft (kg) 18

Cement demand in FY12F (mnT) 111.4




25

27kg/sqft for residential real estate and 22kg/sqft for commercial real estate. The top six cities, in our opinion, account for 80% of grade-A commercial construction and for 65% of the residential real estate in urban India. Thus, cement demand for urban real estate could range from ~11mnT to 13.6mnT between FY12F-FY14F, a CAGR of 7% over the next three years.

We are not bullish on the growth of urban real estate construction in India in FY12F given the liquidity crunch situation for many small developers along with slowing sales and lack of approvals. We expect the situation to improve in FY13F as approvals start coming through while sales volume improves following a cut in prices. However, the actual upward momentum would gain pace only in FY14F, provided the macro situation becomes better.

Fig. 37: Cement demand from urban real estate in the top six cities of India

Source: Propequity, Jones Lang LaSalle, HVS, Nomura estimates

Infrastructure and construction This is the toughest segment to derive cement demand trends, given such factors as the lack of project level data, lumpy order flows and construction and status of construction. To derive cement demand and growth, we rely on the macro data for the infrastructure segment while also looking at project level data on the roads segment.

Since FY01, infrastructure investment in India grew at a CAGR of 12.5% to FY10. Investment as a percentage of GDP has increased from 5.3% to 6.5% over the same period. Over FY09-10, though growth in infrastructure investment has slowed down, we expect further slowdown in FY11, whenever the figures are released by the Planning Commission of India.

Area constructed (mn sqft) FY09 FY10 FY11 FY12F FY13F FY14F Comment

Residential 175 205 225 225 250 287

Based on data from Propequity for delivery volumes committed between 2011-13 and taking a 30% haircut on the same

Office 42 41 47 44 42 40 Based on data from Jones Lang Lasalle till FY13Fand taking a 20% haircut on the same

Retail 6 7 14 12 12 12 Based on data from Jones Lang Lasalle till FY13Fand taking a 20% haircut on the same

Hotel NA NA 5 5 7 7 Based on data from HVS till FY13F and taking a 30% haircut on the same

Total 223 253 291 286 311 346

Cement demand (mnT) FY09A FY10A FY11 FY12F FY13F FY14F

Residential 4.7 5.5 6.1 6.1 6.7 7.8

Office 0.9 0.9 1.0 1.0 0.9 0.9

Retail 0.1 0.2 0.3 0.3 0.3 0.3

Hotel 0.1 0.1 0.2 0.2

Total 5.8 6.6 7.5 7.4 8.1 9.1

YoY growth in cement demand FY09A FY10A FY11 FY12F FY13F FY14F

Residential 17% 10% 0% 11% 15%

Office -2% 15% -6% -5% -5%

Retail 17% 100% -14% 0% 0%

Hotel 0% 40% 0%

Total 14% 14% -1% 9% 12%


26

Fig. 38: Infrastructure investment as a percentage of GDP and growth

Source: Planning Commission of India, Nomura research

Some of the key cement consuming segments of infrastructure have had their projections revised downwards for the 11th year Five Year Plan (2007-12).

Fig. 39: 11th Five Year Plan investment targets

Source: Planning Commission, 12 August 2010 Nomura report, Different Strokes, by analysts Saion Mukherjee and Amar Kedia

The lack of activity in FY08-10 from the government on the infrastructure side in terms of project awards has led to the slowdown in investment in infrastructure in FY10-FY12F. However, this lethargy in terms of award activity is reducing, especially in the chief cement consuming segment, roads, while railways is set to pick up pace with metro rail systems either under construction or planned in many cities of India.

Our infrastructure and construction analysts Saion Mukherjee and Amar Kedia in their 12 August 2010 report, Different Strokes, estimated an INR23.95tn investment opportunity in the key cement consuming sectors over the next five years. If we consider that only 70% of the opportunity envisaged would see the light of the day, we calculate cement demand at 264mnT (see table below). This would mean approximately 52mnT of demand from infrastructure each year, which would be approximately 25% of overall cement demand in FY11. Please note that the annual investment in infrastructure in these sectors to be realised would be INR3.4tn, which would be just 4.3% of India’s FY11 GDP and lower for future years.

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

0

1

2

3

4

5

6

7

FY01 FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10

(INR tn & %) Infrastructure investment (LHS)% of GDP (RHS)Growth in infra investment (RHS)

SectorOriginal projection (INR

tn)Revised projection

(INR tn) % change Comment

Road and Bridges 3.14 2.78 -11% Lower than projected awards in FY08-10

Railways 2.62 2.00 -24% Progress of PPP investment very slow

Irrigation 2.53 2.46 -3%Higher state investments offset lower investments friom centre

Ports 0.88 0.41 -53%PPP projects award below expectation in FY08-09

Airports 0.31 0.36 16% Better than expected investments

Total 9.48 8.01 -16%


27

Fig. 40: Estimated cement demand from infrastructure over the next five years


We believe the above demand estimate could be divided as shown below:

Fig. 41: Cement demand growth from infrastructure In mnT


Below, we look at the roads and railways opportunity more closely.

Roads The award activity in the roads segment was very low in FY07-09 but has picked up since FY09 and FY12 is likely to be the best year in terms of awarding of road projects to private developers with the National Highway Authority of India looking to award 8,000 km of roads. NHAI has already awarded 5,300 kms of roads till Sep’11 worth INR410 bn. Another 2,071 km of roads not part of the National highway Development Programme (NHDP) are to be awarded in FY12 by NHAI.

Fig. 42: Road project award activity by NHAI

Source: NHAI, Nomura estimates

Type

Total opportunity

(INR bn)

To be realised at

70%Construction

intensity

Construction opportunity (INR

bn)

Cement cost as % of

construction opportunity

Cement cost (INR bn)

Cement volumes in mnT (at

INR4,500/ton)

Roads 6,480 4,536 80% 3,629 13% 454 101

Railways 3,360 2,352 60% 1,411 10% 141 31

Irrigation 3,360 2,352 80% 1,882 13% 235 52 Water supply & sanitation 1,584 1,109 80% 887 8% 71 16

Ports 480 336 50% 168 16% 27 6

Airports 240 168 60% 101 8% 8 2

Thermal power 6,480 4,536 50% 2,268 5% 113 25

Nuclear power 768 538 33% 177 3% 5 1

Hydro power 1,200 840 80% 672 20% 134 30

Total 23,952 16,766 11,195 1,189 264

FY13F FY14F FY15F FY16F FY17F

Cement demand 34 44 53 61 73

Growth 27% 21% 15% 20%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F

(Kms)


28

Fig. 43: Monthly detail of completed and planned road award activity by NHAI

Source: NHAI or Nomura estimates

In terms of cement consuming regions, the highest roads awarded are in the central and eastern regions while the western region as of now does not have any significant activity.

Fig. 44: Road awards in FY12 by NHAI

Source: NHAI, Nomura estimates

NHAI is yet to award ~16,000 kms of roads under the NHDP programme and plans to award 7,000 kms in FY13F. Thus, ~15,000 kms of highways are expected to be under construction in FY14F apart from the ones already under construction. Land acquisition is not a major issue as NHAI is awarding projects only after it has acquired a majority of the land required and after receiving an environmental clearance.

We also look at the status of various NHAI road projects which are under construction. Out of 16,260 kms of highways under construction, we believe only 4,525 kms have been completed till Sep-11 against a target of 5,448 kms. The rest is targeted to be completed by FY13-FY14 with the help of the government, targeting construction of 20 kms per day on an India-wide basis. In FY11, only 5kms of roads were constructed per day in India and the pace has now picked up to 11km per day as of Oct-11 (Times of India, October 17, 2011). If this pace is maintained, NHAI’s FY14F target does look possible for completion of the remaining 11,735 kms. Also, with newer roads coming under construction post award, the pace of construction of roads in India could rise to 20km per day by FY14F.

Apart from this, another 11,679 kms of state highways worth INR437 bn are to be bid out, according to the Planning Commission.

MonthLength to be

awarded (kms) No. of ProjectsEstimated total project

cost (INR bn)

April, 2011 481 4 55.3

May, 2011 570 5 46.6

June, 2011 756 5 82.8

July, 2011 1,269 7 109.8

August, 2011 1,357 12 49.5

September, 2011 928 7 66.2

October, 2011 1,373 8 31.1

November, 2011 905 7 91.0

December, 2011 135 3 14.2

January, 2012 220 1 23.1

Total 7,994 59 569.4

Region Length (kms) Project cost (INR bn)

Central 1,805 160.2

Eastern 2,108 137.5

Northern 1,559 153.6

Southern 1,668 137.0

Western 853 58.7


29

Fig. 45: Cement demand from NHAI and state highway construction


Please note that the above demand forecast is only for road contracts where data are available and is a very small part of the overall road opportunity.

Also, with prices of bitumen, which is a by-product of crude oil refining, up by 51% since its bottom in Jun-09, the cost advantage of a bitumen road over a concrete road has reduced considerably, especially since average cement prices are up only 5% in the same time period.

Fig. 46: Comparison of bitumen and cement prices (indexed)

Source: IOC, CMIE, Nomura research

Railways Activity in the country’s railways sector is likely to increase significantly in the future with the advent of metro and mono-rail transportation in metro cities and in some tier 2 towns. The Dedicated Freight Corridors in the west and east of the country will also generate some demand for cement apart from improving logistics for the cement industry itself.

Metro rail systems have been set up in Delhi and Bangalore and are being expanded further. New metro lines are being constructed in Mumbai, Jaipur, Gurgaon, Chennai and Hyderabad and are planned in Kochi, Pune, Navi Mumbai, Kolkata, Ahmedabad, Bhopal, Chandigarh and Indore.

The cement demand from the metro rail projects is shown below at the rate of 37,000 tons per km. These projects are expected to take up to 10 years to be completed,

NHAI roads FY12F FY13F FY14F

Roads constructed per day (kms) 11 15 20

Total length constructed (kms) 4,015 5,475 7,300

Percentage of cement roads (%) 50% 50% 50%

Cement roads length (kms) 2,008 2,738 3,650

Cement usage (tons per km for 4 lane road) 2,000 2,000 2,000

Cement demand (mnT) 4.0 5.5 7.3

State roads FY12F FY13F FY14F

Roads constructed per day (kms) 6 8 10

Total length constructed (kms) 2,190 2,920 3,650

Percentage of cement roads (%) 30% 30% 30%

Cement roads length (kms) 657 876 1,095

Cement usage (tons per km for 2 lane road) 1,200 1,200 1,200

Cement demand (mnT) 0.8 1.1 1.3

Total cement demand (mnT) 4.8 6.5 8.6

0.8

0.9

1.0

1.1

1.2

1.3

1.4

1.5

Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11

Bitumen price (IOC) Cement price (avg)


30

resulting in an average cement demand of 2.5mnT per annum with initial years being close to 1.5mnT and then a pick-up towards the end. Even if only 50% of the planned and under-construction projects see the light of the day, cement demand would be at least 1.3mnT per annum more than it has been in the past from the metro rail systems.

Fig. 47: Cement demand from metro rail systems in India

Source: Nomura research

Industrial capex Industrial capital expansion is also an important contributor of cement demand and, in our opinion, contributes ~15% of the overall cement demand in India. Capex activities have slowed down in India other than in the power and metals sector since FY10 as shown in the chart below.

Fig. 48: Industrial capex activity (indexed to 100 in 1995; Metals on RHS


On the other hand, capacity utilisation as per the RBI’s Order Book, Inventory and Capacity Utilization Survey (OBICUS) is moving higher (Q1 is a seasonal low) from its levels in FY09 and this should augur well for capex activity going forward, though FY12F may not show any significant improvement given the high interest rate scenario. With interest rates peaking and possibly moving down in FY13F, capex activity should again restart given the healthy balance sheet of corporate India. The pickup in activity should also boost cement demand in FY14F.

City Length complete (km)Length under-

construction (km) Length planned (km)Total cost estimated

(INR bn)Cement demand

(mnT)

Delhi 190 112 108 500 8.1

Mumbai 11 62 170 2.7

Bangalore 7 13 130 400 5.3

Chennai 23 31 180 2.0

Kolkata 15 47 0.6

Hyderabad 71 121 2.6

Jaipur 9 27 90 1.3

Chandigarh 41 1.5

Ahmedabad 43 100 1.6

Total 197 183 513 1,608 26

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

0

900

1,800

2,700

3,600

4,500

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

(Indexed to 100) BSE500 (LHS) InfraOil & gas TelecomAuto & Auto Parts CementPower Metals


31

Fig. 49: Capacity utilization by corporate India (as per RBI’s OBICUS)

Source: RBI

Fig. 50: Net gearing of BSE 500 (294 companies with consolidated financials)


Overall view on demand We believe cement demand growth in FY12F is likely to remain at the lower levels witnessed in 1HFY12 given the slowing economy, slow execution by infra and real estate players and low momentum in government sponsored housing and irrigation schemes, especially in South India.

This would be the second consecutive year of sub-5% growth in cement demand in India, an event which has never happened before in the past 20 years in India. The average growth in cement demand over the past 20 years was 8.1%. We believe the demand growth is possibly at its worst level at current levels driven by a governance deficit at the centre and in some states such as Andhra Pradesh, Maharashtra and Karnataka, and a slowing economy amid peakish interest rates.

We expect the unorganised housing sector to continue to act as a bed-rock for cement demand and expect this segment to continue growing at 7.5%, contributing to 4% growth in cement demand.

The organized real estate sector in urban areas is likely to remain stressed in FY12F with cement demand remaining almost flat at FY11F levels but we expect a reduction in property prices in FY13F and lower mortgage rates to contribute to a rebound in construction activity from FY13F onwards. This segment contributes only ~5% of overall cement demand in India and it growing at 9% and 11% pace in FY13F and FY14F, respectively, would contribute to just ~0.5% to cement demand growth.

64

66

68

70

72

74

76

78

8020

08-0

9

2008

-09

2008

-09

2008

-09

2009

-10

2009

-10

2009

-10

2009

-10

2010

-11

2010

-11

2010

-11

2010

-11

2011

-12

Q1: Q2: Q3: Q4: Q1: Q2: Q3: Q4: Q1: Q2: Q3: Q4: Q1:

(%)

0.70

0.75

0.80

0.85

0.90

0.95

1.00

1.05

20112010200920082007


32

The infrastructure segment is likely to follow a similar path to urban real estate – flat in FY12F and a pick-up from FY13F onwards. We expect a 12% growth in the cement consuming infrastructure segments in FY13F and a 20% growth in FY14F. This segment contributes to 25% of overall cement demand and hence we expect overall cement demand to grow by 2% in FY13F and 5% in FY14F through the infrastructure segment.

Industrial capex contributes 15% to overall cement demand growth and we expect it to be flat in FY12F followed by a 10% growth in FY13F and FY14F due to higher capacity utilization necessitating expansion and a rebound in the economy through lower interest rates. This growth could contribute a 1.5% growth in overall cement demand in each year.

Fig. 51: Overall cement demand growth


Thus, on an overall basis we foresee a growth of 4.1% in cement demand in FY12F in line with our 1HFY12F demand growth estimate, a bounce back to the average levels of the past 20 years of 8.1% in FY13F and a sharper rise in FY14F of ~11% as the economy compensates for the lower investments in the previous three-four years.

On a regional basis, the southern region is currently looking at a de-growth in FY12F as Andhra Pradesh, which consumes 7%--8% of India’s cement production, is going through a situation of political turmoil and is seeing demand falling by 15%-20%. Karnataka is another southern state where politics has taken precedence over governance and where cement demand has not grown this year. The rest of the regions, though, are doing reasonably well as far as demand growth is concerned with eastern and central India starting to act as growth drivers for cement consumption through higher infrastructure activity and better rural growth. Demand from northern and western regions is also healthy.

We look at the state wise gross state domestic product (GSDP) growth figures since FY95 and look at the FY95-FY02 and FY03-FY11 averages and we see that there has been a clear acceleration in growth across all regions with the eastern and western regions actually outperforming. We also look at the FY10 GSDP figures to see if there has been a loss of momentum and the southern region which had not shown any significant delta in growth in the past has also lost a lot of momentum.

Fig. 52: Gross state domestic product growth rates cumulated region wise (in %)

Source: Planning Commission, Nomura research

We also analyse the public-private partnership (PPP) projects which are underway in the country and find that the southern region has a large chunk of these projects. This gives us confidence that once the state level political environment improves, demand for cement in the southern region could see a sharp upward spike.

in % FY12F FY13F FY14F Weightage FY12F FY13F FY14F

Unorganized housing 7.5 7.5 7.0 55% 4.1 4.1 3.9

Urban real estate - 9.0 11.0 5% - 0.5 0.6

Infrastructure - 8.0 20.0 25% - 2.0 5.0

Industrial capex - 10.0 10.0 15% - 1.5 1.5

Total 100% 4.1 8.1 10.9

Growth in Growth in cement demand

Average FY95-FY02

Average FY03-FY11

Average FY05-FY11 FY10

Central 4.4 6.1 6.7 7.7

Eastern 5.2 7.8 8.3 11.2

Northern 6.4 8.6 8.9 8.5

Southern 6.6 8.3 8.8 6.5

Western 6.1 9.7 10.0 10.4


33

Fig. 53: PPP project split (by region)

Source: www.pppindiadatabase.com, Nomura research

Fig. 54: PPP projects split (by value)

Source: www.pppindiadatabase.com, Nomura research

Thus, on a regional basis we expect cement demand in the south to fall in FY12F, show lower-than-average growth in FY13F and then bounce back sharply in FY14F. We expect the central region to show an uptick in growth from the lower-than-average levels expected in FY11F and FY12F to 9% by FY14F. Eastern India should also follow central India in its growth path. In the North, we expect growth to remain in the 7.5%-9% range and in western India growth is likely to remain in the 10% range till FY14F. Exports will likely grow in the 7%-8% range as there will be excess capacity in western India allowing higher exports.

We base our demand estimates on the despatch from each region given that 90% of the despatch from each region is consumed within the region itself.

Fig. 55: Regional demand growth pattern

Source: CMA, ACC, Ambuja Cements, Nomura estimates

Central11%

Eastern11%

Northern13%

Southern42%

Western23%

Region No. of projects Value (INR bn)

Central 100 416

Eastern 106 429

Northern 118 480

Southern 277 1,559

Western 143 855

Total 744 3,738

Demand FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F FY15F

Central 16.4 17.6 18.1 20.1 22.0 23.6 24.5 25.7 30.5 32.2 34.1 37.0 40.3 44.0

y-y growth 7% 3% 11% 10% 8% 4% 5% 19% 5% 6.0% 8.5% 9.0% 9.0%

Eastern 17.3 16.7 16.7 18.7 20.1 21.8 23.2 25.8 28.9 29.8 31.9 34.7 38.2 42.0

y-y growth -4% 0% 12% 7% 9% 6% 11% 12% 3% 7.0% 9.0% 10.0% 10.0%

Northern 21.3 24.1 25.3 26.7 29.7 32.1 36.4 40.8 46.1 49.7 53.4 57.7 62.9 68.5

y-y growth 13% 5% 6% 11% 8% 14% 12% 13% 8% 7.5% 8.0% 9.0% 9.0%

Southern 29.1 33.3 36.0 36.7 43.6 49.3 54.1 59.2 63.5 63.7 61.2 64.8 74.6 80.5

y-y growth 15% 8% 2% 19% 13% 10% 9% 7% 0% -4.0% 6.0% 15.0% 8.0%

Western 17.5 19.3 20.6 22.7 24.9 27.4 28.7 28.5 28.9 30.3 33.3 36.7 40.1 43.4

y-y growth 10% 7% 10% 10% 10% 5% -1% 2% 5% 10% 10.0% 9.5% 8.0%

All India 101.7 111.0 116.8 124.8 140.3 154.2 166.9 179.9 198.0 205.6 213.9 230.9 256.1 278.4

y-y growth 9% 5% 7% 12% 10% 8% 8% 10% 4% 4% 8% 11% 9%

Exports 3.4 3.5 3.4 4.1 6 5.9 3.7 3.2 2.9 3.30 3.6 3.8 4.1 4.4

y-y growth 3% -3% 21% 46% -2% -37% -14% -9% 14% 8% 7% 7% 7%

Total 105.1 114.5 120.2 128.9 146.3 160.1 170.6 183.1 200.9 208.9 217.4 234.7 260.2 282.8

y-y growth 9% 5% 7% 13% 9% 7% 7% 10% 4% 4% 8% 11% 9%


34

Capacity – Piling on the tons

What are the upcoming plans of various cement players in terms of capacity addition? What does the capacity utilization picture look like for the next three years?

Between FY02 and FY07 only 30mnT of cement capacity was added in India, while demand increased by 55mnT. This led to capacity utilization moving up from 82% to 97% over the same time period. With the outlook for the Indian economy rosy, almost every cement manufacturer jumped on the bandwagon of increasing capacity. In the next four years to FY11, 120mnT of cement capacity was added in India. On an effective basis, 100mnT of capacity was added. This led to capacity utilization again retracing its steps to 79% in FY11.

Fig. 56: Capacity utilisation vs. effective installed capacity

Source: CMA, Nomura estimates

We have done a cement capacity study by company and have arrived at the upcoming capacity additions in each year, state and region. We also forecast the effective capacity additions each year based on the month of the financial year when the capacity would come online. In most cases we have added a 3-9 month delay to the company’s stated timelines given the delays witnessed in the past and also given the usual issues faced in India regarding land availability, timely availability of equipment and availability of labour and materials. Also, we expect some capacity to be delayed as companies take another look at the prevailing capacity utilization in specific regions. Based on all these factors, we have arrived at our estimates of annual effective capacity additions.

Based on our analysis, we expect effective capacity addition to slow from the levels seen in FY10 and FY11 but still remain at historically high levels of 26mnT in FY12F and 28.5mnT in FY13F before falling in FY14F to 16.5mnT. Regionally post FY12F, we see capacity additions in the traditionally oversupplied southern region declining, with a larger amount of capacity added in the central region. This should help improve the capacity utilization scenario in southern India post the FY12F shock.

We would like to state here that the capacity additions mentioned below are likely to be the worst-case scenario and it is possible that some of these capacity additions get shelved or delayed. In this case, there would be upside risks to our capacity utilization numbers. At this moment we believe our capacity utilization estimate for FY14F at 78% is one of the lower forecasts on the Street.

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50%

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90%

100%

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(mn Tonne) Total all-India capacity Capacity utilisation (RHS)


35

Fig. 57: Yearly capacity additions (in mnT)


Company Location State Region FY12F FY13F FY14F

India Cement - Sri Vishnu Sitapuram AP Southern 1.2

ACC Chanda Maharashtra Western 3.0

Ambuja Cement Bhatapara Chattisgarh Eastern 1.1

Ambuja Cement Maratha Maharashtra Western 0.9

JK Lakshmi Cement Jhajjhar Haryana Northern 0.6

Jaypee Group Sikandrabad UP Central 0.8

Jaypee Group Nalgonda AP Southern 5.0

Birla Corporation Durgapur WB Eastern 0.6

Madras Cements Ariyalur Tamil Nadu Southern 2.5

Jaypee Group Bokaro (SAIL JV) Jharkhand Eastern 2.1

Birla Corporation Chanderia Rajasthan Northern 1.2

Century Textiles Chandrapur Maharashtra Western 0.3

Century Textiles Maihar MP Central 0.4

JSW Steel Kurnool AP Southern 4.4

ABG Shipyard Kutch Gujarat Western 3.3

KCP Ltd. Muktyala AP Southern 1.5

Heidelberg Jhansi UP Central 1.9

Heidelberg Imlai MP Central 2.8

Century Textiles Sagardighi WB Eastern 1.5

KJS Cement Satna MP Central 2.3

Jaypee Group Churk UP Central 1.5

Sagar Cements Gulbarga Karnataka Southern 1.6

Century Plyboards Guwahati Assam Eastern 1.6

Wonder Cement Chanderia Rajasthan Northern 2.5


Jaypee Group Dalla UP Central 1.1

Jaypee Group Siddhi UP Central 1.5

Revathi Cement Satna MP Central 2.5

Chettinad Cement Gulbarga Karnataka Southern 2.7

JK Lakshmi Cement Durg Chattisgarh Eastern 3.0

JK Cement Mangrol Rajasthan Northern 4.4

Ultratech (Grasim) Malkhed Karnataka Southern 4.4

Ultratech (Grasim) Raipur Chattisgarh Eastern 4.8

Lafarge Chittorgarh Rajasthan Northern 2.6

Total 28.9 15.7 29.5


36

Fig. 58: Effective capacity addition (in mnT; taking into account estimated month of start of production)


Company Location State Region FY12F FY13F FY14F

ACC Wadi Karnataka Southern 4.1

Chettinad Cement Karikkali Tamil Nadu Southern 2.1

India Cement - Mahi Bansw ara Rajasthan Northern 1.4

JK Udaipur Udyog Udaipur Rajasthan Northern (0.5)

Jaypee Group Panipat Haryana Northern 0.4

Jaypee Group Sidhi MP Central 0.4

Jaypee Group Kutch Gujarat Western 1.1

Jaypee Group Chunar UP Central 0.4

Jaypee Group Wanakbori Gujarat Western 0.8

Madras Cements Jagayyapet AP Southern 0.5

Prism Cement Satna MP Central 2.7

Shree Cement Jaipur Rajasthan Northern 1.1

Penna Cement Tadpatri AP Southern 1.0

Khyber Industries Khunmoh J&K Northern 0.1

Anjani Portland Mellacherevu AP Southern 1.1

India Cement - Sri Vishnu Sitapuram AP Southern 1.2 -

ACC Chanda Maharashtra Western 2.3 0.8

Ambuja Cement Bhatapara Chattisgarh Eastern 0.7 0.4

Ambuja Cement Maratha Maharashtra Western 0.8 0.2

JK Lakshmi Cement Jhajjhar Haryana Northern 0.1 0.6

Jaypee Group Sikandrabad UP Central 0.6 0.2

Jaypee Group Nalgonda AP Southern 0.4 4.6

Birla Corporation Durgapur WB Eastern 0.2 0.5

Madras Cements Ariyalur Tamil Nadu Southern 0.2 2.3

Jaypee Group Bokaro (SAIL JV) Jharkhand Eastern 1.6 0.5

Birla Corporation Chanderia Rajasthan Northern 0.1 1.1

Century Textiles Chandrapur Maharashtra Western 0.1 0.2

Century Textiles Maihar MP Central 0.1 0.3

JSW Steel Kurnool AP Southern 0.7 3.7

ABG Shipyard Kutch Gujarat Western 0.3 3.0

KCP Ltd. Muktyala AP Southern 0.3 1.3

Heidelberg Jhansi UP Central 1.9

Heidelberg Imlai MP Central 2.8

Century Textiles Sagardighi WB Eastern 0.4 1.1

KJS Cement Satna MP Central 0.6 1.7

Jaypee Group Churk UP Central 0.4 1.1

Sagar Cements Gulbarga Karnataka Southern 0.8 0.8

Century Plyboards Guw ahati Assam Eastern 0.4 1.2

Wonder Cement Chanderia Rajasthan Northern 1.9 0.6


Jaypee Group Dalla UP Central 1.1

Jaypee Group Siddhi UP Central 0.1

Revathi Cement Satna MP Central 0.2

Chettinad Cement Gulbarga Karnataka Southern 2.0

JK Lakshmi Cement Durg Chattisgarh Eastern 0.8

JK Cement Mangrol Rajasthan Northern 0.4

Ultratech (Grasim) Malkhed Karnataka Southern 1.1

Ultratech (Grasim) Raipur Chattisgarh Eastern 0.4

Lafarge Chittorgarh Rajasthan Northern 1.3

Total 26.0 28.5 16.5


37

Fig. 59: Regional yearly capacity additions


Fig. 60: Regional effective capacity additions


Based on the above capacity addition analysis and our demand forecast, we expect capacity utilization to moderate to 74% in FY13F from 79% in FY11 before improving to 78% in FY14F. In southern India, which is a key focus point for the Street, we expect capacity utilization to tumble to 53% in FY13F from 65% in FY11 before recovering to 59% in FY14F. If the demand recovery in southern India is faster than expected, there could be an upside risk to our estimate. Eastern and northern India would witness the best capacity utilization in FY14F while central India could start slipping on account of higher capacity additions. Western India would feel the pressure from cement being supplied from southern India.

In mnT FY12F FY13F FY14F

Central 1.2 8.5 5.1

Eastern 3.8 3.1 7.8

Northern 1.8 2.5 7.0

Southern 14.6 1.6 7.1

Western 7.5 - 2.5

Total 28.9 15.7 29.5

% of total

Central 4.0% 54.1% 17.3%

Eastern 13.2% 19.7% 26.4%

Northern 6.2% 15.9% 23.7%

Southern 50.6% 10.2% 24.1%

Western 26.0% 0.0% 8.5%

Total 100% 100% 100%


Central 4.1 6.1 4.3

Eastern 2.5 2.1 3.5


Southern 11.6 12.6 3.9

Western 5.3 4.2 2.5

Total 26.0 28.5 16.5

% of total

Central 15.8% 21.5% 26.0%

Eastern 9.4% 7.4% 21.1%

Northern 10.0% 12.4% 13.9%

Southern 44.4% 44.1% 23.8%

Western 20.3% 14.6% 15.2%

Total 100% 100% 100%


38

Fig. 61: Overall demand-supply-capacity utilization model

Source: CMA, ACC, Ambuja Cements, Nomura estimates

Ending capacity FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Central 21.0 21.0 21.9 25.0 25.0 25.5 28.9 28.2 30.5 36.4 37.6 46.1 51.2

yoy growth 0% 4% 14% 0% 2% 13% -3% 8% 19% 3% 23% 11%

Eastern 21.7 21.7 22.4 23.0 24.2 25.2 26.3 28.8 33.8 34.5 38.3 41.4 49.2

yoy growth 0% 3% 3% 5% 4% 5% 9% 17% 2% 11% 8% 19%

Northern 25.2 25.2 26.2 27.6 30.7 32.6 36.3 48.3 55.4 66.1 67.9 70.4 77.4

yoy growth 0% 4% 6% 11% 6% 11% 33% 15% 19% 3% 4% 10%

Southern 44.8 44.3 46.2 47.1 51.0 53.5 56.3 73.0 89.7 106.3 120.9 122.5 129.6

yoy growth -1% 4% 2% 8% 5% 5% 30% 23% 18% 14% 1% 6%

Western 21.9 24.9 27.9 28.9 28.9 28.9 28.9 32.4 36.5 42.4 49.9 49.9 52.4

yoy growth 14% 12% 4% 0% 0% 0% 12% 13% 16% 18% 0% 5%

All India 134.6 137.1 144.6 151.6 159.8 165.7 176.8 210.8 246.0 285.8 314.6 330.3 359.8

yoy growth 2% 5% 5% 5% 4% 7% 19% 17% 16% 10% 5% 9%

Effective capacity FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Central 20.2 21.0 21.7 24.2 25.0 25.5 27.2 28.4 28.4 33.0 37.1 43.2 47.5

yoy growth 4% 3% 11% 3% 2% 7% 4% 0% 16% 12% 17% 10%

Eastern 21.2 21.7 22.4 22.8 23.3 24.8 26.0 26.7 32.9 30.1 32.6 34.7 38.2

yoy growth 3% 3% 2% 2% 6% 5% 3% 23% -8% 8% 6% 10%

Northern 23.8 25.2 25.8 27.3 28.7 32.3 35.3 42.1 51.5 62.7 65.3 68.9 71.2

yoy growth 6% 2% 6% 5% 12% 9% 19% 22% 22% 4% 5% 3%

Southern 41.2 44.5 46.2 46.7 49.5 53.2 56.0 59.4 83.6 97.9 109.5 122.1 126.0

yoy growth 8% 4% 1% 6% 7% 5% 6% 41% 17% 12% 12% 3%

Western 21.8 24.1 26.2 28.8 28.9 28.9 28.9 31.0 35.0 40.6 45.9 50.0 52.5

yoy growth 11% 8% 10% 1% 0% 0% 7% 13% 16% 13% 9% 5%

All India 128.2 136.5 142.2 149.8 155.5 164.7 173.5 188.0 232.1 264.8 290.7 319.2 335.6

yoy growth 7% 4% 5% 4% 6% 5% 8% 23% 14% 10% 10% 5%

Demand FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Central 16.4 17.6 18.1 20.1 22.0 23.6 24.5 25.7 30.5 32.2 34.1 37.0 40.3

yoy growth 7% 3% 11% 10% 8% 4% 5% 19% 5% 6.0% 8.5% 9.0%

Eastern 17.3 16.7 16.7 18.7 20.1 21.8 23.2 25.8 28.9 29.8 31.9 34.7 38.2

yoy growth -4% 0% 12% 7% 9% 6% 11% 12% 3% 7.0% 9.0% 10.0%

Northern 21.3 24.1 25.3 26.7 29.7 32.1 36.4 40.8 46.1 49.7 53.4 57.7 62.9

yoy growth 13% 5% 6% 11% 8% 14% 12% 13% 8% 7.5% 8.0% 9.0%

Southern 29.1 33.3 36.0 36.7 43.6 49.3 54.1 59.2 63.5 63.7 61.2 64.8 74.6

yoy growth 15% 8% 2% 19% 13% 10% 9% 7% 0% -4.0% 6.0% 15.0%

Western 17.5 19.3 20.6 22.7 24.9 27.4 28.7 28.5 28.9 30.3 33.3 36.7 40.1

yoy growth 10% 7% 10% 10% 10% 5% -1% 2% 5% 10% 10.0% 9.5%

All India 101.7 111.0 116.8 124.8 140.3 154.2 166.9 179.9 198.0 205.6 213.9 230.9 256.1

yoy growth 9% 5% 7% 12% 10% 8% 8% 10% 4% 4% 8% 11%

Exports 3.4 3.5 3.4 4.1 6 5.9 3.7 3.2 2.9 3.30 3.6 3.8 4.1

yoy growth 3% -3% 21% 46% -2% -37% -14% -9% 14% 8% 7% 7%

Total 105.1 114.5 120.2 128.9 146.3 160.1 170.6 183.1 200.9 208.9 217.4 234.7 260.2

yoy growth 9% 5% 7% 13% 9% 7% 7% 10% 4% 4% 8% 11%

Capacity utilization FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Central 81% 84% 83% 83% 88% 93% 90% 90% 108% 98% 92% 86% 85%

Eastern 82% 77% 75% 82% 86% 88% 89% 96% 88% 99% 98% 100% 100%

Northern 90% 96% 98% 98% 103% 99% 103% 97% 90% 79% 82% 84% 88%

Southern 71% 75% 78% 79% 88% 93% 97% 100% 76% 65% 56% 53% 59%

Western 80% 80% 79% 79% 86% 95% 99% 92% 83% 75% 73% 73% 76%

All India 82% 84% 84% 86% 94% 97% 98% 97% 87% 79% 75% 74% 78%


39

Cost of production – Not likely to repeat past trend There has been severe pressure on cement production costs over the past two years, driven primarily by an increase in raw material, fuel and power, and freight costs, which usually form 70% of the overall costs for manufacturing cement. Operating margin for the industry has gone down significantly since FY07 despite higher cement prices.

Fig. 62: Costs as percentage of gross sales value (data for 31 cement manufacturers)

Source: ACE Equity, Nomura research

How are key costs likely to move from current levels?

Raw material costs The chief raw materials for cement manufacturers are limestone and fly-ash. All cement manufacturers have their own limestone mines close to their plants, which given India’s large limestone reserves, should suffice for another 30 years at the very least, in our estimate. Apart from mining costs, the only cost to be paid is royalty fees to the government. This is where the catch lies, as the government has proposed a new mining bill stating that an equivalent amount of royalty from mining of minerals should be paid into a local area development fund. This effectively doubles the royalty on limestone, which currently stands at INR72/ton of LD grade limestone. The government is also taking another look at royalty rates and could increase them in the future. If the new mining bill is approved by Parliament, limestone costs would increase by 28-50% on a per ton basis. If it does not go through, limestone costs would increase at a CAGR of 8% over the next three years, in our view.

Fly-ash, which is a waste product from burning coal in power plants, is blended by cement manufacturers with OPC-grade cement to produce PPC-grade cement. More than 75% of cement produced in India is now of PPC grade. Earlier fly-ash, which presents a large disposal problem for power plants, was given to cement companies at a negligible cost. Now, power plants have received permission to charge for the fly-ash sold to cement companies and with freight costs having moved up significantly, transporting fly-ash has also become a costly affair. Fly-ash costs have shown some decline of late but still could increase at the 7% per annum inflationary rate over the next three years.

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

FY07 FY08 FY09 FY10 FY11

Raw material Power & fuel Freight Operating profit margin


40

Fig. 63: Limestone cost per ton


Fig. 64: Fly-ash cost per ton


Coal and petcoke Coal costs make up 14-23% of a cement company’s total costs, and the recent hike in March 2011 by Coal India of 30% has hit the industry hard. In FY11, with the increase in imported coal, overall coal cost per ton of cement increased 20-40%. With coal linkage from Coal India declining over the years, companies have been forced to buy higher-priced coal in e-auctions or to import higher calorific value coal from Indonesia and South Africa. This has increased the overall blended coal cost for cement. With Coal India’s production languishing at lower levels, coal linkage for cement companies is likely to decline further. For the new capacities, coal linkages are likely to be minimal.

50

100

150

200

250

300


(INR/ton) ACC Ultratech India Cement Shree Cement

225

275

325

375

425

475

525

575


(INR/ton) ACC Ambuja Ultratech Shree Cement


41

Fig. 65: Sources of coal purchase


Fig. 66: Coal and petcoke cost per ton of cement


Also, according to the cement companies, Coal India could hike prices for non-power consumers of coal to bring them in line with global prices on a gross calorific value basis. This would mean that cost of coal for cement companies could continue to increase in the future.

In the short term, international coal prices have started coming off since January 2011, though the depreciation in the INR against the USD by 16.5% YTD has completely negated the decrease in USD-denominated prices.

0%

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ACC Ambuja Ultratech India Cements Shree Cements

Coal linkage E-auction Imports Petcoke

250

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350

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500

550

600

FY08 FY09 FY10 FY11

(INR/ton of cement)


Shree Cement India Cement


42

Fig. 67: Indonesian coal reference price


Fig. 68: Richard’s Bay (South Africa) coal price


Shree Cements uses petcoke as a fuel for its kiln and power plant. Prices for petcoke, which had gone up almost six times between April 2009 and May 2011, have also come off 30% from the peak to October 2011, and this should augur well for Shree Cements going forward. With ongoing problems in Europe, which is a major petcoke-consuming geography, petcoke prices could remain weak for a while.

Fig. 69: Petcoke (US Gulf) prices


While we do not expect imported coal prices to rise in FY13F (our Coal India analyst Anirudh Gangahar expects only a 3.4% rise in coal prices in India in FY13F) from current levels given the global macro environment, the risk lies in Coal India increasing prices for non-power customers again in FY13F. Also, reducing linkages could result in a higher blended cost. We expect coal costs to increase by 15% on average in FY12F, remain flat in FY13F on a poor global environment and rise 10% in FY14F. We expect petcoke costs to increase 12.5% in FY12F and to fall 10% in FY13F before increasing 10% in FY14F.

Power costs Power costs usually comprise about 9-12% of cement’s manufacturing costs. With power unavailability a chronic issue in India, most large manufacturers now set up a captive power plant when they set up new capacity or expand an old one. This has enabled them to keep their power costs under control, though of late they have started moving up due to higher prices of coal and lower availability of coal from Coal India.

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43

We expect companies to continue adding power capacity in all expansion projects, which would push up the capital cost of the cement plant from historical levels by about USD10/ton. We expect power costs to increase in line with coal costs, as most of the power generation will be in-house.

Fig. 70: Percentage of power requirement generated in-house


Fig. 71: Power cost per ton of cement


Freight costs Freight costs make up 20% of a cement manufacturer’s overall costs. Cement freight and raw materials for cement are transported through rail and road in most cases, and sometimes by sea for coastal plants. Rail freight is the least expensive mode at INR1-1.1/ton/km, while road freight is the costliest at INR1.5-1.7/ton/km. Since cement is bulky and it is costly to transport, transport by road is usually limited to 300-400 kms, while on rail cement can transported for 500-600kms.

Transport by railway is limited by the availability of wagons and the slots on the railway line, along with the lack of linkages between the plant and the nearest railway line.

Freight costs are driven by two factors, the increase in the lead distance and increase in per ton per km cost. We have analysed state rail freight data and collated it into the cement regions to see how both have changed over the past 2.5 years.

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FY08 FY09 FY10 FY11

ACC Ambuja Ultratech Shree Cement India Cement

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340

390

FY08 FY09 FY10 FY11

(INR/ton of cement)


Shree Cement India Cement


44

Fig. 72: Lead distance by rail and region of loading

Source: Ministry of Railways, Nomura research

Fig. 73: Cost per ton per km on railways


As per our analysis ~47-48% of cement and clinker in India is transported through rail, with the percentage transported in North India being the lowest while the percentage transported in Central India the highest.

Fig. 74: Percentage of cement transported through rail by region of loading


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(kms) FY10 FY11 1HFY12

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45

Fig. 75: Freight cost per ton of cement


Freight costs have gone up for most players over the past four years as diesel prices and wage costs have moved up. The shift away from rail freight due to limited availability of wagons has also resulted in freight costs moving up. The increase in diesel costs in mid-2011 will put further pressure on road freight costs. The railways have imposed a 10% surcharge on the base freight rate and a 5% developmental surcharge on the net tariff of all commodities from 15 October, 2011 as part of the busy season. It applies a surcharge every year, but for a period of six months at the most. This year they have decided to apply the surcharge for nine months until 30 June 2012. This move will result in further pressure on freight costs to the extent of ~5.5% per annum. Oil marketing companies in India have consistently raised petrol prices due to high crude oil prices but have refrained from raising diesel prices. If diesel prices were to be hiked in future, on which it is difficult to make a call, it would push up road transport costs, too. Firms are now investing in rail linkages, owned wagons, depots and bulk terminals to reduce their freight costs. This would push up capital costs for a cement plant by USD15/ton. We expect blended freight costs to increase at a CAGR of 8% over the next three years.

On an overall basis, we expect the key costs to increase as shown in the table below:

Fig. 76: Increase in key costs for cement production


400

450

500

550

600

650

700

750

FY08 FY09 FY10 FY11

(INR/ton of cement)


Shree Cements India Cements

(y-y)% change FY12F FY13F FY14F

Limestone 10% 8% 8%

Fly-ash 15% 8% 5%

Coal 15% 0% 10%

Petcoke -5% 5% 5%

Freight 10% 7% 7%


46

Cement pricing – Up, up, but not away We believe cement manufacturing firms will have a profitability targeting strategy in terms of EBITDA/ton to ensure that the ROCE on new plants (replacement cost) is maintained at the very least at 12% (equal to weighted average cost of capital at D:E of 1:1) in the medium term. At our estimated replacement cost for new plants (inclusive of captive power and logistics infrastructure) of INR6,250/ton, the EBITDA/ton works out to INR750 at full utilization or INR1,070 at a 70% capacity utilization, for an ROCE of 12%.

In our view, cement companies will gradually hike prices over the next three years to reach the EBITDA/ton level of INR1,080/ton. With the top firms currently making close to INR875/ton as EBITDA in 1HFY12, it would necessitate an increase of INR10/50kg bag of cement over and above the increase in cost. We expect costs to increase at a CAGR of 6% over the next three years, and cement companies would need to increase prices in the region of 6.5%-7% per annum to achieve the same. We believe cement companies will try to achieve this level by FY14F. In our opinion, as long as production discipline is maintained, firms would be able to hike prices to cover the increase in costs at the very least. Cement prices have increased by 14% in 1HFY12 over FY11, suggesting that companies have managed to pass on the cost increases this year. If EBITDA/ton does not reach the break-even ROCE level, we think firms would find it unprofitable to put up new capacities and there would be downside risks to our capacity addition estimates and hence upside risks to our capacity utilization estimates. This situation would also be positive for the sector. Production discipline is the key, in our view, for pricing to move up from here, and in the following section of this report, we explain why we believe production discipline will be maintained.

Fig. 77: Recent trend of cement prices across metro cities

Source: CMIE, Nomura research

The most important question – Will production discipline break?

While we recognize the scale of overcapacity in the industry, our answer to this is NO. It is better to be profitable on lower volumes than to make losses on momentarily higher volumes and finally larger losses on lower volumes. We believe that cement companies have learned the lessons of FY02-03 and 2QFY11 well, when companies broke production discipline, fought on price and ended up making losses or very low profits.

200

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275

300

325

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12

(INR/ 50 kg bag) Mumbai Delhi Kolkata Chennai


47

Fig. 78: Trend in EBITDA per tonne


Companies have realised that fighting on price in a fragmented market is a lose-lose situation, while maintaining production discipline is a win-win scenario. There is no win-lose scenario in this industry, where competitors are quick to cut prices to maintain market share. Our view is based on four factors:

• Cement is a price-inelastic commodity: A cut in the price of cement is unlikely to lead to a rise in demand either from the retail or the institutional market. While a reduction in the price of a particular brand could lead a shift in demand toward the brand, the good times would last only for a short time, which could may mean a couple of days at best before competitors respond.

• Losses will occur if utilization is increased: More than 80% of the cost of cement manufacturing is variable in nature, providing low operating leverage. In fact, in the current scenario, higher capacity utilization would actually mean lower prices and hence lower profits. We present an analysis of a 1mnT plant in the oversupplied southern India region, with a typical cost structure and varying levels of capacity utilization and the price response to the higher capacity utilization.

As can be seen from the table below, any attempt to increase capacity utilization would trigger a price response from other players, pushing the price down to the variable cost of production and resulting in large operating-level losses. This is one of the biggest factors preventing producers from breaking their self-imposed production discipline.

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48

Fig. 79: Variable cost of cement manufacturing In INR


Fig. 80: Profitability at various utilization levels In INR


• Market share cannot be gained in an environment where everybody has surplus capacity, only profits can be lost: In the above case, we had presented a scenario in which increasing capacity utilization could bring about losses as prices are cut competitively. In reality, the scenario could be far worse, with prices collapsing but companies not able to increase their utilization at all if demand were to remain constant, thus incurring much higher losses than those envisaged above.

In this situation, a player A decides to increase his market share by increasing his utilization and selling more at a slightly reduced price. This would set off a negative spiral and create losses for the entire region without any corresponding increase in market share for anyone.

In our view, cement companies are well aware of this situation and will want to ensure it is avoided at all costs. In our opinion, market share can be increased only by setting up new capacity in an environment of high capacity utilization and good growth in demand.

• Top six players control more than 50% of the cement industry: The top six players, ACC, Ambuja, Ultratech, Jaiprakash Associates, Shree Cements and India Cements, control more than 50% of the market, which makes it easier for them to control the industry dynamics. While there is a long tail of cement players, many of them do not matter in the overall context as they are unable to move pricing anywhere outside their immediate catchment area.

Type Cost unit

Raw material cost

Limestone 1.5 ton/ton of cement

Limestone cost 175 INR/ton

Fly-ash 0.2 ton/ton of cement

Fly-ash cost 360 INR/ton

Gypsum 0.1 ton/ton of cement

Gypsum cost 2,300 INR/ton

Other raw material cost 50 INR/ton of cement

Total raw material cost 500 INR/ton of cement

Fuel cost

Coal 0.10 ton/ton of cement

Coal cost 6,500 INR/ton

Total fuel cost 650 INR/ton of cement

Power cost

Power required 110 units/ton of cement and auxiliary

Power cost/unit 3.7 INR/unit

Total power cost 407 INR/ton of cement

Freight cost

Lead distance by rail 500 km

Lead distance by road 350 km

Rail transport share 35%

Cost of rail transport 1.10 INR/ton/km

Cost of road transport 1.60 INR/ton/km

Loading charges 50 INR/ton of cement

Total freight cost 607 INR/ton of cement

Packing material cost 135 INR/ton of cement

Dealer commision 100 INR/ton of cement

Total variable cost 2,398 INR/ton of cement

Capacity utilization 55% 65% 75%

Capacity (mnT) 1 1 1

Volume produced and sold (mnT) 0.55 0.65 0.75

Selling price per bag (INR) 250 200 150

Excise duty (INR) 25 20 12

VAT (INR) 36 29 22

Realization per 50kg bag (INR) 189 151 117

Realization per ton (INR) 3,775 3,020 2,335

Total realization (INR mn) 2,076 1,963 1,751

Raw material cost per ton (INR) 500 500 500

Fuel cost per ton (INR) 650 650 650

Power cost per ton (INR) 407 407 407

Freight cost per ton (INR) 607 607 607

Packing cost per ton (INR) 135 135 135

Dealer commssiion per ton (INR) 100 100 100

Total variable cost per ton (INR) 2,398 2,398 2,398

Total variable cost (INR mn) 1,319 1,559 1,799

Fixed costs (INR mn)

Ermployee cost 150 150 150

Repairs and maintenance 125 125 125

Selling,admin and general expenses 150 150 150

Total fixed costs (INR mn) 425 425 425

Total costs (INR mn) 1,744 1,984 2,224

EBITDA (INR mn) 332 (21) (472)

EBITDA/ton (INR) 604 (32) (630)


49

Fig. 81: How a downward spiral in prices could occur if discipline were to break down

Source: Nomura research

Player A - Volume 1mnT; Other players -Volume 5mnT - Market demand - 6mnT;

Cement price - INR250/bag

Player A increase volume to 1.5mnT and reduces price by INR20/bag; Other players

suffer a fall to 4.5mnT

Other players respond by cutting prices to INR230/bag; Equlibrium regained with player A at 1mnT and others at 5mnT;

Prices at INR230/bag

Player A cuts prices by another INR20/bag;Player A volume at 1.5mnT; others at

4.5mnT

Other players respond by cutting prices to INR210/bag; equilibrium regained at lower

price of INR210/bag

Player A becomes aggressive; slashes price to INR175/bag and sells 2mnT; others

at 4mnT

Other players left with no option but to cut prices to INR175/bag; equilibrium regainedbut at much lower price of INR175/bag; all companies start reporting losses at similar

capacity utilization as earlier


50

Fig. 82: Market share by capacity and despatch for top 6 players


Will production discipline break if the cost of production declines?

Again, unlikely in our view. Even if the cost of production moves down from here, cement firms do need to increase their EBITDA/ton by INR200/ton while the smaller firms based in South India may need to increase by INR300/ton to reach the break-even ROCE level on new capacity. Until this level is breached decisively, price competition is unlikely to rear its ugly head, in our view. We believe that production would need to be matched with demand in any case, or else a downward price spiral would occur.

Will production discipline break if demand shows a sharp spurt?

This scenario could present a risk to production discipline, as some firms may scramble to gain the incremental demand for themselves and gain market share through higher production and lower prices. This could set off a negative price spiral and result in low profits and even losses. At the same time, we expect this situation would be temporary in nature, as the lower profits would, in our view, jolt the manufacturers to again reduce production and increase prices.

Risks to our view on production discipline

Accusations of “cartelization” against cement companies: If accusations of cartelization by cement companies are proved, there could be a risk to our view on production discipline. Cement companies are under investigation by authorities such as CCI regarding potential cartelization.

In our view, while this is a risk, cement companies have been accused of this many times in the past several years without any significant negative impact. So far, only once, in 2007, were allegations of cartelization proven, and was for a case that was 17 years old and in only one town in India. In this case, only a cease-and-desist order was issued to the involved firms. We list below the allegations of cartelisation against the cement industry over the past decade. Also with almost 50 companies in the industry in our view it would be difficult to prove cartelization on a mass scale if at all. The companies are also not making super-normal profits which would help in proving the allegation of cartelization.

50%

51%

52%

53%

54%

55%

56%

57%


Capacity market share Despatch market share


51

Fig. 83: Allegations of cartelization against the cement industry

Source: Various media sources (The Hindu Business Line, Apr 10, 2002; Times of India, 26th Jul, 2007, The Economic Times, 15th Apr 2009), Nomura research

• New entrants could rock the boat: New entrants to the industry or a region might reduce prices for a while in a bid to gain market share. While this is certainly a fear on the Street we think new entrants will be limited in the industry due to the increasing costs of setting up new plants through higher land costs and the requirement to set up power and logistics infrastructure, as well as current lower levels of returns on new plants. Also, new entrants that have already set up their plants are struggling with their own balance sheets and would not want to make operating level losses, in our view.

As an example, Jaypee Group has set up a 4.5mnT plant in Andhra Pradesh, but will probably not fight for market share given the overleveraged nature of its balance sheet. As per a news article in The Economic Times on 16 November, 2011 Jaypee also has plans to sell a stake in its southern India based cement plants, and in this situation it would not want to report any significant losses.

JSW Group has also set up a 2.5mnT unit in Andhra Pradesh as its first foray into the cement sector. With its flagship company JSW Steel caught up with issues of its own in Karnataka regarding the availability of iron ore, it might not want to start a price war in the cement sector, in our view.

• Government intervention: There is always a risk of intervention by state governments in a bid to reduce prices of cement, though in our view this is always a temporary phenomenon.

Year Complaint Action

1990 Authority starts investigation against cement cartelPasses order in 2007, asking firms to cease and desist

2002 Tamil Nadu government blames cement cartel for price rise No action

2006 Builder's association of India alleges price rigging by cement companies No action

2007 Authority starts investigation against complaint of cartelization by cement industry No action

2008 Tamil Nadu government threatens to nationalise cement companies in the state No action

2009 Builder's association of India alleges price rigging by cement companies No action

2011 Real estate developer's complain to Competition Commission of India regarding cement cartelisation Under investigation

Key company data: See page 2 for company data and detailed price/index chart.

Ambuja Cements ABUJ.NS ACEM IN


EQUITY RESEARCH

Premium valuations appear well deserved

Profitability and ROCE one of the best in the industry; likely to improve further

December 8, 2011

Rating Starts at

Buy

Target price Starts at

INR 186

Closing price December 2, 2011

INR 161

Potential upside +15.5%

Action: Initiate with Buy We initiate coverage of ACEM as Buy. We believe ACEM’s location in the non-southern regions of India should help it achieve robust volume growth and high capacity utilisation by CY13F. The operational efficiencies introduced in CY09 and CY10 have helped ACEM achieve class-leading profitability that is near up-cycle levels. In our view, this indicates that ACEM is under no pressure to increase its prices over and above the cost increase, like other firms, in order to reach up-cycle profitability. Contrary to consensus, we estimate ACEM’s EBITDA/ton at a CAGR of 5.7% until CY13F on the back of continued pricing power. Historically, ACEM has always traded at a large premium to the prevailing replacement cost, given its higher profitability and leading return ratios; we expect this premium to continue as ROCE improves over the next two years.

Catalysts: Uptick in capacity utilisation and continuing pricing power An increase in ACEM’s capacity utilisation in the northern, western and eastern regions of India and its continued ability to at least pass on cost increases to customers would be positive. In case costs led by coal prices move downwards, it would be a positive catalyst, in our view.

Valuation: Large premium to replacement cost well deserved We value ACEM on a mid-cycle multiple to current replacement cost after adjusting for the ratio of one-year forward ROCE to mid-cycle ROCE. ACEM’s mid-cycle EV/ton to replacement cost/ton multiple has been a 27% premium and adjusting for a 14% higher one-year forward ROCE vs. mid-cycle ROCE, we value ACEM at a 44% premium to current replacement cost of USD121/ton, arriving at our TP of INR183.

31 Dec FY10 FY11F FY12F FY13F

Currency (INR) Actual Old New Old New Old New

Revenue (mn) 74,194 85,379 97,250 113,638

Reported net profit (mn) 12,668 13,096 15,094 17,687

Normalised net profit (mn) 12,402 13,096 15,094 17,687

Normalised EPS 8.11 8.56 9.87 11.56

Norm. EPS growth (%) 1.4 5.6 15.3 17.2

Norm. P/E (x) 20.0 N/A 19.0 N/A 16.5 N/A 14.0

EV/EBITDA (x) 12.5 10.9 9.1 7.7

Price/book (x) 3.4 N/A 3.1 N/A 2.8 N/A 2.6

Dividend yield (%) 1.5 N/A 2.2 N/A 2.8 N/A 4.0

ROE (%) 18.4 17.1 18.0 19.4

Net debt/equity (%) net cash net cash net cash net cash


Anchor themes

We believe production discipline in the sector is likely to continue enabling ability to increase pricing and maintain mid-cycle ROCE while moving towards upcycle profitability. Demand should bounce back in FY14F while capacity utilisation is likely to bottom out in FY13F.

Nomura vs consensus

We are non-consensus in our view of improving profitability and usage of mid-cycle multiples.

Research analysts





Nomura | Ambuja Cements December 8, 2011

53

Key data on Ambuja Cements Income statement (INRmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 71,194 74,194 85,379 97,250 113,638Cost of goods sold -38,026 -40,188 -46,643 -52,961 -62,985Gross profit 33,168 34,006 38,736 44,289 50,653SG&A -14,316 -15,882 -18,420 -20,456 -22,956Employee share expense -2,728 -3,437 -4,072 -4,833 -5,624Operating profit 16,124 14,688 16,244 19,001 22,073

EBITDA 19,094 18,560 20,754 23,723 26,993Depreciation -2,970 -3,872 -4,510 -4,723 -4,920Amortisation

EBIT 16,124 14,688 16,244 19,001 22,073Net interest expense -224 -487 -78 -72 -65Associates & JCEs

Other income 2,133 2,184 2,543 2,634 3,259Earnings before tax 18,033 16,385 18,709 21,563 25,267Income tax -5,849 -3,983 -5,613 -6,469 -7,580Net profit after tax 12,184 12,402 13,096 15,094 17,687Minority interests

Other items

Preferred dividends

Normalised NPAT 12,184 12,402 13,096 15,094 17,687Extraordinary items 0 265 0 0

Reported NPAT 12,184 12,668 13,096 15,094 17,687Dividends -3,967 -4,457 -6,264 -8,054 -9,844Transfer to reserves 8,217 8,211 6,832 7,040 7,843

Valuation and ratio analysis

FD normalised P/E (x) 20.3 20.0 19.0 16.5 14.0FD normalised P/E at price target (x) 23.3 22.9 21.7 18.9 16.1Reported P/E (x) 20.3 19.6 19.0 16.5 14.0Dividend yield (%) 1.5 1.5 2.2 2.8 4.0Price/cashflow (x) 11.4 12.3 14.2 10.8 10.1Price/book (x) 3.8 3.4 3.1 2.8 2.6EV/EBITDA (x) 12.6 12.5 10.9 9.1 7.7EV/EBIT (x) 15.0 15.8 13.9 11.4 9.4Gross margin (%) 46.6 45.8 45.4 45.5 44.6EBITDA margin (%) 26.8 25.0 24.3 24.4 23.8EBIT margin (%) 22.6 19.8 19.0 19.5 19.4Net margin (%) 17.1 17.1 15.3 15.5 15.6Effective tax rate (%) 32.4 24.3 30.0 30.0 30.0Dividend payout (%) 32.6 35.2 47.8 53.4 55.7Capex to sales (%) 18.0 10.4 7.0 5.1 4.4Capex to depreciation (x) 4.3 2.0 1.3 1.1 1.0ROE (%) 20.1 18.4 17.1 18.0 19.4ROA (pretax %) 21.6 17.7 18.5 21.0 23.7

Growth (%)

Revenue 14.2 4.2 15.1 13.9 16.9EBITDA 8.7 -2.8 11.8 14.3 13.8EBIT 7.7 -8.9 10.6 17.0 16.2Normalised EPS 4.3 1.4 5.6 15.3 17.2Normalised FDEPS 4.3 1.4 5.6 15.3 17.2

Per share

Reported EPS (INR) 8.00 8.28 8.56 9.87 11.56Norm EPS (INR) 8.00 8.11 8.56 9.87 11.56Fully diluted norm EPS (INR) 8.00 8.11 8.56 9.87 11.56Book value per share (INR) 42.45 47.91 52.38 56.98 62.10DPS (INR) 2.40 2.49 3.50 4.50 6.43Source: Nomura estimates

Relative performance chart (one year)

Source: ThomsonReuters, Nomura research

(%) 1M 3M 12M

Absolute (INR) 0.7 16.5 18.5

Absolute (USD) -3.5 4.7 3.9

Relative to index 6.1 17.5 36.2

Market cap (USDmn) 4,840.1

Estimated free float (%) 40.9

52-week range (INR) 164.9/111.6

3-mth avg daily turnover (USDmn)

7.43

Major shareholders (%)

Holcim 46.4

LIC 11.4

Source: Thomson Reuters, Nomura research

Notes

Improvement in EBITDA / tonne to derive EPS CAGR of 11.8% between CY10-CY13F

110

120

130

140

150

160

170

90

100

110

120

130

140

150

Jan

11

Feb

11

Mar

11

Apr

11

May

11

Jun

11

Jul 1

1

Aug

11

Sep

11

Oct

11

Nov

11

Dec

11

PriceRel MSCI India(INR)


54

Cashflow (INRmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 19,094 18,560 20,754 23,723 26,993Change in working capital 6,562 -579 1,934 1,258 -175Other operating cashflow -3,940 2,205 -5,205 -1,922 -2,211Cashflow from operations 21,716 20,186 17,482 23,059 24,608Capital expenditure -12,844 -7,710 -6,000 -5,000 -5,000Free cashflow 8,872 12,476 11,482 18,059 19,608Reduction in investments -3,946 1,011 0 0 0Net acquisitions

Reduction in other LT assets

Addition in other LT liabilities

Adjustments 16 22 0 0 0Cashflow after investing acts 4,942 13,509 11,482 18,059 19,608Cash dividends 3,967 4,457 6,264 8,054 9,844Equity issue 1 23 0 0

Debt issue -1,230 -1,007 0 0 0Convertible debt issue

Others -7,391 -8,307 -12,529 -16,109 -19,688Cashflow from financial acts -4,653 -4,834 -6,264 -8,054 -9,844Net cashflow 289 8,675 5,218 10,005 9,764Beginning cash 8,518 8,807 17,482 22,700 32,705Ending cash 8,807 17,481 22,700 32,705 42,469Ending net debt -7,150 -16,831 -22,049 -32,055 -41,818Source: Nomura estimates

Balance sheet (INRmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 8,807 17,482 22,700 32,705 42,469Marketable securities 0 0 0 0 0Accounts receivable 1,522 1,282 1,549 1,727 2,008Inventories 6,832 9,019 10,986 11,394 14,236Other current assets 2,632 3,571 3,875 4,435 5,028Total current assets 19,793 31,353 39,110 50,260 63,741LT investments 7,270 6,260 6,260 6,260 6,260Fixed assets 60,049 64,314 65,804 66,081 66,161Goodwill

Other intangible assets

Other LT assets 1,496 1,271 1,271 1,271 1,271Total assets 88,608 103,197 112,444 123,872 137,432Short-term debt

Accounts payable 10,671 12,976 17,449 19,852 23,394Other current liabilities

Total current liabilities 10,671 12,976 17,449 19,852 23,394Long-term debt 1,657 650 650 650 650Convertible debt

Other LT liabilities 11,599 16,275 14,217 16,201 18,377Total liabilities 23,926 29,901 32,316 36,704 42,421Minority interest

Preferred stock

Common stock 3,047 3,060 3,060 3,060 3,060Retained earnings 61,662 70,241 77,073 84,113 91,956Proposed dividends

Other equity and reserves -27 -5 -5 -5 -5Total shareholders' equity 64,682 73,296 80,128 87,168 95,011Total equity & liabilities 88,608 103,197 112,444 123,872 137,432

Liquidity (x)

Current ratio 1.85 2.42 2.24 2.53 2.72Interest cover 71.9 30.2 208.2 265.6 339.4

Leverage

Net debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash

Activity (days)

Days receivable 9.7 6.9 6.0 6.2 6.0Days inventory 77.8 72.0 78.3 77.3 74.3Days payable 99.4 107.4 119.0 128.9 125.3Cash cycle -11.9 -28.5 -34.7 -45.4 -45.0Source: Nomura estimates

Notes

Strong FCF generation due to limited capex requirement

Notes

Balance sheet to remain in net cash state


55

Our top pick amongst the large-caps We initiate coverage of Ambuja Cements with a Buy rating as we believe the company’s operations are located in regions in India that are likely to continue to witness high growth and not face any significant over-capacity issues. This should enable ACEM to derive pricing power and help the company increase its already class-leading and close to up-cycle profitability (EBITDA/ton) and mid-cycle ROCE further. We believe ACEM has some of the most valuable cement capacities in India, given its location and profitability.

Investment summary

Fig. 84: Summary


Located in higher growth, lower capacity addition regions ACEM, with a capacity of 27mnT, is the third-largest cement player in India. ACEM has a presence in four out of five regions of India, with the southern region missing from its portfolio. With the southern region facing a double whammy of low demand and very high capacity, we believe it is a positive that Ambuja has no presence in that area. Of ACEM’s capacity, 50% is located in the northern and eastern parts of India and another 45% is located in the western part of India.

Fig. 85: Capacity break up (region wise)


The western, central and eastern regions are likely to witness strong growth over the next few years, driven by increased infrastructure investment and faster rural growth. As well, capacity additions in the northern, western and eastern regions of India are likely to be much lower than the southern region of India. While central India could witness higher capacity addition than in the past, Ambuja’s exposure to this region is limited.

CY06 CY07 CY08 CY09 CY10 CY11F CY12F CY13F

Installed capacity (mn tonne) 16.30 18.50 22.00 22.00 25.00 27.00 27.00 27.00

(y-y) % growth 23% 13% 19% 0% 14% 8% 0% 0%

Sales volume (cement) (mn tonne) 22.6 16.8 17.6 18.8 20.0 21.2 22.9 24.9

(y-y) % growth 77% -26% 5% 7% 6% 6% 8% 9%

Effective capacity utlisation (%) 104% 98% 104% 80% 79% 85% 92%

Average capacity utilisation (%) 102% 97% 88% 86% 86% 82% 85% 92%

Realisation (INR per tonne) 2,773 3,349 3,537 3,766 3,652 4,017 4,218 4,492

(y-y) % growth 36% 21% 6% 6% -3% 10% 5% 6%

Cost (INR per tonne) 1,827 2,132 2,540 2,754 2,725 3,039 3,181 3,399

(y-y) % growth 24% 17% 19% 8% -1% 12% 5% 7%

EBITDA (INR per tonne) 947 1,217 997 1,011 927 978 1,037 1,093

(y-y) % growth 68% 29% -18% 1% -8% 6% 6% 5%

ROCE (%) 25% 37% 27% 25% 20% 20% 22% 23%

Central6%

Eastern18%

Northern31%Southern

0%

Western45%


56

Fig. 86: Region wise demand growth In mnT


Fig. 87: Region wise effective capacity additions In mnT


We expect ACEM to report volume growth of 6% in CY11F, 8% in CY12F and ~9% in CY13F. Growth in CY13F, by our estimates, is likely to become constrained by high utilisation in eastern and northern India. Because of this, we expect ACEM’s next round of expansion to occur in northern and eastern India.

We estimate ACEM’s overall capacity utilisation to decline a bit in CY11F to 79% on account of expansion and then increase to 85% in CY12F and 92% in CY13F.

Demand FY11 FY12F FY13F FY14F

Central 32.2 34.1 37.0 40.3

y-y growth 5% 6.0% 8.5% 9.0%

Eastern 29.8 31.9 34.7 38.2

y-y growth 3% 7.0% 9.0% 10.0%

Northern 49.7 53.4 57.7 62.9

y-y growth 8% 7.5% 8.0% 9.0%

Southern 63.7 61.2 64.8 74.6

yoy growth 0% -4.0% 6.0% 15.0%

Western 30.3 33.3 36.7 40.1

y-y growth 5% 10% 10.0% 9.5%

All India 205.6 213.9 230.9 256.1


Central 4.1 6.1 4.3

Eastern 2.5 2.1 3.5


Southern 11.6 12.6 3.9

Western 5.3 4.2 2.5

Total 26.0 28.5 16.5

% of total

Central 15.8 21.5 26.0

Eastern 9.4 7.4 21.1

Northern 10.0 12.4 13.9

Southern 44.4 44.1 23.8

Western 20.3 14.6 15.2

Total 100 100 100


57

Fig. 88: Capacity, despatch & utilisation level region wise

Note: As per CMA installed capacity in CY09 is 18.0 but as per annual report its 22.0 mn tonne. CY09 based on company data will be 86%.

Source: CMA, Company data, Nomura research

Class-leading profitability can improve further Historically, Ambuja Cements has not been one of the lowest cost cement producers in the country, but since CY09 it has increased its operating efficiencies significantly and has suffered possibly the lowest cost increases in the country since then. The primary reason has been Ambuja’s investment in building up clinker manufacturing facilities, which has reduced its purchase from outside saving on cost. The cost reduction is likely to be to the tune of INR256/ton of cement in CY11. Ambuja had also set up 400MW of power plants by CY10, which has helped in reducing dependence on power from the grid and external purchase and also reduced cost. The power plant suffices for 77% of Ambuja’s overall requirement, with some facilities still devoid of captive power plants being dependent on outside purchase.

Ambuja’s freight expenses growth has also been below industry levels, due to the benefits from investing in rail linkages and other logistics infrastructure, including ships for sea transport.

Fig. 89: Year-over-year increase in various costs per ton of cement


We believe this has turned Ambuja into one of the efficient producer in the industry and has helped it register close to up-cycle profitability. While the upside from cost efficiency is now likely over, we believe Ambuja now only needs to pass on the cost increase in terms of price hikes and does not need to increase its prices over and above the cost increase like other firms in order to reach up-cycle profitability and a reasonable level of ROCE on current replacement cost.

Ambuja (Capacity) CY06 CY07 CY08 CY09 CY10 CY11F CY12F CY13F

Central - - - - 1.5 1.5 1.5 1.5

Eastern 2.0 2.7 3.0 3.0 5.0 5.0 5.0 5.0

Northern 6.2 6.6 7.4 7.4 8.3 8.3 8.3 8.3

Southern - - - - - - - -

Western 6.9 6.9 7.6 7.6 10.3 12.3 12.3 12.3

Total 15.1 16.2 18.0 18.0 25.0 27.0 27.0 27.0

Ambuja (Despatch)

Central - - - - 0.8 0.9 1.1 1.2

Eastern 2.1 2.3 2.7 3.2 3.6 4.0 4.4 5.0

Northern 6.2 6.5 6.8 7.2 7.0 7.2 7.7 8.3

Southern - - - - - - - -

Western 8.0 8.1 8.2 8.4 8.6 9.1 9.8 10.4

Total 16.3 16.9 17.7 18.8 20.0 21.2 22.9 24.9

Ambuja (Capacity utilisation)

Central 53% 61% 71% 83%

Eastern 104% 85% 90% 107% 72% 79% 87% 99%

Northern 100% 98% 92% 97% 85% 87% 93% 100%

Southern

Western 116% 117% 107% 110% 84% 74% 80% 85%

Total 108% 104% 98% 104% 80% 79% 85% 92%

FY00 FY01 FY02 FY03 FY04 CY05 CY06 (18m) CY07 CY08 CY09 CY10

Raw material cost -17% 50% 25% -10% 8% 1% 49% 19% 24% 47% -27%

Power cost 29% 2% -11% 5% -7% 11% 25% 4% 16% 1% 11%

Fuel cost 4% 3% -4% -7% 7% 24% -9% 12% 29% 1% 10%

Freight Expense -10% -1% -6% 20% 7% 0% 44% 28% 5% 3% 4%

Employee cost 11% 0% 7% -4% 21% -2% 35% 21% 22% -4% 16%

Other manufacturing, admin & other expense 11% 6% -9% -11% 13% 3% 21% 11% 24% -3% 7%

Total 4% 8% -2% -2% 7% 7% 24% 17% 19% 8% -1%


58

Fig. 90: Ambuja expected EBITDA / tonne- best in class amongst peers, in our view


We estimate realisations per ton at a CAGR of ~7% between CY10-CY13F, and costs to increase at a CAGR of ~7.5% resulting in EBITDA/ton growth of 5.7% on a conservative basis. By CY13F we expect EBITDA/ton to cross the INR1070/ton mark mentioned earlier in the report where the ROCE on current replacement cost reaches breakeven level at a 70% capacity utilisation level. Given ACEM’s significantly higher capacity utilisation of 85% in CY12F, it would be well ahead of breakeven ROCE on the replacement cost level. In our view, ACEM would be one of the very few companies in the industry which can cross this level by CY13F.

Fig. 91: Trend in realisation, cost and EBITDA per tonne


Strong free cash flow on a net cash balance sheet provides a comfort factor The company has a net cash balance sheet with almost INR30bn of cash and liquid investments expected on the balance sheet in CY11F. In the absence of any solid capex plans we expect this cash and liquid investment to move up to INR51bn, which should be enough to fund 8mnT of new cement capacity at current replacement cost. However, this cash is likely to keep the ROCE subdued at mid-cycle levels, but we believe return on invested capital (ROIC) will improve in CY13F.

In a macro environment where worldwide firms are struggling for liquidity and there is solvency risk for sovereigns and companies, we believe such a large amount of cash in the company will provide a comfort level to investors.

Financials

We see ACEM reporting a 15.3% CAGR in net sales, driven by volume growth mentioned above and a 7% CAGR in pricing between CY10-CY13F. We expect cost of production to show a CAGR of 7.5% in the same time period, resulting in core cement EBITDA/ton (excluding other income) moving up from INR927/ton in CY10 to INR1037/ton in CY12F and further to INR1093/ton in CY13F, a CAGR of 5.7%. We expect a CAGR of 11.8% in the company’s EPS between CY10-CY13F.

We estimate ROCE to improve from 20.1% in CY10 to 21.6% in CY12F and 23% in CY13F, which would be at the upper end of the mid-cycle levels, driven by the higher

EBITDA/tonne FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

ACC 501 472 366 486 480 689 749 786 1,108 681 734 797 832

Ambuja 739 618 494 512 562 947 1,217 997 1,011 927 978 1,037 1,093

Ultratech 802 1,010 937 950 707 908 968 998

Shree 751 385 453 588 587 1,189 1,319 1,078 1,322 680 961 987 1,056

India Cement 166 210 447 870 1,146 976 661 342 888 826 704

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59

EBITDA/ton and higher capacity utilisation. We believe the company’s ROCE is one of the best in the industry because of higher profitability.

Fig. 92: Ambuja’s solid expected ROCE’s ratios vs peers


Fig. 93: Key assumptions


Valuation

Consensus is extremely negative on the stock, driven by concerns of the company’s declining profitability due to cost increases and the possible inability to pass on costs due to low levels of utilisation in the industry. Consensus valuation is at down-cycle multiples. In our opinion, consensus has also neglected to realise that ACEM has traditionally traded at a large premium to the prevailing replacement cost, given its focus on non-southern regions in India and high profitability.

We have a contrarian opinion where we believe that the company’s core areas of northern, western (mainly Gujarat) and eastern India are unlikely to see any major capacity additions that could result in pricing pressure. We also expect cost increases to moderate in CY12F. In our view, ACEM’s current profitability, which is almost close to up-cycle levels, gives it a cushion of not having to raise prices above cost increases to improve return ratios. This should keep the company relatively competitive in the market and enable it to sell more volumes.

We prefer to use an asset value-based methodology in terms of EV/ton vs. replacement cost/ton against an earnings-based methodology, given the wide variation in earnings between cycles and also due to timing differences between cost increase and price hikes.

Given mid-cycle ROCE over the next two years, we believe ACEM should also trade at a mid-cycle multiple to the replacement cost per ton in terms of EV/ton. The mid-cycle EV/ton multiple (premium or discount) corresponds to the mid-cycle ROCE of the firm. We adjust this mid-cycle multiple by the ratio of the one-year forward ROCE to the mid-cycle ROCE of the company to arrive at a more accurate multiple.

ROCE (%) FY02 FY03 FY04 FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

ACC 15% 16% 12% 16% 16% 34% 33% 27% 32% 17% 18% 20% 21%

Ambuja 10% 9% 9% 11% 16% 25% 37% 27% 25% 20% 20% 22% 23%

Ultratech 32% 36% 26% 25% 17% 18% 18% 17%

Shree 5% 7% 11% 15% 17% 30% 31% 24% 27% 13% 24% 20% 20%

India Cement 8% -2% 2% 2% 8% 17% 20% 15% 10% 3% 11% 10% 8%

Key assumptions CY06 CY07 CY08 CY09 CY10 CY11F CY12F CY13F

(y-y) % volume growth 77% 11% 5% 7% 8% 6% 8% 9%

(y-y) % realisation growth 36% 21% 6% 6% -3% 10% 5% 7%

(y-y) % power cost -4% 23% 40% 17% -11% 26% 0% 10%

(y-y) % fuel 0% 19% 36% 7% -3% 26% 0% 10%

(y-y) % freight 48% 27% 5% 3% 4% 12% 7% 7%


60

Fig. 94: Trend in ROCE


ACEM’s EV/ton to replacement cost mid-cycle multiple over the last 10 years has been a large 27% premium. In fact, Ambuja has traded below replacement cost only in FY03 and Sep-08 to Mar-09 in the last ten years. We expect a ROCE of 21.6% in CY12F vs. a mid-cycle ROCE of 19% in the last 10 years, a premium of 14%. Thus, our target multiple to the replacement cost per ton for ACC of INR6,250/ton (USD121/ton at INR-USD rate of INR51.7) would be a premium of 44% (1.27x1.14=1.44) or an EV/ton of INR8,993/ton (USD174/ton). We multiply this with ACEM’s current capacity of 27mnT to arrive at our target EV. Based on this methodology, we value ACEM at INR183/share, which provides a 22.8% upside to its current share price. The implied EV/EBITDA for the stock would be 10.2x CY12F EBITDA. The stock is currently trading at an EV/ton of USD138/ton or implied 8x CY12F EV/EBITDA, which we believe does not take into consideration the potential improvement in ROCE and profitability going forward.

Fig. 95: Valuation


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Last 10 years avg. ROCE [A] (%) 19

ROCE (CY12E) [B] (%) 22

Last 10 years avg. premium/discount to RC/Tonne [C] 1.27

Target premium/discount to RC/Tonne [D]=(B*C/A) 1.46

Current EV/Tonne (INR) [E] 6,250

Target EV/Tonne [F]= [D]*[E] 9,095

Total capacity 27.0

Target EV (INR mn) [G] 245,570 161

Debt (CY12E) [H] 650 (0)

Cash & Marketable securities [I] 36,470 25

Other Investments [J] 494 0

Equity value (G-H+I+J) 283,884 186

No of shares 1,530

Target price 186


61

Fig. 96: EV / tonne vs replacement cost


Fig. 97: 1 yr forward EV/EBITDA


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Shree Cement SHCM.NS SRCM IN


EQUITY RESEARCH

Top pick – Buy with 37% upside

Well located, cost leader with diversified Power(ful) earnings; attractive valuation

December 8, 2011

Rating Starts at

Buy


INR 2933


INR 2132


Action: Significant discount to mid-cycle valuation unjustified; Buy We initiate coverage on Shree Cement with a Buy rating. We believe Shree, with the leanest cost structure amongst our coverage, an ROCE profile similar to other large players, a strong balance sheet supported by diversified earnings from the power business and no exposure to the southern region of India where there is a supply glut, should trade at its mid-cycle valuation, in line with peers. Shree Cement is our top pick with a TP of INR2,933, providing upside potential of 37%. At CMP, the stock is building in a 32% discount to current replacement cost, which in our view is unwarranted.

Catalysts: Improvement in realisation, pick up in merchant power rate and strong power offtake Any ability to pass on cost increase, signing of additional power agreements with SEBs along with an uptick in merchant power rates would be key positive catalysts for the stock.

Valuation: Fair value at mid-cycle discount We value Shree’s cement business on a mid-cycle multiple to current replacement cost after adjusting for the ratio of one-year forward ROCE to mid-cycle ROCE. Shree’s mid-cycle EV/ton is at par with replacement cost/ton and adjusting for 1% higher one-year forward ROCE vs. mid-cycle ROCE, we value Shree at a 1% premium to current replacement cost of USD121/ton. Separately, we have valued its power portfolio (~400 MW) at 6x EV/EBITDA, nearly a 40% discount to large players to arrive at our target price of INR2,933.

31 Mar FY11 FY12F FY13F FY14F


Revenue (mn) 35,119 41,695 48,414 54,390



Normalised EPS 74.19 92.51 128.28 185.07

Norm. EPS growth (%) -65.1 24.7 38.7 44.3

Norm. P/E (x) 28.9 N/A 23.2 N/A 16.7 N/A 11.6

EV/EBITDA (x) 10.2 7.4 6.1 4.9



ROE (%) 13.5 15.2 18.3 22.0

Net debt/equity (%) 77.9 55.0 21.1 net cash


Anchor themes

We believe production discipline in the sector is likely to enable firms to continue increasing prices and maintain a mid-cycle ROCE while moving towards upcycle profitability. Demand will bounce back in FY14F while capacity utilization will bottom out in FY13F.

Nomura vs consensus

We are slightly ahead of consensus on earnings while offering mid-cycle multiple rather than down-cycle ones.

Research analysts





Nomura | Shree Cement December 8, 2011

63

Key data on Shree Cement Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 36,321 35,119 41,695 48,414 54,390Cost of goods sold -17,973 -22,355 -25,440 -30,100 -33,737Gross profit 18,348 12,764 16,255 18,315 20,653SG&A -7,441 -8,680 -8,923 -9,354 -9,165Employee share expense -1,586 -1,985 -2,315 -2,762 -3,298Operating profit 9,321 2,099 5,017 6,198 8,190


EBIT 9,321 2,099 5,017 6,198 8,190Net interest expense -766 -978 -1,457 -1,184 -762Associates & JCEs

Other income 758 468 514 566 623Earnings before tax 9,313 1,589 4,075 5,580 8,051Income tax -1,918 993 -856 -1,116 -1,610Net profit after tax 7,395 2,582 3,219 4,464 6,440Minority interests

Other items

Preferred dividends

Normalised NPAT 7,395 2,582 3,219 4,464 6,440Extraordinary items

Reported NPAT 7,395 2,582 3,219 4,464 6,440Dividends -530 -571 -571 -571 -571Transfer to reserves 6,865 2,011 2,649 3,894 5,870


FD normalised P/E (x) 10.1 28.9 23.2 16.7 11.6FD normalised P/E at price target (x) 13.8 39.5 31.7 22.9 15.8Reported P/E (x) 10.1 28.9 23.2 16.7 11.6Dividend yield (%) 0.7 0.8 0.8 0.8 0.8Price/cashflow (x) 5.7 8.4 7.7 6.6 5.8Price/book (x) 4.1 3.8 3.3 2.8 2.3EV/EBITDA (x) 6.1 10.2 7.4 6.1 4.9EV/EBIT (x) 9.8 43.0 17.4 13.0 8.8Gross margin (%) 50.5 36.3 39.0 37.8 38.0EBITDA margin (%) 41.4 25.2 28.4 27.2 27.0EBIT margin (%) 25.7 6.0 12.0 12.8 15.1Net margin (%) 20.4 7.4 7.7 9.2 11.8Effective tax rate (%) 20.6 -62.5 21.0 20.0 20.0Dividend payout (%) 7.2 22.1 17.7 12.8 8.9Capex to sales (%) 32.6 32.8 14.4 8.3 7.4Capex to depreciation (x) 2.1 1.7 0.9 0.6 0.6ROE (%) 48.6 13.5 15.2 18.3 22.0ROA (pretax %) 25.2 4.7 11.2 13.9 18.7

Growth (%)

Revenue 34.0 -3.3 18.7 16.1 12.3EBITDA 57.6 -41.1 33.7 11.3 11.6EBIT 24.6 -77.5 139.0 23.5 32.1Normalised EPS 21.5 -65.1 24.7 38.7 44.3Normalised FDEPS 21.5 -65.1 24.7 38.7 44.3

Per share




(%) 1M 3M 12M

Absolute (INR) 7.8 28.6 5.5

Absolute (USD) 3.3 15.6 -7.6




52-week range (INR) 2200/1500


0.64


Bangur's 65.5


Notes

Improvement in EBITDA / tonne and merchant power sale to derive EPS CAGR of 36%

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 15,025 8,857 11,840 13,182 14,705Change in working capital 739 1,294 -378 -59 -118Other operating cashflow -2,730 -1,212 -1,798 -1,734 -1,750Cashflow from operations 13,033 8,939 9,664 11,389 12,838Capital expenditure -11,835 -11,516 -6,000 -4,000 -4,000Free cashflow 1,199 -2,578 3,664 7,389 8,838Reduction in investments 3,958 0 0 0Net acquisitions

Reduction in other LT assets -599 0 0 0Addition in other LT liabilities 0 0 0 0Adjustments -7,474 599 0 0 0Cashflow after investing acts -6,275 1,380 3,664 7,389 8,838Cash dividends -530 -571 -571 -571 -571Equity issue 0 0 0 0 0Debt issue 6,101 -983 0 0 0Convertible debt issue

Others 146 618 0 0 0Cashflow from financial acts 5,717 -936 -571 -571 -571Net cashflow -558 444 3,093 6,818 8,267Beginning cash 4,723 4,164 4,608 7,701 14,520Ending cash 4,164 4,608 7,701 14,520 22,787Ending net debt 16,899 15,471 12,378 5,559 -2,708Source: Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 4,164 4,608 7,701 14,520 22,787Marketable securities 15,922 11,965 11,965 11,965 11,965Accounts receivable 824 1,082 1,284 1,489 1,673Inventories 3,581 4,042 4,595 5,423 6,108Other current assets 7,252 4,656 5,523 6,408 7,198Total current assets 31,744 26,353 31,068 39,805 49,730LT investments

Fixed assets 17,194 21,949 21,126 18,142 15,627Goodwill


Other LT assets 124 723 723 723 723Total assets 49,062 49,025 52,916 58,670 66,080Short-term debt

Accounts payable 4,668 6,264 7,121 8,404 9,466Other current liabilities 4,999 2,820 3,205 3,783 4,261Total current liabilities 9,667 9,084 10,327 12,187 13,727Long-term debt 21,062 20,079 20,079 20,079 20,079Convertible debt

Other LT liabilities 0 0 0 0

Total liabilities 30,729 29,163 30,406 32,266 33,806Minority interest

Preferred stock

Common stock 348 348 348 348 348Retained earnings 17,984 19,513 22,162 26,056 31,926Proposed dividends

Other equity and reserves

Total shareholders' equity 18,332 19,862 22,510 26,404 32,274Total equity & liabilities 49,062 49,025 52,916 58,670 66,080

Liquidity (x)


Leverage

Net debt/EBITDA (x) 1.12 1.75 1.05 0.42 net cashNet debt/equity (%) 92.2 77.9 55.0 21.1 net cash

Activity (days)


Notes

Strong operating cash flow from both cement & power business

Notes

Shree to turn net cash positive due to strong free cash flow


65

Top pick - Upside of 37% We initiate coverage on Shree Cement with a Buy rating as we believe its operations are located in regions that will continue to witness high growth and not face any over-capacity issues. This should allow Shree to pass on any cost increase, and this, coupled with its cost leadership, should enable the company to achieve mid-cycle ROCE. The stock is now available at a significant discount to its mid-cycle levels.

Investment summary

Fig. 98: Summary of key variables

Note: EBITDA per tonne includes clinker sales

ROCE for cement business


Capacities — well located in hinterland of growth and lower capacity addition All of Shree Cement’s 13.5 mn tonne capacity are located in the northern (11.7mn tonne) and central regions (1.8 mn tonne) of India, where we believe the demand supply situation is quite favourable for the sector. On account of the lower capacity addition over FY09-11 and better demand, we expect capacity utilisations (over FY12-FY14F) in the northern / central regions to remain at higher levels of 85% / 88% (average) vs. all India average capacity utilisation of 75% over the same period. We believe its geographical advantage, coupled with new capacity addition should see Shree Cement achieving strong volume growth of 8%, 9%, and 9% in FY12F, FY13F and FY14F, respectively, which would result in average capacity utilisation of 86% during the same period, a level similar to that of Ambuja Cement (ACEM IN, BUY PT INR 186).

Fig. 99: Capacity breakup (region wise)

Source: Company data. Nomura research

FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Installed capacity (mn tonne) 4.73 6.83 9.00 10.20 13.50 13.50 13.50 13.50

(y-y)% growth 58% 44% 32% 13% 32% 0% 0% 0%

Sales volume (cement) (mn tonne) 4.8 6.3 7.7 9.3 9.3 10.1 11.0 12.0

(y-y)% growth 51% 31% 22% 20% 1% 8% 9% 9%

Effective capacity utlisation (%) 107% 110% 85% 103% 86% 79% 86% 93%

Realisation (INR per tonne) 2,767 3,193 3,112 3,372 3,114 3,506 3,688 3,842

(y-y)% growth 35% 15% -3% 8% -8% 13% 5% 4%

Cost (INR per tonne) 1,579 1,874 2,034 2,050 2,434 2,545 2,701 2,786

(y-y)% growth 8% 19% 9% 1% 19% 5% 6% 3%

EBITDA (INR per tonne) 1,189 1,319 1,078 1,322 680 961 987 1,056

(y-y)% growth 103% 11% -18% 23% -49% 41% 3% 7%

ROCE (%) 30% 31% 24% 27% 13% 24% 20% 20%

Rajasthan87%

Uttarakhand13%


66

Operating cost lowest amongst peers Historically, Shree Cement is the most cost efficient cement producer (among stocks you cover) as it has lower operating power and freight costs. Shree saves on power costs, as it not only has 100% captive power availability at its clinker units, but also its electricity consumption per tonne is the lowest due to the company’s continuous operational initiatives. The table below shows captive power availability amongst large cement players and per tonne consumption of electricity (in kWh).

Fig. 100: Lowest amongst peers

Note: Based on CY10 or FY11


Fig. 101: Captive power availability (as of FY11)

Note: Based on clinker units


With well-positioned grinding units, we believe the company is able to sell a large chunk of its cement in the nearby markets, resulting in lower lead distances. This is further supported by better logistics management, its freight cost is ~34% lower compared to other large players (based on FY11). Added together, its overall cost per tonne of cement is nearly 17% lower than its peers. We believe that as the cement business is largely a pure commodity business, having a lean cost structure allows a company to be more competitive and helps handle the vagaries of business cyclicality better.

Solid CAGR ~23% increase from cement business over FY11-14F On our estimates, average capacity utilisation in the northern / central markets are expected to be in the range of 82-92% over the next three years, thus we believe cement players in the northern market are better positioned to pass on any incremental cost increase to customers. We have factored in y-y FY12F, FY13F and FY14F net realisation growth of 13%,5%, and 4%, respectively, from INR3,114 per tonne in FY11. The company's clinker / power plants are well equipped to handle both PET Coke and Coal, which we believe gives it a distinct advantage in capitalising on cost arbitrage between these two fuels. As of now, on account of the decline in pet coke prices, we have assumed FY12F, FY13F, and FY14F y-y changes in fuel costs of -5%, 5%, and 5%, respectively. This results in lower y-y overall cost increases of 5%, 6%, 3% in FY12F, FY13F and FY14F, respectively.

Fig. 102: Cost break up per tonne


Fig. 103: Pet coke price


CompanyElectricity consumption (units

/ tonne)

ACC 87

Ambuja 83

Ultratech 82

Shree Cement 79

India Cement 93

Company Installed capacity (MW) Captive power (%)

ACC 350 ~90%

Ambuja 400 ~80%

Ultratech 540 ~78%

Shree Cement 265 100%

India Cement 120 ~65%

* For India Cement-120 MW under construction

Shree FY10 FY11 FY12F FY13F FY14F

Raw material 445 569 624 662 635

Power cost 153 190 211 222 233

Fuel cost 396 553 529 555 583

Freight Expense 445 411 444 477 501

Employee cost 155 193 217 238 262

Depreciation 557 658 639 602 518

Total 2,050 2,434 2,545 2,701 2,786

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With better realisation and smaller increases in fuel price, we expect EBITDA / tonne to grow from INR680 per tonne (FY11) to INR987/INR1,056 per tonne in FY13F/FY14F, respectively. This should lead to cement EBITDA registering c.23% CAGR over FY11-FY14F. We expect the company’s ROCE to return to the mid-cycle level of 20% from FY11 lows of 13%.

Fig. 104: Trend in EBITDA / Tonne

Note: Includes clinker sales


Fig. 105: Trend of EBITDA from Cement business


Fig. 106: Key asumptions


Power portfolio — hedges cement earnings cyclicality The company’s installed power capacity is expected to increase to 560MW from 260MW in the current year. Out of new 300MW power capacity, management mentioned that the first 150MW got commissioned in October 2011, while the second 150MW plant is set to be synchronised by December 2011. Based on our volume estimates, the company would require c.120-150MW of power for its cement business, while the rest of it will look to sell as merchant power. Management has mentioned that it has recently entered into a contract for sale of 225MW of power with various SEBs for October 2011–June 2012 at an average rate of INR4.25 per unit.

On our estimates, of this surplus c.400MW we expect the company to be able to sell on an average 230MW each year in FY13-14F. The merchant tariff rates have declined to c.INR4 per unit from its peak (c.INR 7-10 unit) in January 2009 and have been stabilised around these levels. We have assumed a conservative average net realisation of INR4.0 per unit over FY12-14F. We see upside risk to our earnings with any uptick in merchant power rates from these trough levels and higher-than-expected fall in coal / pet coke prices.

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(y-y)% volume growth 51% 31% 22% 20% 1% 8% 9% 9%

(y-y)% realisation growth 35% 16% 0% 8% -6% 11% 5% 4%

(y-y)% power cost 4% 18% 14% -25% 30% 10% 5% 5%

(y-y) % fuel 16% 27% 29% -19% 38% -5% 5% 5%

(y-y)% freight 3% 31% 0% 8% -8% 8% 8% 5%


68

Fig. 107: Trend of merchant power and coal prices


Based on our conservative assumption of INR4.0 per unit (average) for merchant power sales over FY12-14F and 10%, 5%, and 5% increases in coal prices in FY12F, FY13F and FY14F, respectively, we expect EBITDA margin on power sales to be in the range of 23-37%. On these conservative estimates, the power business should contribute on an average c.12% to overall company’s overall FY12-14F EBITDA.

Fig. 108: EBITDA margin for merchant power business


Fig. 109: EBITDA contribution from Power business


Strong FCF generation – room for capacity expansion On the back of strong volume growth, higher realisation and sale of power from newer capacities and no further capex requirement, we expect the company to generate cumulative FCF of INR20.0bn over FY12-14F and should turn net cash positive from modest gearing levels of c.0.17x at FY11-end

The company has plans to attain 20mn tonne cement capacity by FY17F. For this, it has acquired a mining lease for limestone in Chhattisgarh and Karnataka and is in process of completing land acquisitions at both the locations. At an average FCF run rate (FY12-FY14F) of INR 6.6 bn per year, the company should be able to fund the major part of this expansion through internal accruals, leaving further room for growth by using certain leverage.

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Valuation- Top Buy- Cement business available at 32% discount to historical average

Valuation methodology rationale For the cement business, we prefer an asset value-based methodology in terms of EV/tonne vs. replacement cost/tonne against an earnings-based methodology, given the wide variation in earnings between cycles and also due to timing differences between cost increase and price hikes. Given mid-cycle ROCE over the next two years, we believe the company’s cement business should also trade at a mid-cycle multiple to the replacement cost in terms of EV/tonne. The mid-cycle EV/tonne multiple (premium or discount) corresponds to the mid-cycle ROCE. We adjust this mid-cycle multiple by the ratio of the one-year forward ROCE to the mid-cycle ROCE of the company to arrive at a more accurate multiple.

Valuation Shree’s EV/tonne to replacement cost mid-cycle multiple over the last 10 years has been at 0%. We expect a ROCE of 20.2% in FY13F vs. a mid-cycle ROCE of 19.9% in the last 10 years, a premium of 1.0%. Thus, our target multiple to the replacement cost per ton for Shree of INR6,250/ton (USD121/ton at INR-USD rate of INR51.7) would be a premium 1.0% or an EV/ton of INR6,321/ton (USD122/ton). We multiply this with Shree’s capacity of 13.5mn tonne to arrive at our target EV.

Separately, we have valued Shree’s power business conservatively at 6.0x EV/EBITDA, which is nearly at 40% discount to other pure play power generating companies.

Based on this methodology, we value Shree at INR2,933 per share, which provides an upside of 38% to its current price. At CMP of INR2,132 per share, (adjusting for power business valuation) the company’s cement business is currently available at 26% discount to replacement cost / tonne compare to its 10-year long term average of 0%.

As a cross check, our TP of INR 2,933 implies EV/EBITDA of 7.5x for cement business.

Fig. 110: Trend in ROCE


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Fig. 111: Valuation


Fig. 112: EV/Tonne vs. replacement cost


Fig. 113: 1yr fwd EV/EBITDA


Key risks

• Due to geographical concentration of its capacity in North, any potential slow down of infrastructure sector / construction activity in the northern region would result in lower sales volume growth /realisation, one key downside risk to our estimates for Shree.

• Lower power offtake due to the poor economic health of state electricity boards (SEBs), lower-than-expected prices for Merchant power and dependence on imported coal /pet coke for power generation, could significantly impact Shree’s power earnings.

• Better cement and merchant power realisations are likely to be key upside risks to our estimates for Shree.

Cement Business per share

Last 10 years avg. ROCE [A] (%) 20.0%

ROCE (FY13F) [B] (%) 20%

Last 10 years avg. premium/discount to RC/Tonne [C] (%) 1.00

Target premium/discount to RC/Tonne [D] = (C*B/A) 1.01

Current EV/Tonne (INR) [E] 6,250


Total capacity (FY13F) 13.5

Target EV (INR mn) [G] 85,336 2,450

Power Business

EV/EBITDA 6.0

EBITDA (FY13F) 1,737

Target EV (INR mn) [H] 10,423 299

Debt (FY13F) [I] 20,079 (576)

Cash & Marketable securities [J] 26,484 760

Other Investments [K] 0

Equity value (G+H-H+I+J+K) 102,165 2,933

No of shares 35

Target price 2,933

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Grasim Industries GRAS.NS GRASIM IN


EQUITY RESEARCH

Enter UltraTech through Grasim

Market leader available at discount through parent company

December 8, 2011

Rating Starts at

Buy


INR 3014


INR 2451

Potential upside +23%

Action: Initiate coverage with Buy; UltraTech at INR3,502 EV/tonne We initiate coverage of Grasim with a Buy rating, as the company provides diversified exposure to cement and VSF business, with market leadership, impressive margins and strong management. With total capital expenditure of INR144bn outlined for the next three years, the company is set to achieve volume growth in both VSF and cement businesses and should retain its market leadership, in our view. We believe Grasim provides a good way to get exposure to UltraTech Cement (UTCEM IN, Neutral; ~60% owned by Grasim) at a less expensive valuation. At Grasim’s CMP, UltraTech is available at a 45% discount to our fair value of INR1,259/share or an implied EV/tonne of INR3,502/tonne, which we believe is attractive given our belief that UltraTech should trade at a premium to replacement cost of INR6,250/tonne.

Catalysts: Sharp uptick in cement volume growth, breakdown of production discipline or a fall in VSF prices An upside catalyst is faster-than-expected recovery in volume growth. On the downside, a surprise breakdown in production discipline could lead to lower cement prices and a fall in cotton prices could pressure VSF prices.

Valuation: Potential upside of 23% We arrive at a target price of INR3,014, valuing the company’s non-cement business at 5.0x EV/EBITDA (FY13F) and the UltraTech Cement stake at our TP of INR1,259/share. We then apply a 20% holding company discount. Separately, we value Grasim’s equity holding in other group companies at CMP, applying a 20% discount thereafter, and value other investments at book value.



Revenue (mn) 212,690 236,912 262,935 301,912



Normalised EPS 315.66 396.95 436.05 502.28

Norm. EPS growth (%) -15.4 25.8 9.8 15.2

Norm. P/E (x) 7.8 N/A 6.2 N/A 5.6 N/A 4.9

EV/EBITDA (x) 6.2 4.9 4.7 3.8



ROE (%) 18.6 20.4 19.5 19.5

Net debt/equity (%) 39.3 32.6 36.4 24.0


Anchor themes

We believe production discipline in the sector is likely to continue, enabling companies to increase pricing and maintain mid-cycle ROCE while moving towards upcycle profitability. Demand should bounce back in FY14F, while capacity utilization will bottom out in FY13F.

Nomura vs consensus

We are in line with consensus on earnings, but we use mid-cycle multiples when valuing Ultratech rather than downcycle ones.

Research analysts





Nomura | Grasim Industries December 8, 2011

72

Key data on Grasim Industries Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 199,334 212,690 236,912 262,935 301,912Cost of goods sold -100,080 -119,413 -128,320 -140,674 -162,205Gross profit 99,253 93,278 108,592 122,261 139,708SG&A -40,748 -45,454 -49,533 -56,693 -64,279Employee share expense -10,586 -12,375 -12,724 -14,437 -16,428Operating profit 47,920 35,449 46,335 51,130 59,000


EBIT 47,920 35,449 46,335 51,130 59,000Net interest expense -3,346 -4,056 0 0 0Associates & JCEs

Other income 5,356 7,135 4,040 4,219 4,782Earnings before tax 49,930 38,528 50,375 55,349 63,783Income tax -15,705 -9,576 -13,967 -15,355 -17,714Net profit after tax 34,225 28,952 36,409 39,995 46,069Minority interests

Other items

Preferred dividends

Normalised NPAT 34,225 28,952 36,409 39,995 46,069Extraordinary items 3,361 0 0 0 0Reported NPAT 37,586 28,952 36,409 39,995 46,069Dividends -2,751 -1,834 -1,835 -1,835 -1,835Transfer to reserves 34,836 27,118 34,573 38,159 44,234



Growth (%)

Revenue 8.3 6.7 11.4 11.0 14.8EBITDA 33.7 -19.1 24.8 10.1 15.8EBIT 38.3 -26.0 30.7 10.3 15.4Normalised EPS -15.4 25.8 9.8 15.2Normalised FDEPS -15.4 25.8 9.8 15.2

Per share

Reported EPS (INR) 409.88 315.66 396.95 436.05 502.28Norm EPS (INR) 373.23 315.66 396.95 436.05 502.28Fully diluted norm EPS (INR) 373.23 315.66 396.95 436.05 502.28Book value per share (INR) 1,584.21 1,802.76 2,085.09 2,395.46 2,764.88DPS (INR) 29.99 20.00 20.01 20.01 20.01Source: Nomura estimates



(%) 1M 3M 12M

Absolute (INR) -2.7 13.9 4.3

Absolute (USD) -6.8 2.3 -8.6




52-week range (INR) 2626.35/1981.2


3.64


Aditya Birla Group 25.5

LIC 12.2


Notes

EPS CAGR of 16.5% expected for FY11-FY14F

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 57,867 46,832 58,469 64,376 74,572Change in working capital 3,271 -8,299 -3,105 -3,212 -4,831Other operating cashflow -12,850 -2,938 -10,421 -11,647 -13,445Cashflow from operations 48,288 35,595 44,942 49,517 56,297Capital expenditure -6,737 -24,471 -40,000 -65,000 -35,000Free cashflow 41,550 11,124 4,942 -15,483 21,297Reduction in investments -31,132 -12,574 0 0 0Net acquisitions



Adjustments 2,731 4,953 0 0 0Cashflow after investing acts 13,149 3,503 4,942 -15,483 21,297Cash dividends -3,290 -2,237 -2,239 -2,239 -2,239Equity issue 382 22 0 0 0Debt issue -3,169 11,835 0 18,000 -18,000Convertible debt issue

Others -6,971 -12,649 0 0 0Cashflow from financial acts -13,049 -3,029 -2,239 15,761 -20,239Net cashflow 100 474 2,703 278 1,058Beginning cash 2,270 2,370 2,844 5,547 5,824Ending cash 2,370 2,844 5,547 5,824 6,882Ending net debt 53,622 64,984 62,281 80,003 60,950Source: Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 2,370 2,844 5,547 5,824 6,877Marketable securities

Accounts receivable 8,803 14,346 15,980 17,735 20,364Inventories 21,835 27,216 28,998 32,267 36,944Other current assets 12,371 14,378 16,013 17,769 20,400Total current assets 45,379 58,784 66,538 73,597 84,586LT investments 66,759 79,333 79,333 79,333 79,333Fixed assets 145,527 157,894 185,761 237,516 256,944Goodwill


Other LT assets 20,071 24,203 24,203 24,203 24,203Total assets 277,735 320,214 355,835 414,648 445,065Short-term debt



Preferred stock


Other equity and reserves 20,057 19,616 19,616 19,616 19,616Total shareholders' equity 145,304 165,349 191,244 219,712 253,595Total equity & liabilities 277,736 320,214 355,835 414,648 445,065

Liquidity (x)

Current ratio 1.17 1.35 1.46 1.50 1.56Interest cover 14.3 8.7 na na na

Leverage

Net debt/EBITDA (x) 0.93 1.39 1.07 1.24 0.82Net debt/equity (%) 36.9 39.3 32.6 36.4 24.0

Activity (days)

Days receivable 15.6 19.9 23.4 23.4 23.0Days inventory 80.3 75.0 80.2 79.5 77.9Days payable 69.6 60.8 64.6 64.1 62.8Cash cycle 26.3 34.0 39.0 38.8 38.1Source: Nomura estimates

Notes

Capital expansion plans to lead to lower free cash flow generation

Notes

Balance sheet has enough cash and liquid investments to fund capex


74

Market leadership, with strong management Grasim provides exposure to two distinct businesses with market leadership along with strong management. In the Viscose Staple Fibre (VSF) business, with total installed capacity of 0.33mn tonnes, it enjoys nearly a monopoly in the Indian market, which provides the company strong pricing power with its customers. With continued efforts in the past towards backward integration, the company has one of the lowest cost structures globally, in our view. In the cement business, through its subsidiary UltraTech Cement (~60% stake), it has the highest cement capacity (48.75mn tonnes) in India, and is among the top 10 players in the world. As one of the biggest players in the Industry, the company can drive higher realisations through high value product mix – namely White cement, Ready-mix concrete (RMC), etc.

Set for future growth To retain its leadership position in both key businesses, the company has lined up total capex of around ~INR144bn to be spent over FY12-FY14E. Specifically, in the cement business, it plans to spend around ~INR52bn to increase its cement capacity by ~20% through brownfield expansion and another ~INR58bn towards improvement in freight management and captive power generation facilities. In the VSF business, in order to capitalise on future growth, the company is expanding its capacity by around 47% from 0.33mn tonnes to 0.49mn tonnes, requiring total expenditure of INR~28bn (includes INR7.5bn for a caustic soda plant as part of its backward integration). We view these expansion plans as positive, as both the cement and VSF business, being commodity businesses, leave less room to compete on product differentiation; thus, achieving cost competitiveness through economies of sales and backward integration becomes imperative.

We expect only limited external funding requirements for these expansion plans on account of a steady stream of operating cash flow from both businesses. Hence, gearing levels (adjusted with investments in marketable securities) are expected to remain at comfortable levels of around 10%, according to our estimates.

Cement business to drive 16% EBITDA CAGR Historically, VSF prices have been strongly correlated to cotton prices. Cotton prices have corrected by 43% since their peak in March 2011, which contributed to the company seeing its VSF realisation fall by 18%q-q in June11 quarter. For 1H FY12, Grasim’s VSF realisation are up 18% y-y, but we have built in only a 4.8% y-y increase for full-year FY12F and flat realisations in FY13F and a modest 5% y-y increase in VSF in FY14F. As a result, we expect the standalone company’s (non-cement business) EBITDA will only see marginal growth in FY13F. With the commissioning of new capacity in FY14, however, we expect EBITDA to jump 33% y-y in FY14F to INR20.5bn from INR15.4bn in FY13F.

Fig. 114: VSF business volume / realisation estimates


We expect UltraTech to report a 19.3% CAGR in net sales over FY11-FY14F driven by volume growth and an 8% CAGR in blended pricing from FY11-FY14F. We look for the cost of production to show a CAGR of 6.7% over the same time period, resulting in core cement EBITDA/tonne (excluding other income) to move up from INR707/tonne in FY11 to INR907/tonne in FY12F and further to INR998/tonne in FY14F, a CAGR of 12.2%.

Viscose Staple Fibre FY10 FY11 FY12F FY13F FY14F

Capacity (TPA) 333,975 333,975 333,975 333,975 489,975

Production (Tonne) 302,092 305,087 297,765 321,586 385,903

Capacity utilisation (%) 90% 91% 89% 96% 79%

Average capacity utilisation 90% 91% 89% 96% 94%

Sales volume 306,355 303,873 296,276 319,978 383,974

% change yoy -1% -3% 8% 20%

Net realisation (INR /tonne) 97,421 117,587 123,302 123,302 129,467

% change yoy 20.7% 4.9% 0.0% 5.0%


75

At a consolidated level, the cement business contributes nearly 76% (based on FY12F) to the top line. On the EBITDA level, however, the contribution from the VSF business is higher given its higher margins. We expect a modest top-line CAGR of 12% over FY11-14F on a consolidated basis, as newer capacities in VSF and the cement business are only expected to be operational in FY14F and FY15F, respectively. Led by the cement business, we expect consolidated EBITDA and PAT to each post a CAGR of ~16.6% over FY11-FY14F.

Valuation

We have used a sum-of-the-parts (SOTP) valuation methodology to arrive at our target price of INR3,014 per share, which provides potential upside of 23%. We value the non-cement business at 5.0x FY13F EV/EBITDA and valued its 60.3%. UltraTech Cement stake at our price target of INR1,259 per share, and thereafter applies a 20% holding discount. Separately, we value its equity holdings in other group companies at the current market price (CMP), applying a 20% discount thereafter. We value other investments at book value.

At the CMP, assuming a target EV/EBITDA multiple of 5.0x for non-cement business, UltraTech Cement is available at a 45% discount to our target price of INR1,259. In our view, Grasim provides exposure to UltraTech Cement at a less expensive valuation.

Thus, at the current price, Grasim provides exposure to UltraTech Cement at an attractive INR3,502 EV/tonne vs other large players, namely ACC and Ambuja Cements, which are currently trading at INR6,160 EV/tonne and INR7,306 EV/tone, respectively.

As a cross-check, on a consolidated basis, Grasim shares are currently available at a one-year forward EV/EBITDA of 4.1x vs the 10-yr average EV/EBITDA multiple of 4.7x, which looks attractive, in our view.

Fig. 115: Valuation


per share

EBITDA (FY13F) of Standalone 15,754

EV of standalone @ 5.0x EV/EBITDA [A] (INR mn) 78,770 859

Ultratech stake

Equity value of Ultratech Stake @ 60.34% (at target price) (INR mn) 208,132

Holding company discount @ 20% (41,626)

Value after holding company discount [B] (INR mn) 166,506 1,816

Equity shares held @ current market price (with 20% holding discount) [C] 25,641 280

Investments @ book value [D] (INR mn) 33,494 365

Net Debt FY11[E] (INR mn) 7,991 87

Capex over FY12 & 13F [F] 20,000 218

Target value (A+B+C+D-E-F) 276,419 3,014

No of shares 92

Target Price 3,014

2,451

23%


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Fig. 116: One-year forward EV/EBITDA


Risks

Risks to downside: 1) a breakdown in production discipline amongst cement players will result in lower profitability of Ultratech Cement. Given the company derives nearly 61% valuation from its UltraTech Cement subsidiary, this can be a key downside risk to company’s valuations; 2) Historically, VSF prices have been correlated to cotton prices. Larger-than-expected fall in cotton prices can impact company’s VSF realisations, thus impacting profitability, as VSF business nearly contributes ~18% to the top line.

Key risks to the upside: 1) Higher-than-expected realisation / volume on account of its leadership position in cement & VSF business can be a upside risk to our earnings. 2) We have assumed continuation of existing correlation between VSG & cotton prices and assumed subdued VSF prices going forward. Hence, any breakdown of this correlation would impact the company’s earnings to the upside, in our view.

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UltraTech Cement ULTC.NS UTCEM IN


EQUITY RESEARCH

Await a better entry point

Improved geographical spread and cost rationalisation to help achieve higher profitability

December 8, 2011

Rating Starts at

Neutral


INR 1259


INR 1177

Potential upside +7%

Action: Initiate coverage with a Neutral; we await a correction Post the Samruddhi Cement merger with UltraTech in July 2010, we believe UltraTech has a more diversified geographical spread, with a reduced dependence on the stressed southern region of India. This should reduce volatility in UltraTech’s business emanating from the southern region, while also increasing its realisations through the exposure to the northern and eastern regions. UltraTech is investing INR18bn in reducing power and freight costs over the next 30 months. These two factors together could drive EBITDA/ton 40% higher from FY11 levels by FY14F. In our view, ongoing expansion of 9.2mnT by end FY14F would ensure LT growth. Unfortunately, the positives are being built in by the stock at this point, trading at a 7% premium to replacement cost, which we believe is close to its fair value. We advise investors to wait for a better entry point.

Catalysts: Sharp uptick in volume growth or breakdown of production discipline An upside catalyst could be faster-than-expected recovery in volume growth. On the downside, a surprise breakdown of the production discipline could lead to lower prices and a sharp under-performance.

Valuation: Average of ACEM’s and ACC’s replacement cost multiple With the fundamentals of the company in terms of geographical spread, profitability and return ratios lying between Ambuja (Buy, TP:INR186) and ACC (Neutral, TP: INR1155) , the EV/ton to replacement cost/ton multiple should be an average of the two, which is a 14% premium to the replacement cost per ton of INR6,250. Based on this we arrive at our target price of INR1,259, an upside of 7%.



Revenue (mn) 133,456 179,747 201,047 226,647



Normalised EPS 51.24 71.58 80.76 86.75

Norm. EPS growth (%) -41.6 39.7 12.8 7.4

Norm. P/E (x) 23.2 N/A 16.6 N/A 14.7 N/A 13.7

EV/EBITDA (x) 13.7 9.2 8.5 7.5



ROE (%) 18.4 17.0 16.6 15.5

Net debt/equity (%) 37.5 36.3 42.8 32.1


Anchor themes

We believe production discipline in the construction materials sector is likely to continue enabling its ability to increase pricing and maintain mid-cycle ROCE while moving towards upcycle profitability. Demand should bounce back in FY14F while capacity utilisation is likely to bottom out in FY13F.

Nomura vs consensus

We are in line with consensus on earnings, while offering mid-cycle multiples rather than down-cycle ones.

Research analysts





Nomura | UltraTech Cement December 8, 2011

78

Key data on UltraTech Cement Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 70,965 133,456 179,747 201,047 226,647Cost of goods sold -47,916 -97,270 -127,352 -140,961 -162,124Gross profit 23,049 36,186 52,395 60,086 64,523SG&A -4,245 -10,398 -12,931 -14,690 -16,365Employee share expense -2,506 -6,665 -8,473 -9,672 -11,087Operating profit 16,298 19,123 30,991 35,725 37,071


EBIT 16,298 19,123 30,991 35,725 37,071Net interest expense -1,175 -2,771 -4,478 -5,710 -4,798Associates & JCEs

Other income 759 1,510 1,312 1,377 1,446Earnings before tax 15,881 17,862 27,825 31,392 33,719Income tax -4,949 -3,820 -8,208 -9,261 -9,947Net profit after tax 10,932 14,042 19,617 22,131 23,772Minority interests

Other items

Preferred dividends

Normalised NPAT 10,932 14,042 19,617 22,131 23,772Extraordinary items

Reported NPAT 10,932 14,042 19,617 22,131 23,772Dividends -747 -1,918 -2,192 -2,466 -2,740Transfer to reserves 10,185 12,124 17,424 19,665 21,032


FD normalised P/E (x) 13.6 23.2 16.6 14.7 13.7FD normalised P/E at price target (x) 14.3 24.6 17.6 15.6 14.5Reported P/E (x) 13.6 23.2 16.6 14.7 13.7Dividend yield (%) 0.5 0.6 0.7 0.8 0.8Price/cashflow (x) 9.8 15.7 11.8 10.3 8.8Price/book (x) 3.2 3.1 2.6 2.3 2.0EV/EBITDA (x) 16.9 13.7 9.2 8.5 7.5EV/EBIT (x) 20.9 19.1 12.0 10.8 10.2Gross margin (%) 32.5 27.1 29.1 29.9 28.5EBITDA margin (%) 28.4 20.1 22.3 22.7 22.3EBIT margin (%) 23.0 14.3 17.2 17.8 16.4Net margin (%) 15.4 10.5 10.9 11.0 10.5Effective tax rate (%) 31.2 21.4 29.5 29.5 29.5Dividend payout (%) 6.8 13.7 11.2 11.1 11.5Capex to sales (%) 3.7 -3.1 16.7 27.4 11.0Capex to depreciation (x) 0.7 -0.5 3.3 5.6 1.9ROE (%) 26.6 18.4 17.0 16.6 15.5ROA (pretax %) 20.5 13.6 14.4 14.2 13.2

Growth (%)

Revenue 10.2 88.1 34.7 11.9 12.7EBITDA 14.7 32.7 49.8 13.7 10.6EBIT 13.5 17.3 62.1 15.3 3.8Normalised EPS 11.9 -41.6 39.7 12.8 7.4Normalised FDEPS -41.6 39.7 12.8 7.4

Per share




(%) 1M 3M 12M

Absolute (INR) 3.5 8.0 7.1

Absolute (USD) -0.9 -3.0 -6.1




52-week range (INR) 1207.9/883.4


3.45


Grasim Industries 60.3

LIC 7.5


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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 20,179 26,780 40,128 45,617 50,457Change in working capital -1,056 -704 -1,108 -424 -263Other operating cashflow -3,984 -5,345 -11,374 -13,593 -13,299Cashflow from operations 15,139 20,731 27,645 31,599 36,895Capital expenditure -2,592 4,119 -30,000 -55,000 -25,000Free cashflow 12,547 24,850 -2,355 -23,401 11,895Reduction in investments -6,348 -20,608 0 10,000 0Net acquisitions



Adjustments

Cashflow after investing acts 6,199 4,242 -2,355 -13,401 11,895Cash dividends -871 -2,244 -2,565 -2,886 -3,206Equity issue 0 14 0 0 0Debt issue -5,371 12 5,000 17,000 -7,000Convertible debt issue

Others -165 -1,414 0 0 0Cashflow from financial acts -6,407 -3,632 2,435 14,114 -10,206Net cashflow -208 611 80 714 1,689Beginning cash 1,045 837 1,448 1,528 2,242Ending cash 837 1,448 1,528 2,242 3,930Ending net debt 15,208 39,998 44,918 61,204 52,516Source: Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 837 1,448 1,528 2,242 3,930Marketable securities 16,696 37,303 37,303 27,303 27,303Accounts receivable 2,158 6,023 8,112 9,073 10,229Inventories 8,217 19,565 25,607 28,507 32,315Other current assets 3,511 10,551 14,194 15,876 17,898Total current assets 31,419 74,890 86,745 83,002 91,675LT investments

Fixed assets 52,011 125,056 145,919 191,027 202,642Goodwill


Other LT assets

Total assets 83,430 199,946 232,664 274,029 294,317Short-term debt



Preferred stock




Liquidity (x)


Leverage


Activity (days)



80

Gaining through the merger last year We initiate coverage on UltraTech with a Neutral rating. In our view, its merger with Samruddhi Cement (cement assets of Grasim Ltd.) in July 2010 has given UltraTech a much wider and stable portfolio of assets, reducing its dependence in the southern and western part of the country. This should enable UltraTech to show higher levels of growth than it would have without Samruddhi and also gain some pricing power on an overall basis. We believe the multiple to replacement cost for UltraTech should be the average of Ambuja Cements and ACC, given the average level of profitability and location of assets. The stock is currently close to those levels, trading at a 7% premium to the replacement cost.

Investment summary

Pan-India player post merger with Samruddhi Cements Grasim Ltd., which owns UltraTech and also owned ~25mnT of cement assets, demerged its cement assets into a company known as Samruddhi Cement and then merged Samruddhi into UltraTech. Most of Grasim’s cement plants are in the northern and central regions of India, while UltraTech was primarily exposed to the southern and western regions, with 81% of its capacity in these two regions. This merger has enabled UltraTech to gain an almost perfectly diversified portfolio with a ~25% exposure to the northern, western, southern and central and eastern regions. The merger has also given UltraTech a capacity of ~49mnT, making UltraTech the single-largest player in the country, with a c.19% market share.

Fig. 117: Capacity break region wise (before the merger of Samruddhi Cement)


Fig. 118: Current capacity break-up (region wise)

Source: CMA, Nomura research, as of 30th Sep 2011

Volume growth may remain weak though, limited by high utilisation in high growth regions While volume growth will be weak in FY12F driven by the expected de-growth in the southern region, we expect the company to report below industry level growth in FY12F and FY13F, constrained by capacity in the east and higher than industry level utilisation in the south. We expect UltraTech to report volume growth of 3% in FY12F, 7% in FY13F and 7.4% in FY14F lower than our estimated industry level growth of 8.1% in FY13F and 10.9% in FY14F.

We expect overall capacity utilisation of UltraTech to trend from 75% in FY11F to 78% in FY12F and then trend higher again to 89% in FY14F.

Central0% Eastern

19%

Northern0%

Southern31%

Western50%

Central11%

Eastern14%

Northern23%Southern

26%

Western26%


81

Fig. 119: Capacity, despatch, utilisation trend (region wise)

Note: FY11 is adjusted for acquisition Samruddhi Cement from July 2010

Source: CMA, Nomura estimates

Operational efficiencies to be improved The company is investing INR7.8bn to set up 120MW of power plants for its existing capacities, including a 45 MW waste heat recovery power plant, which should reduce power costs. Apart from this, the company is investing INR10bn in a logistics infrastructure, including railway sidings, wagons and a jetty for sea transport to reduce its freight costs. While it is difficult to calculate the cost savings from these investments, we believe that the ROCE from cost savings through these investments should be at least equal to the company’s ROCE of 18%, which could lead to potential cost savings of INR3.2 bn. These investments are likely to be made in FY13F and FY14F and the full impact may only be visible in the longer term from FY15F onwards

Improvement in regional profile to help in pricing power and profitability The ongoing production discipline in the industry should be maintained, in our view, and this should help the company increase realisations and improve its profitability. The company’s realisations are already up 18% y-y on a blended basis in 1HFY12, due to a sharp up-move in the south. This coupled with its improved regional exposure and operational efficiencies should enable its profitability to move closer to up-cycle levels.

We expect EBITDA/ton levels at a CAGR of 12.4% between FY11-14F and reach close to its up-cycle levels by FY14F. Most of the improvement in EBITDA/ton is likely to come through in FY12F itself driven by the higher realisations.

Ultratech (Effective capacity) FY07 FY08 FY09 FY10 FY11 FY12F FY13F FY14F

Central - - - - 5.6 5.6 5.6 5.6

Eastern 3.4 3.4 4.1 4.1 6.6 6.6 6.6 6.6

Northern - - - - 11.1 11.1 11.1 11.1

Southern 3.5 3.5 3.3 6.8 12.6 12.6 12.6 12.6

Western 10.1 10.1 11.0 11.0 12.8 12.8 12.8 12.8

Total 17.0 17.0 18.4 21.9 48.7 48.7 48.7 48.7

Ultratech (Despatch)

Central - - - - 4.2 4.5 5.0 5.1

Eastern 3.7 3.6 3.9 4.3 6.4 6.8 7.1 7.1

Northern - - - - 6.6 7.3 8.6 9.8

Southern 3.0 3.1 3.5 4.5 9.2 8.8 8.8 9.8

Western 8.0 8.3 8.4 8.8 10.2 10.4 11.0 11.7

Total 14.7 15.0 15.8 17.6 36.6 37.9 40.5 43.5

Ultratech (Capacity utilisation)

Central 75% 81% 89% 91%

Eastern 108% 107% 96% 104% 96% 103% 107% 107%

Northern 60% 66% 77% 88%

Southern 86% 89% 106% 66% 73% 70% 70% 77%

Western 79% 82% 76% 80% 80% 81% 86% 91%

Total 86% 88% 86% 80% 75% 78% 83% 89%


82

Fig. 120: Trend in realisation, cost and EBITDA per tonne

Note: UltraTech realisation are blended (include sale of White Cement, RMC)


Aggressive capacity expansion under way; ROCE may look subdued The company has started expanding its capacity at two of its existing plants in Karnataka (southern region) by 4.4mnT and in Chhattisgarh (eastern region) by 4.8mnT. The company also plans to set up 95MW of power plants in these two brown field expansions. Total investment to be made is INR61bn and management targets to complete this by 1QFY14, though in our view a delay of 6-9 months is quite possible. The full impact of these capacities will be felt only in FY15F. At this point, we believe it is still too early to start giving value to these capacities and we would for firm visibility on the time-line and the market situation in FY15F before attributing value to them. These capacity expansions though do ensure continuing growth beyond FY14F.

Including capex for the operational efficiencies, the 9.2mnT expansion and another INR31bn to be invested in existing plants and mines to lengthen their life, UltraTech has an aggressive capex plan of INR110 bn over the next three years. During this time, we believe the ROCE of the company will be subdued because of these investments.

UltraTech unlikely to have a net cash balance sheet like its peers UltraTech’s expansion and efficiency improvement capex of INR110 bn will not allow its balance sheet to turn net cash positive, like its peers ACC and Ambuja

Financials

We see UltraTech reporting a 19.3% CAGR in net sales driven by the volume growth mentioned above and an 8% CAGR in blended pricing between FY11-FY14F. We expect cost of production to show a CAGR of 6.7% in the same time period resulting in core cement EBITDA/ton (excluding other income) to move up from INR707/ton in FY11 to INR908/ton in FY12F and further to INR998/ton in FY14F, a CAGR of 12.2%. We expect a CAGR of 19% in the company’s EPS between FY11-FY14F.

We expect the company’s ROCE to improve from 17.5% in CY10 to 18.3% in FY12F, but fall back to 16.7% in FY14F, on the back of the investments in the expansion.



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(y-y)% volume growth -3% 6% 11% 69% 3% 7% 7%

(y-y)% realisation growth 10% 6% 0% -2% 17% 5% 6%

(y-y)% power cost 24% 110% -13% 17% 27% 0% 5%

(y-y) % fuel 10% 46% -20% 47% 27% 0% 10%

(y-y)% freight 13% 3% 4% 23% 11% 8% 6%


83

Valuations

Consensus is largely negative on the stock, driven by concerns of lower capacity utilisation leading to reduction in prices and hence profitability. Consensus valuation is at down-cycle multiples.

We believe that while capacity utilisation is likely to remain low for another year, it will bounce back in CY13F. In our opinion the low utilisation itself signals the matching of demand and supply and hence no risks to pricing. The continuation of production discipline would enable the ability to increase prices and hence lead to mid-cycle profitability and ROCE, in our view.

Given the lack of trading history for UltraTech before FY06, we are unable to provide the mid-cycle EV/ton to replacement cost/ton multiple. In our opinion, UltraTech’s fundamentals lie somewhere between Ambuja’s and ACC’s in terms of its geographical spread and profitability. ACC has a higher exposure to the southern region, while Ambuja has no exposure to the southern region at all. UltraTech is almost equally spread out around the country with 26% of its capacity in the south. This makes UltraTech’s geographical exposure better than ACC’s but inferior to Ambuja’s. In terms of profitability, it has an expected EBITDA/ton of INR908/ton in FY12F, while Ambuja has an EBITDA/ton of INR978/ton and ACC has an EBITDA/ton of INR734/ton in CY11F. Without the capacity expansion investment, we estimate that UltraTech’s ROCE would also lie somewhere in between ACC’s and Ambuja’s in CY12F/FY13F.

This leads us to offer an EV/ton to replacement cost/ton multiple to UltraTech, which is the average of ACC’s and Ambuja’s. ACC has traded at a mid-cycle multiple of 1% discount to replacement cost, while Ambuja has traded at an average of 27% premium to replacement cost. This leads us to offer UltraTech a 14% premium to the current replacement cost of INR6,250/ton (USD121/ton). With the one-year forward ROCE at 18% and equal to the mid-cycle industry average ROCE of 18%, we do not need to adjust the 14% premium. This gives us an EV/ton of 7,144/ton for UltraTech and we arrive at our 12 month target price of INR1,259, an upside potential of just 7% from here, in our view. The implied EV/EBITDA for the stock would be FY13F EBITDA of 8x.

Valuation

Fig. 122: Valuation


Valuation per share

Cement business

Avg. premium/discount to RC/Tonne [A] (%) 1.0

Premium for Ultratech [B] 14%

Avg long term ROCE industry [C] 18.0%

ROCE (FY13F) [D] 18.0%

Target premium/discount to RC/Tonne [E]=(1+[B])*[D]/[C 1.14

Current EV/Tonne (INR) [D] 6,250


Total capacity 49.4

Target EV (INR mn) [G] 352,547 1,286

Investments in subsidiaries & JVs @ book value [H] 2,475 9

Debt (FY12E) [I] 46,446 (169)

Cash & Marketable securities [J] 36,356 133

Equity value (G+H-I+J) 344,932 1,259

No of shares 274

Target price 1,259


84

Fig. 123: EV/ ton vs replacement cost

Source: Bloomberg. Nomura estimates

Fig. 124: 1 yr fwd EV/EBITDA

Note: UltraTech’s earnings profile has changed after merger of Samruddhi Cement

Source: Bloomberg. Nomura estimates

Risks

Risks to upside: 1) Higher than-expected-volume growth in India; 2) Lower-than-expected capacity additions in India; 3) Fall in coal prices 4) higher-than-expected GDP growth in India, and 5) Commissioning of new capacities before our estimated date of 4QFY14.

Risks to downside: 1) Slower growth continuing for longer than expected, 2) breakdown in production discipline resulting in lower pricing, 3) higher interest rates in India resulting in slower GDP growth, 4) higher-than-expected capacity additions, 5) a sharp increase in cost and 6) low returns on the efficiency improvement capital investment to be made in the next two years.

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ACC ACC.NS ACC IN


EQUITY RESEARCH

High exposure to southern India

Improving profitability and ROCE; valuations fair though; Initiate with a Neutral

December 8, 2011

Rating Starts at

Neutral


INR 1155


INR 1214

Potential downside -4.9%

Action: Initiate with Neutral; TP of INR1,155 We initiate coverage of ACC with a Neutral rating. We believe ACC will report mid-cycle profitability and return ratios going forward against consensus expectations of a down-cycle. We expect production discipline to continue in the industry and help firms retain pricing power. On the other hand, ACC’s high exposure to the southern India region, which has high levels of over-capacity, and its almost-full capacity utilisation in other higher growth regions are likely to constrain volume growth in the next two years. We look for an EPS CAGR of 10.6% over the next three years. However, valuations are currently at mid-cycle levels; we would wait for a better entry point.

Catalysts: Sharp uptick in volume growth or breakdown of production discipline An upside catalyst for would be a faster-than-expected recovery in volume growth. On the downside, a surprise breakdown of the production discipline could lead to lower prices and a sharp under-performance.

Valuation: Trading at mid-cycle asset-based valuation We prefer to use an asset-based valuation methodology, given wide earnings volatility between cycles. We value ACC at a mid-cycle EV/ton to replacement cost multiple after adjusting for the ratio of one-year forward ROCE to mid-cycle ROCE. This gives us a value of INR1,155 for ACC, which is USD115/ton of capacity, a discount of 4.7% to the replacement cost of USD121/ton. The implied EV/EBITDA on CY12F is 8.2x. Thus the downside to market price is just 1%.

31 Dec FY10 FY11F FY12F FY13F


Revenue (mn) 77,173 95,618 106,274 119,801



Normalised EPS 57.56 58.53 68.48 77.93

Norm. EPS growth (%) -30.5 1.7 17.0 13.8

Norm. P/E (x) 20.9 N/A 20.6 N/A 17.6 N/A 15.5

EV/EBITDA (x) 14.6 12.2 10.1 8.7



ROE (%) 17.3 16.3 17.4 18.0

Net debt/equity (%) net cash net cash net cash net cash


Anchor themes

We believe production discipline in the sector is likely to enable firms to continue increasing prices and maintain a mid-cycle ROCE while moving towards upcycle profitability. Demand should bounce back in FY14F while capacity utilisation is likely to bottom out in FY13F.

Nomura vs consensus

We are almost in line with consensus in our EPS estimates, though consensus continues to offer downcycle multiples, which we find perplexing.

Research analysts





Nomura | ACC December 8, 2011

86

Key data on ACC Income statement (INRmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FRevenue 80,272 77,173 95,618 106,274 119,801Cost of goods sold -41,005 -45,000 -57,992 -63,864 -72,841Gross profit 39,267 32,173 37,626 42,410 46,960SG&A -14,716 -16,322 -19,360 -21,276 -23,260Employee share expense -3,677 -4,619 -5,075 -5,552 -6,072Operating profit 20,874 11,232 13,191 15,582 17,627

EBITDA 24,295 15,159 17,848 20,616 22,974Depreciation -3,421 -3,927 -4,657 -5,035 -5,347Amortisation 0 0 0 0 0EBIT 20,874 11,232 13,191 15,582 17,627Net interest expense -843 -568 -431 -143 0Associates & JCEs 0 0 0 0 0Other income 2,411 3,569 2,735 2,947 3,296Earnings before tax 22,442 14,234 15,495 18,386 20,924Income tax -6,877 -3,414 -4,494 -5,516 -6,277Net profit after tax 15,565 10,819 11,001 12,870 14,647Minority interests 0 0 0 0 0Other items

Preferred dividends

Normalised NPAT 15,565 10,819 11,001 12,870 14,647Extraordinary items 0 0 0 0 0Reported NPAT 15,565 10,819 11,001 12,870 14,647Dividends -5,051 -6,677 -5,263 -6,014 -6,390Transfer to reserves 10,514 4,142 5,739 6,856 8,256



Growth (%)

Revenue 10.2 -3.9 23.9 11.1 12.7EBITDA 44.4 -37.6 17.7 15.5 11.4EBIT 50.4 -46.2 17.4 18.1 13.1Normalised EPS 39.8 -30.5 1.7 17.0 13.8Normalised FDEPS 39.8 -30.5 1.7 17.0 13.8

Per share




(%) 1M 3M 12M

Absolute (INR) -1.6 18.4 23.4

Absolute (USD) -5.7 6.4 8.1




52-week range (INR) 1237.4/915.48


7.61


Holcim 46.2

LIC of India 16.9


Notes

EPS CAGR of 10.6% between CY10-13F

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Cashflow (INRmn) Year-end 31 Dec FY09 FY10 FY11F FY12F FY13FEBITDA 24,295 15,159 17,848 20,616 22,974Change in working capital 6,273 -916 1,297 465 -653Other operating cashflow -5,444 4,884 -6,018 -1,982 -2,837Cashflow from operations 25,123 19,127 13,127 19,099 19,484Capital expenditure -15,440 -10,500 -4,000 -5,000 -5,000Free cashflow 9,684 8,627 9,127 14,099 14,484Reduction in investments -7,966 -2,270 0 0 0Net acquisitions



Adjustments 0 0 0 0 0Cashflow after investing acts 1,718 6,357 9,127 14,099 14,484Cash dividends -5,051 -6,677 -5,263 -6,014 -6,390Equity issue 1 0 0 0 0Debt issue 849 -431 -2,639 -2,599 0Convertible debt issue

Others 105 4,088 0 0 0Cashflow from financial acts -4,097 -3,020 -7,902 -8,614 -6,390Net cashflow -2,379 3,337 1,226 5,485 8,094Beginning cash 9,842 7,464 10,800 12,026 17,511Ending cash 7,464 10,801 12,026 17,511 25,605Ending net debt -1,795 -5,562 -9,427 -17,511 -25,605Source: Nomura estimates

Balance sheet (INRmn) As at 31 Dec FY09 FY10 FY11F FY12F FY13FCash & equivalents 7,464 10,800 12,026 17,511 25,605Marketable securities 0 0 0 0 0Accounts receivable 2,037 1,783 2,209 2,455 2,768Inventories 7,790 9,150 11,474 12,638 15,008Other current assets 5,654 5,801 7,073 7,861 8,862Total current assets 22,945 27,534 32,782 40,466 52,243LT investments 14,756 17,027 17,027 17,027 17,027Fixed assets 63,145 66,452 65,795 65,761 65,414Goodwill


Other LT assets

Total assets 100,846 111,013 115,604 123,253 134,684Short-term debt

Accounts payable 20,603 20,940 26,260 28,923 31,953Other current liabilities

Total current liabilities 20,603 20,940 26,260 28,923 31,953Long-term debt 5,669 5,238 2,599 0 0Convertible debt


Preferred stock




Liquidity (x)

Current ratio 1.11 1.31 1.25 1.40 1.64Interest cover 24.8 19.8 30.6 109.0 na

Leverage

Net debt/EBITDA (x) net cash net cash net cash net cash net cashNet debt/equity (%) net cash net cash net cash net cash net cash

Activity (days)


Notes

Strong FCF generation due to no major capex requirement

Notes

Balance sheet to remain in net cash position


88

High southern exposure limits volume growth We initiate coverage on ACC Ltd. with a Neutral recommendation. We believe that profitability is likely to trend higher, while return ratios will remain at mid-cycle levels from FY12F onwards as cost pressure reduces and production discipline helps the company retain its ability to increase realisations. Asset-based valuations (premium/discount to replacement cost) though appear fair at the moment, trading at mid-cycle levels.

Investment Summary

Fig. 125: Summary


Pan-India player, but high exposure to southern India ACC with an overall capacity of 30.4mnT is the second-largest player in the country and has a presence in all five regions of the country. With recent capacity expansions of 7mnT in Karnataka and Maharashtra, ACC has become more exposed to the southern and western regions, which are facing over-capacity and low utilisation rates.

Fig. 126: Capacity split region wise (as of FY12)


Higher exposure to southern region to limit volume growth potential ACC has about 35% of its capacity in the southern region of India (on our estimates) which is likely to face an all-time low capacity utilisation level of 53% in FY13F on low demand growth and excess capacity. In addition, another 13% of the company’s capacity

CY09 CY10 CY11F CY12F CY13F

Installed capacity (mn tonne) 26.17 26.77 30.37 30.37 30.37

(y-y)% growth 16% 2% 13% 0% 0%

Sales volume (cement) (mn tonne 21.3 21.0 23.7 25.3 27.0

(y-y)% growth 3% -1% 13% 6% 7%

Effective capacity utlisation (%) 97% 95% 82% 83% 89%

Average capacity utilisation (%) 87% 79% 83% 83% 89%

Realisation (INR per tonne) 3,680 3,585 3,943 4,121 4,347

(y-y)% growth 8% -3% 10% 4% 5%

Cost (INR per tonne) 2,572 2,904 3,209 3,323 3,516

(y-y)% growth -1% 13% 10% 4% 6%

(y-y)% growth 41% -39% 8% 9% 4%

ROCE (%) 32% 17% 18% 20% 21%

Central14%

Eastern19%

Northern19%

Southern35%

Western13%


89

is located in eastern Maharashtra, a region which is traditionally supplied by plants located in the southern region. Thus for all practical purposes almost 51% of its capacity is likely to see slow growth in FY13F and FY14F. This is compounded by the fact that its capacities in the rest of India have utilisation rates close to 100% or even more, this limits any significant volume growth potential from these regions. We expect ACC to report volume growth of 13% in CY11F (driven by expanded capacity) and 6.5% in CY12F and 7% in CY13F both lower than our estimated industry level growth of 8.1% in CY12F/FY13F and 10.9% in CY13F/FY14F.

In its next round of capacity expansion, we believe ACC will focus on the central and northern regions to correct this imbalance.

We expect ACC’s overall capacity utilisation to trend from 95% in CY10 to 82% in CY11F (on account of addition of capacity) and then trend higher again to 89% in CY13F.

Fig. 127: Snapshot of installed capacity, despatch and utilisation region wise


Profitability to improve as realisations rise while cost increase moderates We believe profitability for ACC in terms of EBITDA/ton is likely to trend higher from CY10 levels as the ongoing production discipline continues to help the company to increase realisations and pass on cost hikes in CY11F and CY12F. YTD realisations are up ~7% and we expect a further 5% hike in 4QCY11.

In CY13F we expect good demand growth in India, which would help overall capacity utilization to improve and increase pricing power. We also expect cost increases to moderate in CY12F as the weak global macro situation could result in weaker imported coal and crude oil prices, which would result in less pressure on fuel and power costs and freight costs respectively. International coal prices have fallen 19% since Aug’10 though as of now most of the advantage has been taken away by the depreciation of the INR against the USD. These two costs make up roughly 45% of ACC’s overall production costs.

We expect EBITDA/ton levels at a CAGR of 7.7% between CY10-13F and reach close to its up-cycle levels by CY13F.

ACC (Effective capacity) 2006 2007 2008 2009 2010 2011F 2012F 2013F

Central 3.70 4.31 4.31 4.3 4.3 4.3 4.3 4.3

Eastern 4.54 4.77 4.77 4.8 5.3 5.9 5.9 5.9

Northern 5.00 5.68 5.68 5.7 5.7 5.7 5.7 5.7

Southern 5.67 6.03 6.03 6.0 6.0 10.7 10.7 10.7

Western 1.00 1.00 1.00 1.0 1.0 2.5 4.0 4.0

Total 19.91 21.78 21.78 21.8 22.4 29.1 30.6 30.6

ACC (Despatch)

Central 3.9 4.1 4.5 4.9 4.8 4.5 4.6 4.6

Eastern 4.1 4.3 4.4 4.4 4.4 5.0 5.5 5.9

Northern 4.4 4.9 5.1 5.5 5.5 5.5 5.6 5.7

Southern 5.2 5.1 5.4 5.4 5.4 7.1 7.1 7.9

Western 1.1 1.2 1.1 1.1 1.1 1.8 2.7 3.1

Total 18.6 19.6 20.6 21.2 21.2 23.9 25.5 27.3

ACC (Capacity utilisation)

Central 104% 96% 105% 113% 111% 106% 106% 108%

Eastern 90% 90% 92% 91% 83% 85% 93% 99%

Northern 88% 87% 90% 97% 97% 97% 99% 101%

Southern 92% 85% 90% 89% 89% 66% 66% 74%

Western 107% 116% 111% 109% 109% 72% 67% 78%

Total 94% 90% 95% 97% 95% 82% 83% 89%


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Fig. 128: Realisation, cost and EBITDA per tonne trend


Free cash flow generation to remain strong in absence of capex plans Apart from a 25MW power plant at one of its facilities, ACC does not have any capacity expansion plans as of now post the 7mnT expansion completed early this year. This would result in extremely strong free cash flow generation over the next three years on a balance sheet which is already net cash. We expect cash and liquid investments on the balance sheet to reach INR38.4bn by CY13F, which would be enough to fund another 6mnT of capacity at today’s replacement cost. This cash though will keep the ROCE subdued at mid-cycle levels, but return on invested capital (ROIC) is likely to improve in CY13F.

Financials

We see ACC reporting a 15.8% CAGR in net sales, driven by volume growth (mentioned above) and a 6.6% CAGR in pricing between CY10-13F. We expect cost of production to show a CAGR of 6.5% in the same time period, resulting in core cement EBITDA/ton (excluding other income) to move up from INR681/ton in CY10 to INR797/ton in CY12F and further to INR832/ton in CY13F, a CAGR of 6.9%. We expect a CAGR of 10.6% in EPS between CY10-13F.

We expect ROCE to improve from 17.4% in CY10, which was almost at the down-cycle levels, to 20.2% in CY12F and 21.2% in CY13F, which would be mid-cycle levels, driven by the higher EBITDA/ton and higher capacity utilisation.


Note: Power cost, corresponds to captive power generation


Valuation

Consensus is largely negative on the stock, driven by concerns of lower capacity utilisation leading to a reduction in prices and hence profitability. Consensus valuations are at down-cycle multiples.

689 749 786

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(y-y)% volume growth 45% 6% 6% 3% -1% 13% 7% 7%

(y-y)% realisation growth 31% 13% 4% 8% -3% 10% 5% 6%

(y-y)% power cost 9% 14% 28% -20% 14% 27% 0% 10%

(y-y) % fuel 10% 15% 47% 4% 4% 27% 0% 10%

(y-y)% freight 10% 5% 0% 3% 3% 15% 7% 7%


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We believe that while capacity utilisation is likely to remain low for another year it will rebound in CY13F. In our opinion the low utilisation itself signals matching of demand and supply and hence no risks to pricing. The continuation of production discipline would enable the ability to increase prices and hence lead to mid-cycle profitability and ROCE, in our view.

We prefer an asset value based methodology in terms of EV/ton vs. replacement cost/ton against an earnings-based methodology, given the wide variation in earnings between cycles and also due to timing differences between cost increase and price hikes.

Given mid-cycle ROCE over the next two years we believe ACC should also trade at a mid-cycle multiple to the replacement cost in terms of EV/ton. The mid-cycle EV/ton multiple (premium or discount) corresponds to the mid-cycle ROCE. We adjust this mid-cycle multiple by the ratio of the one-year forward ROCE to the mid-cycle ROCE of the company to arrive at a more accurate multiple.

Fig. 130: ROCE trend


ACC’s EV/ton to replacement cost mid-cycle multiple over the last 10 years has been a very small 1% discount. We expect a ROCE of 20.2% in CY12F vs. a mid-cycle ROCE of 20.9% in the last 10 years, a discount of 3.7%. Thus our target multiple to the replacement cost per ton for ACC of INR6,250/ton (USD121/ton at INR-USD rate of INR51.7) would be a discount of 4.7% or an EV/ton of INR5,959/ton (USD115/ton). We multiply this with ACC’s current capacity of 30.6mnT to arrive at our target EV. Based on this methodology we value ACC at INR1,155/share, which provides a very small 1% downside to the current price. The implied EV/EBITDA for the stock would be 8.2x CY12F EBITDA.

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Fig. 131: EV/ tonne vs replacement cost

Source: Bloomberg, Nomura estimates

Fig. 132: 1yr Fwd EV/EBITDA

Source: Bloomberg, Nomura estimates

Fig. 133: Valuation


Risks

Risks to upside: 1) Higher-than-expected volume growth; 2) Lower-than-expected capacity additions; 3) Fall in coal prices and 4) higher-than-expected GDP growth.

Risks to downside: The company operates in1) Slower growth continuing for longer than expected; 2) Breakdown in production discipline resulting in lower pricing; 3) higher interest rates in India resulting in slower GDP growth; 4) higher-than-expected capacity additions and 5) a sharp increase in costs.

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Last 10 years avg. ROCE [A] (%) 20.9

ROCE (CY12E) [B] (%) 20.2

Last 10 years avg. premium/discount to RC/Tonne [C] (%) 0.99

Target premium/discount to RC/Tonne [E]=(B*C/A) 0.953

Current Replacement cost/tonne (INR) [D] 6,250


Total capacity 30.6

Target EV (INR mn) [G] 182,487 971

Debt (CY12E) [H] - -

Cash & Marketable securities [I] 30,281 161

Other Investments [J] 4,257 23

Equity value (G-H+I+J) 217,025 1,155

No of shares 188

Target price 1,155


India Cements ICMN.NS ICEM IN


EQUITY RESEARCH

Limited downside but better plays available

Initiate with Neutral; most sensitive to price realisation

December 8, 2011

Rating Starts at

Neutral


INR 80


INR 76


Action: Neutral; sensitive to price realisations We initiate coverage of India Cements with a Neutral rating. Given its complete exposure to the Southern region, volume growth for the company looks constrained over the next two years and, we think, profitability of the firm would depend on continued production discipline. Given that the Southern market is highly fragmented, the breakdown of production discipline could always remain an overhang. With prices having risen a sharp 20%y-y in the Chennai market (proxy for the South) since Jul’11, we expect realisations will remain flat, at best, going forward, keeping ROCEs at sub-10%. In this scenario, we would prefer Ultratech or ACC for any south exposure. The current price though is building in a 54% discount to current replacement costs of USD121/ton, which is the highest discount in the past 10 years; hence, we see limited downside here.

Catalysts: Sharp uptick in volume growth or breakdown of production discipline An upside catalyst would be the ability to pass cost increases and monetisation of the IPL franchise. On the downside, a surprise breakdown of production discipline could lead to lower prices, thus impacting profitability and return ratios.

Valuation: Upside of only 5% We value India Cements on EV/CE multiple (ROCE-g)/(WACC-g), as the significant fluctuation in profitability and return ratios over the past several years makes it difficult to calculate a mid-cycle level. Using this methodology, our target price for the company is INR80, including the IPL franchise value of INR17 per share.



Revenue (mn) 35,035 41,853 42,145 43,652

Reported net profit (mn) 682 3,490 3,117 2,719

Normalised net profit (mn) 659 3,490 3,117 2,719

Normalised EPS 2.14 11.36 10.15 8.85

Norm. EPS growth (%) -78.8 429.8 -10.7 -12.7

Norm. P/E (x) 34.8 N/A 6.6 N/A 7.4 N/A 8.4

EV/EBITDA (x) 10.8 5.0 4.9 5.0



ROE (%) 1.7 8.2 6.9 5.7

Net debt/equity (%) 59.2 61.9 51.6 44.3


Anchor themes

We believe production discipline in the sector is likely to enable firms to continue increasing prices and maintain a mid-cycle ROCE while moving towards upcycle profitability. Demand will bounce back in FY14F while capacity utilization will bottom out in FY13F.

Nomura vs consensus

We are largely in line with consensus on earnings.

Research analysts





Nomura | India Cements December 8, 2011

94

Key data on India Cements Income statement (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FRevenue 37,743 35,035 41,853 42,145 43,652Cost of goods sold -17,277 -17,801 -18,178 -18,282 -19,332Gross profit 20,466 17,235 23,676 23,863 24,320SG&A -12,002 -12,777 -13,663 -14,183 -15,196Employee share expense -2,500 -2,532 -2,627 -2,832 -3,144Operating profit 5,964 1,926 7,386 6,848 5,981


EBIT 5,964 1,926 7,386 6,848 5,981Net interest expense -1,426 -1,417 -2,820 -2,695 -2,406Associates & JCEs

Other income 339 368 216 237 255Earnings before tax 4,877 876 4,781 4,390 3,830Income tax -1,770 -218 -1,291 -1,273 -1,111Net profit after tax 3,108 659 3,490 3,117 2,719Minority interests

Other items

Preferred dividends

Normalised NPAT 3,108 659 3,490 3,117 2,719Extraordinary items 436 23 0 0 0Reported NPAT 3,543 682 3,490 3,117 2,719Dividends -716 -537 -358 -358 -358Transfer to reserves 2,827 145 3,132 2,758 2,361


FD normalised P/E (x) 7.4 34.8 6.6 7.4 8.4FD normalised P/E at price target (x) 7.9 37.3 7.0 7.9 9.0Reported P/E (x) 6.5 33.6 6.6 7.4 8.4Dividend yield (%) 3.1 2.3 1.6 1.6 1.6Price/cashflow (x) na 18.2 9.9 3.8 4.4Price/book (x) 0.6 0.6 0.5 0.5 0.5EV/EBITDA (x) 5.3 10.8 5.0 4.9 5.0EV/EBIT (x) 7.3 24.5 6.8 6.9 7.5Gross margin (%) 54.2 49.2 56.6 56.6 55.7EBITDA margin (%) 22.0 12.5 23.8 22.7 20.3EBIT margin (%) 15.8 5.5 17.6 16.2 13.7Net margin (%) 9.4 1.9 8.3 7.4 6.2Effective tax rate (%) 36.3 24.8 27.0 29.0 29.0Dividend payout (%) 20.2 78.8 10.3 11.5 13.2Capex to sales (%) 5.2 15.8 11.9 5.9 5.7Capex to depreciation (x) 0.8 2.3 2.0 0.9 0.9ROE (%) 9.1 1.7 8.2 6.9 5.7ROA (pretax %) 8.1 2.5 8.9 8.0 6.9

Growth (%)

Revenue 9.8 -7.2 19.5 0.7 3.6EBITDA -18.1 -47.4 127.9 -3.8 -7.4EBIT -27.6 -67.7 283.6 -7.3 -12.7Normalised EPS -94.0 -78.8 429.8 -10.7 -12.7Normalised FDEPS -94.0 -78.8 429.8 -10.7 -12.7

Per share




(%) 1M 3M 12M

Absolute (INR) -6.9 6.9 -30.6

Absolute (USD) -10.9 -3.9 -39.2

Relative to index -1.5 7.9 -12.9

Market cap (USDmn) 446.9


52-week range (INR) 112.8/62.05


1.80


EWS Finance & Investments Pvt Ltd

9.0

LIC of India 6.7


Notes

Valuations inexpensive but return ratios weak

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Cashflow (INRmn) Year-end 31 Mar FY10 FY11 FY12F FY13F FY14FEBITDA 8,296 4,366 9,949 9,570 8,861Change in working capital -741 -2,013 -3,734 136 -377Other operating cashflow -7,650 -1,094 -3,895 -3,731 -3,261Cashflow from operations -95 1,258 2,320 5,975 5,223Capital expenditure -1,955 -5,527 -5,000 -2,500 -2,500Free cashflow -2,050 -4,269 -2,680 3,475 2,723Reduction in investments -1,550 1,537 0 0 0Net acquisitions



Adjustments 0 0 0 0 0Cashflow after investing acts -3,600 -2,732 -2,680 3,475 2,723Cash dividends -716 -537 -358 -358 -358Equity issue 2,836 0 0 0 0Debt issue 982 3,059 3,000 -3,000 -2,000Convertible debt issue

Others 184 4 0 0 0Cashflow from financial acts 3,286 2,525 2,642 -3,358 -2,358Net cashflow -314 -207 -38 116 365Beginning cash 852 538 331 293 409Ending cash 538 331 293 409 774Ending net debt 20,789 24,230 27,268 24,151 21,787Source: Nomura estimates

Balance sheet (INRmn) As at 31 Mar FY10 FY11 FY12F FY13F FY14FCash & equivalents 538 331 293 409 774Marketable securities

Accounts receivable 4,853 2,544 2,975 2,975 3,064Inventories 4,478 4,973 5,173 5,282 5,641Other current assets 18,896 21,191 24,744 24,744 25,480Total current assets 28,764 29,039 33,184 33,410 34,959LT investments 3,140 1,603 1,603 1,603 1,603Fixed assets 46,215 48,743 51,180 50,958 50,577Goodwill


Other LT assets 206 181 181 181 181Total assets 78,326 79,566 86,149 86,152 87,321Short-term debt


Other LT liabilities

Total liabilities 36,967 38,669 42,119 39,364 38,171Minority interest

Preferred stock




Liquidity (x)


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Notes

Free cash flow generation from FY13F on absence of expansion plans

Notes

Loans and advances are high and generate low returns


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Initiate with a Neutral We initiate coverage of India Cements with a Neutral rating and a target price of INR80, given its complete exposure to the Southern region of India and our view that return ratios for this company, which have been historically low, will continue to remain low. We expect volume growth will remain constrained and realisations will remain flat, at best, going forward. We expect profitability will fall due to flat realisations in FY13-FY14F although earnings will be cushioned somewhat by the commissioning of captive power plants and coal imports from its own Indonesian coal mine. Downside to the stock appears limited, as it is trading at a significant discount (over the past 10 years) to current replacement costs but upside appears capped as its valuation is highly sensitive to realisations, which we expect to remain flat over the next two years.

Summary

Fig. 134: Summary of key variables


Highest exposure to the Southern region; poor visibility on volume growth Of India Cements’ existing 14.05mn tonne total capacity (excluding its subsidiary Trinetra Cement), nearly 92% of its capacity is located in Southern India, which puts it in a very vulnerable position, we think. Given the lower cement demand in the Southern region, along with further expected capacity addition of 14.6 mn tonnes next year in the south, we expect India Cements’ capacity utilisation to hit a trough level of 66% in FY13F and, thereafter expect utilisation levels to improve only marginally to 68% by FY14F. As new capacities find a place in the market, we do not expect India Cement will be able to grow volumes, despite its relatively strong position in the Southern market. We expect volume to decline y-y by 8% in FY12F and remain flat y-y in FY13F, before a marginal uptick in (~3% y-y growth) in FY14F on a low base.


Installed capacity (mn tonne) 8.81 12.95 14.05 14.05 14.05 14.05 14.05

(y-y)% growth 3% 47% 8% 0% 0% 0% 0%

Sales volume (cement) (mn tonne) 9.2 9.1 10.5 9.9 9.2 9.2 9.5

(y-y)% growth 10% -1% 15% -5% -7% 0% 3%

Effective capacity utlisation (%) 105% 93% 81% 71% 66% 66% 68%

Realisation (INR per tonne) 3,286 3,596 3,339 3,379 4,257 4,257 4,257

(y-y)% growth 23% 9% -7% 1% 26% 0% 0%

Cost (INR per tonne) 2,155 2,665 2,685 3,074 3,454 3,527 3,657

(y-y)% growth 19% 24% 1% 14% 12% 2% 4%

EBITDA (INR per tonne) 1,146 976 661 342 888 826 704

(y-y)% growth 32% -15% -32% -48% 160% -7% -15%

ROCE (%) 20% 15% 10% 3% 11% 10% 8%

8% 8% 8% 8% 8% 8% 8%


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Fig. 135: Installed capacity (region-wise; FY12F)


Highest operating cost amongst peers; setting in cost efficiencies India Cements has the highest operating cost among peers, which makes it highly vulnerable to any fall in realisations. Its higher operating costs can be attributed to higher power and fuel costs, as 70% of its coal requirement is met through imports and ~90% of its power requirement is met through grid supply. Combined, its fuel and power costs are nearly ~60% higher than peers on a per tonne basis. In order to curtail operating costs, the company is setting up a 50MW power plant each in Andhra Pradesh and Tamil Nadu and has bought a coal mine concession in Indonesia. According to management, its first power plant in Sankar Nagar in Tamil Nadu is likely to commence operations in 3QFY12F, while the second power plant will commence operations from 4QFY13F. After both these plants become operational, we expect ~60% of the company’s total power requirement will be met through captive generation, which should bring in cost savings of around INR30-40 per tonne of cement, on our estimates. On the coal front, management has indicated that mining work in Indonesia will commence in 4QFY12, while coal shipments will start a few months later. On our numbers, this will bring in cost savings of around INR450-600 per tonne of coal, which would translate into cost savings of INR50-55 per tonne of cement. In Indonesia, the new rule of exporting coal only at the set reference price could negate the expected large savings in coal which the company expected to generate. In all, we estimate, its new power plants and coal from its Indonesia mine will yield cost savings of only around INR80-85 per tonne of cement.

Profitability to fall as realisations remain flat, but moderate cost increases to provide some cushion YTD, cement prices in Chennai (proxy for Southern India) have risen 20% y-y. Despite the overcapacity in the Southern markets, producers have been able to implement price increases, largely due to strong production discipline maintained by them. We do not expect production discipline to break down, as only production discipline can ensure the profitability of cement firms. However, after a sharp price increase of around 20%y-y, alongside poor demand, we do not expect any meaningful uptick in prices over the next two years. Hence, we have built in 0% growth in realisations over FY13 & FY14F.

Southern92%

Western8%


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Fig. 136: Cement prices in Chennai

Source: CMIE, Nomura research

In our cost assumptions, we expect the benefit from coal imports and its first power plant to flow from FY13F. In FY13F, the new 50MW power plant and coal imports will only meet 9% and 23% of its power and fuel requirement, respectively; however, once these capacities ramp-up fully and the second power plant is commissioned by end-FY13F, we estimate these ratios will increase to 56% and 77%, respectively.

On the back of higher realisations achieved in the current year due to 20% y-y growth in prices, we estimate EBITDA/tonne to jump from INR342 per tonne in FY11 to almost INR888 per tonne in FY12F. Thereafter, as we expect realisations to remain flat, we expect EBITDA per tonne to trend downward, as any impact of cost increases will be felt directly on EBITDA, although its new power plant and coal imports from its Indonesian coal mine will provide some cushion. We expect EBITDA per tonne to fall to INR826 and INR704 per tonne in FY13 and FY14, respectively. Due to a high base in FY12F, we estimate EBITDA of the cement business to register a fall at a 10% CAGR over FY13-FY14F.

Fig. 137: Trend in EBITDA /tonne

Note: EBITDA / tonne – adjusted for other operating income


Fig. 138: EBITDA trend of the cement business


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Fig. 139: Summary of key assumptions


Lower ROCE: High cost base, lower return yielding investments in other businesses India Cements has the lowest ROCE, compared with its peers. This is attributed to its inferior operating margins (high fuel and power costs) and lower asset turnover of 0.5X in FY11, which is nearly 38% below that of other cement players such as ACC, Ambuja, Shree Cement. If we view its asset turnover ratio from the pure hard assets (proxy gross block) perspective it still appears reasonable compared with peers. In our view, the cause for concern is the loans and advances extended to its various subsidiaries (which operate in varied businesses) and other investments that are not yielding adequate returns.

India Cements too has invested in expanding its capacity like other large industry players such as ACC, Ambuja, and Shree Cement. However, we note that over the past 6-7 years (which includes the industry upcycle), all its peer companies have generated significant free cash flows, except India Cements. Currently, while the other players are net cash positive or will turn net cash positive, we do not expect to see much improvement in India Cements’ debt levels. In fact, we expect its debt levels to rise further to INR27.5bn by end-FY12F from INR24.5bn (end-FY11) before sliding back to INR22.6bn by end-FY14F.

Fig. 140: ROCE comparison vs. peers


Fig. 141: Trend in gearing levels


Value unlocking from IPL franchise – positive catalyst for the stock India Cements owns the Indian Premier League (IPL) cricket team Chennai Super Kings, which the company bought for USD91mn in an auction in 2008. On face value, this investment has nearly quadrupled, based on the prices the Pune and Kochi teams were sold for in the auction in 2010.

A listing of its IPL team or offloading its stake in the IPL franchise will, in our view, help the company monetise this investment. On a positive note, we believe, the monetisation of Chennai Supper Kings would be much easier as compared with the other teams as the team has been the best overall performer in the past four IPL sessions and it is led by the Indian cricket team captain MS Dhoni, who enjoys a strong brand value. We

Key assumptions FY08 FY09 FY10 FY11 FY12F FY13F FY14F

(y-y)% volume growth 10% -1% 15% -5% -7% 0% 3%

(y-y)% realisation growth 23% 9% -7% 1% 26% 0% 0%

(y-y)% power cost 0% 0% 0% 0% 5% -10% 0%

(y-y) % fuel 21% 39% -14% 22% 5% -3% 2%

(y-y)% freight 20% 6% 10% 21% 10% 10% 5%

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believe any efforts towards value unlocking from the IPL franchise will be a key positive catalyst for the stock.

Valuation methodology and risks

Methodology Our target price of INR80 for India Cements is based on a sum-of-the-parts methodology. We value its cement business on an EV/IC multiple-based method as wildly fluctuating profitability and return ratios over the last several years makes it difficult to calculate a mid-cycle level. Using the average ROCE of 9.5% that we expect the company to generate during FY12-FY14F our price target for the company works out to INR 80 per share, including value of company's ownership in Indian Premier League franchise “Chennai Super Kings” at INR 17/share.

Valuation: Initiate with Neutral – return ratios to remain low but limited downside from current levels By adopting the above methodology, our TP for India Cement is INR80, which includes the IPL franchise valuation at INR17 per share. As a cross-check, our TP of INR80 implies an EV/EBITDA of 4.5x for its cement business.

Fig. 142: SOTP valuation


SOTP valuation per share

WACC [A] 13.5%

Average ROACE (FY12-FY14) [B] 9.5%

Terminal Growth [C] 4%

Target EV / IC multiple [D] = (B-C)/(A-C) 0.58

Average capital employed for FY12-14F [E] INR mn 73,432

Target EV (INR mn) [F] 42,789 139

Chennai Super Kings (IPL) valuation

PV of IPL franchise (based on latest auction of Pune & Kochi Team) INR mn 6,963

Value of CSK (adjusted for future payments) INR mn [G] 5,181 17

Total value (INR mn) [F+G] 47,970

Net debt (FY13E) [H] 24,151 (79)

Other Investments [I] 885

Equity value (F+G-H+I+J) 24,704 80

No of shares 307

Target price 80


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Fig. 143: EV/Tonne vs. replacement cost


Fig. 144: One-year forward EV/EBITDA per tonne


Valuation – most sensitive to realisations Due to its high operating cost base, the company exhibits the highest sensitivity to changes in realisations. Therefore, continued production discipline among the southern players is critical to maintain profitability and better return ratios, in our view. Given that the Southern market is the most fragmented, ability to take price hikes would always depend on the competition and hence return ratios are likely to remain at sub-10% levels in FY13F and FY14F. We do not expect much upside for the stock from current levels.

On the downside, if production discipline breaks and assuming that prices correct by 10%, we estimate EBITDA per tonne of only INR423 and ROCE will drop drastically to 5% (from the current 10%). However, we see limited downside for the stock as it is already building in a 54% discount to its replacement cost, which is the widest discount in the past 10 years.

Key risks

• Given the geographical concentration of its capacity in the South, where there is a glut supply scenario, any breakdown in production discipline amongst cement players will lead to a correction in cement prices, thus significantly impacting earnings on the downside.

• Resolution of the Telangana issue and a faster-than-expected pick-up in infrastructure / construction activity in Andhra Pradesh will result in better-than-expected sales volume growth / improvement in realisations, which will be a key upside risk to our earnings estimates.

• Unlocking value of its IPL team at a value higher than our expectation will be a key upside risk

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Appendix A-1

Analyst Certification

We, Aatash Shah and Vineet Verma, hereby certify (1) that the views expressed in this Research report accurately reflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this Research report and (3) no part of our compensation is tied to any specific investment banking transactions performed by Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Issuer Specific Regulatory Disclosures Mentioned companies Issuer name Ticker Price Price date Stock rating Sector rating Disclosures ACC ACC IN INR 1204 05-Dec-2011 Neutral Not rated 4 Ambuja Cements ACEM IN INR 160 02-Dec-2011 Buy Not rated Grasim Industries GRASIM IN INR 2451 02-Dec-2011 Buy Not rated India Cements ICEM IN INR 75 02-Dec-2011 Neutral Not rated Shree Cement SRCM IN INR 2131 02-Dec-2011 Buy Not rated Ultratech Cement UTCEM IN INR 1176 02-Dec-2011 Neutral Not rated

Disclosures required in the European Union

4 Market maker Nomura International plc or an affiliate in the global Nomura group is a market maker or liquidity provider in the securities / related derivatives of the issuer.

Previous Rating Issuer name Previous Rating Date of change ACC Not rated 08-Dec-2011 Ambuja Cements Not rated 08-Dec-2011 Grasim Industries Not rated 08-Dec-2011 India Cements Not rated 08-Dec-2011 Shree Cement Not rated 08-Dec-2011 Ultratech Cement Not rated 08-Dec-2011

Rating and target price changes

Ticker Old stock rating New stock rating Old target price New target price

ACC ACC IN Not rated Neutral N/A INR 1155

Ambuja Cements ACEM IN Not rated Buy N/A INR 183

Grasim Industries GRASIM IN Not rated Buy N/A INR 3014

India Cements ICEM IN Not rated Neutral N/A INR 80

Shree Cement SRCM IN Not rated Buy N/A INR 2933

Ultratech Cement UTCEM IN Not rated Neutral N/A INR 1259

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ACC (ACC IN) INR 1204 (05-Dec-2011) Rating and target price chart (three year history)

Neutral (Sector rating: Not rated)

Date Rating Target price Closing price 06-Oct-2010 917.00 1026.60 15-Jan-2010 830.00 980.60 24-Jul-2009 609.00 845.15 23-Apr-2009 466.00 647.70 10-Feb-2009 Reduce 543.80

For explanation of ratings refer to the stock rating keys located after chart(s)

Valuation Methodology Given mid-cycle ROCE over the next two years we believe ACC should also trade at a mid-cycle multiple to the replacement cost in terms of EV/ton. We adjust this mid-cycle multiple by the ratio of the one year forward ROCE to the mid-cycle ROCE of the company to arrive at a more accurate multiple. ACC’s EV/ton to replacement cost mid-cycle multiple over the last 10 years has been a very small 1% discount. We expect a ROCE of 20.2% in CY12F vs. a mid-cycle ROCE of 20.9% in the last 10 years, a discount of 3.7%. Thus our target multiple to the replacement cost per ton for ACC of INR6,250/ton (USD121/ton at INR-USD rate of INR51.7) would be a discount of 4.7% or an EV/ton of INR5,959/ton (USD115/ton). We multiply this with ACC’s current capacity of 30.6mnT to arrive at our target EV and TP of INR1155. Risks that may impede the achievement of the target price Risks to upside: 1)Higher than expected volume growth, 2) Lower than expected capacity additions,3) Fall in coal prices and 4) higher than expected GDP growth Risks to downside: 1)Slower growth continuing for longer than expected, 2) Breakdown in production discipline resulting in lower pricing, 3)higher interest rates in India resulting in slower GDP growth, 4) higher than expected capacity additions and 5) sharp increase in costs

Ambuja Cements (ACEM IN) INR 160 (02-Dec-2011) Rating and target price chart (three year history)

Buy (Sector rating: Not rated)

Date Rating Target price Closing price 06-Oct-2010 113.00 143.40 15-Jan-2010 86.00 112.80 24-Jul-2009 67.00 95.05 10-Feb-2009 Reduce 73.95


Valuation Methodology We value ACEM on a mid-cycle multiple to current replacement cost after adjusting for the ratio of one year forward ROCE to mid-cycle ROCE. ACEM’s mid-cycle EV/ton to replacement cost/ton multiple has been a 27% premium and adjusting for a 14% higher 1 year forward ROCE vs. mid-cycle ROCE, we value ACEM at a 44% premium to current replacement cost of USD121/ton. Based on this our price target works out INR 183 per share

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Risks that may impede the achievement of the target price Risks to downside: 1) Slower growth continuing for longer than expected, 2) Breakdown in production discipline resulting in lower pricing, 3)higher interest rates in India resulting in slower GDP growth, 4) higher than expected capacity additions and 5) sharp increase in costs

Grasim Industries (GRASIM IN) INR 2451 (02-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 06-Oct-2010 2181.00 2348.25 06-Oct-2010 Neutral 2348.25 15-Jan-2010 2480.00 2844.75 30-Jul-2009 1680.00 2752.40 16-Apr-2009 1429.00 1609.35 16-Apr-2009 Reduce 1609.35 02-Feb-2009 1376.61 1189.75 02-Feb-2009 Buy 1189.75


Valuation Methodology We arrive at a target price of INR3,014, valuing the company’s non-cement business at 5.0x EV/EBITDA (FY13F) and 60.3% stake in Ultratech Cement at our TP of INR1,259/share with a 20% holding company discount. Separately, we value its equity holding in other group companies at CMP, applying a 20% discount thereafter, and valued other investments at book value. Risks that may impede the achievement of the target price Key risks to the upside: 1) Higher-than-expected VSF and cement volume growth and better realization and 2) a breakdown of the historical correlation between VSF & cotton prices. Risks to downside: 1) breakdown in production discipline amongst cement players resulting in lower pricing and 3) a higher-than-expected fall in VSF prices, led by a fall in cotton prices.

India Cements (ICEM IN) INR 75 (02-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 06-Oct-2010 89.00 122.90 15-Jan-2010 115.00 131.00 23-Jul-2009 113.00 141.75 23-Jul-2009 Reduce 141.75 29-Jan-2009 93.00 100.20 29-Jan-2009 Neutral 100.20


Valuation Methodology Our target price of INR80 for India Cements is based on a sum-of-the-parts methodology. We value its cement business on an EV/IC multiple-based method as wildly fluctuating profitability and return ratios over the last several years makes difficult to calculate a mid-cycle level. Using the average ROCE of 9.5% that we expect the company to generate during FY12-FY14F our price target for the company work out to INR 80 per share, including value of company's ownership in Indian Premier League franchise “Chennai Super Kings” at INR 17/share.

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Risks that may impede the achievement of the target price • Due to geographical concentration of its capacity in South, where there is glut supply scenario, any breakdown in production discipline amongst cement players will lead to correction in cement prices, thus significantly impacting earnings on the downside. •Resolution of Telangana issue and faster-than-expected pick up in infrastructure / construction activity in Andhra Pradesh will result in better-than-expected sales volume growth / improvement in realisation, which will be a key upside risk to our earnings estimates. •Unlocking the value of IPL team at a value higher than our expectation will be a key upside risk

Shree Cement (SRCM IN) INR 2131 (02-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 06-Oct-2010 2044.00 2060.95 06-Oct-2010 Neutral 2060.95 15-Jan-2010 1829.00 2225.55 29-Jul-2009 1053.00 1576.70 16-Apr-2009 Reduce 796.05 11-Dec-2008 625.00 426.15 11-Dec-2008 Buy 426.15


Valuation Methodology Our target price of INR2,933 for Shree Cement is based on a sum-of-the-parts basis. We value its cement business on a mid-cycle multiple to current replacement cost after adjusting for the ratio of one year forward ROCE to mid-cycle ROCE. Shree’s mid-cycle EV/ton is at par with replacement cost/ton and adjusting for 1% higher 1 year forward ROCE vs. mid-cycle ROCE, we value Shree at a 1% premium to current replacement cost of USD121/ton. Separately, we have valued its power portfolio (~400 MW) at 6x EV/EBITDA, nearly 40% discount to large power generating companies. Risks that may impede the achievement of the target price • Due to geographical concentration of its capacity in North, any potential slow down of infrastructure sector / construction activity in the northern region will result in lower sales volume growth /realisation, one of the key downside risk to our estimates. • Lower power off take due to poor health of state electricity boards (SEBs), lower-than-expected price for Merchant power and dependence on imported coal /pet coke for power generation, can significantly impact its power earnings. • Better cement & merchant power realisation will be a key upside risks to our estimates

Ultratech Cement (UTCEM IN) INR 1176 (02-Dec-2011) Rating and target price chart (three year history)


Date Rating Target price Closing price 06-Oct-2010 897.00 1105.05 15-Jan-2010 880.00 1036.75 22-Jul-2009 463.00 750.25 22-Apr-2009 410.00 567.95 22-Apr-2009 Reduce 567.95 20-Jan-2009 395.00 389.45 20-Jan-2009 Neutral 389.45


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Valuation Methodology With the fundamentals of the company in terms of geographical spread, profitability and return ratios lying between Ambuja and ACC, we believe the EV/ton to replacement cost/ton multiple should be an average of the two, which is a 14% premium to the replacement cost per ton of INR6,250. Risks that may impede the achievement of the target price Risks to upside: 1) Higher than expected volume growth, 2) Lower than expected capacity additions,3) Fall in coal prices and 4) higher than expected GDP growth Risks to downside: 1) Slower growth continuing for longer than expected, 2) Breakdown in production discipline resulting in lower pricing, 3)higher interest rates in India resulting in slower GDP growth, 4) higher than expected capacity additions and 5) sharp increase in cost.

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