Indiancementsector

Equity Research April 21, 2008 BSE Sensex: 16481

INDIA

Cement sector Strapping foundations Reason for report: Initiating coverage ACC SELL (Rs799) Ambuja Cement SELL (Rs113) Grasim BUY (Rs2,569) India Cements HOLD (Rs180) J K Cement BUY (Rs150) Shree Cement BUY (Rs1,078) UltraTech Cement BUY (Rs784)

The Indian cement industry, which has been in an uptrend since ’04, is caught up in growing concerns of impending overcapacity by FY09, which we believe is overdone. We met with key equipment suppliers to fairly assess incremental supplies likely in the next three years. We estimate that cement demand could surprise by posting a CAGR of over 11% in the next five years. We believe that FY09 would continue to witness supply shortage while FY10 could witness demand-supply parity, based on our analysis of incremental supply and expected robust demand. While the industry would continue to face cost pressures as well as Government intervention, we feel their impact would be largely passed on. However, we rule out aggressive price hikes by cement players and thus prefer stocks with strong volume growth and/or cost savings. We rate Grasim and Shree Cement (SCL) as our top picks. f Fears of oversupply unrealistic. With the Street expecting oversupply in FY09E itself, we met up with cement equipment manufacturers for a fair assessment of expected supplies over the next two years. Many projects are running behind schedule, with average period of project execution having risen to 30-36 months from 24 months. This coupled with a 3-4mth ramp-up would ensure that incremental supplies are much lower than market expectations. We expect FY09E and FY10E incremental supplies to be 16mnte and 29mnte respectively. f Demand could surprise. We believe that there could be rise in the historical cement-to-GDP at 1.3x, given large-scale investment in infrastructure in the XI Five Year Plan (FYP). This coupled with continued housing demand as well as incremental demand for commercial spaces and special economic zones (SEZs) could drive demand at CAGR of 11.6% over the next five years. Consequently, while we expect supply shortage in FY09, we believe there would be demandsupply parity in FY10E. Hence, we do not envisage pricing pressures till FY10E. f Cost pressures to be passed on. The cement industry is likely to face severe cost pressures from rising cost of coal, pet coke, fly ash and freight. However, these would be passed on in a scenario of supply tightness, although we rule out aggressive price hikes due to fear of Government intervention.

Novonil Guha [email protected] +91 22 6637 7385

f Our top picks – Grasim and Shree Cement. Based on our belief that price upside for the next two years would offset cost escalations, we prefer stocks that are likely to report robust volume growth and/or cost savings. Grasim and SCL are likely to benefit from capacity additions; this coupled with their inexpensive valuations make them extremely attractive. Please refer to important disclosures at the end of this report

Cement sector, April 21, 2008

ICICI Securities

TABLE OF CONTENTS Investment summary .......................................................................................................3 Oversupply fears exaggerated........................................................................................3 Demand growth of 11-12% achievable ...........................................................................3 Pricing pressure unlikely till FY11E.................................................................................3 Cost escalations to be passed on ...................................................................................4 Attractive valuations ........................................................................................................5 Oversupply fears hyped ..................................................................................................6 Announced capacities likely to be delayed .....................................................................6 Incremental supply overstated ........................................................................................8 12% demand growth achievable.....................................................................................9 Cement demand – High correlation with GDP ................................................................9 Housing to remain largest demand contributor .............................................................10 Infrastructure share to rise ............................................................................................12 Corporate capex............................................................................................................13 SEZs, commercial construction ....................................................................................13 Demand-supply parity likely in FY10 ...........................................................................15 Pricing pressure unlikely, but upside limited too.......................................................16 Government intervention impacts sentiment.................................................................17 Cost pressures a concern, but to be passed on.........................................................19 Power and fuel ..............................................................................................................19 Freight costs..................................................................................................................20 Cost comparison – Key cement companies..................................................................20 Attractive valuations......................................................................................................22 We prefer stocks with volume upside and/or cost savings ...........................................23 Key risks .........................................................................................................................24 Estimates – Incremental supply and demand ...............................................................24 Government pressure ...................................................................................................24 Input cost pressure........................................................................................................24 Index of Tables and Charts ...........................................................................................25

Companies ACC ................................................................................................................................. 27 Ambuja Cement .............................................................................................................. 39 Grasim ............................................................................................................................. 49 India Cements ................................................................................................................. 63 JK Cement ...................................................................................................................... 75 Shree Cement ................................................................................................................. 87 UltraTech Cement ........................................................................................................... 99 Prices as on April 21, ’08

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Cement sector, April 21, 2008

ICICI Securities

Investment summary Oversupply fears exaggerated Poor performance by the cement sector since December ’07 has been primarily due to reluctance by cement manufacturers to raise cement prices and overall adverse conditions in the market. Inability of cement producers to hike prices along with fears of oversupply likely in FY09 made the future of the cement sector seem bleak. However, price hikes were effected in March ’08 and April ’08 to pass on rise in input costs, although we believe that the expectation of oversupply is highly overdone. As per our meetings with cement equipment manufacturers, FY09E and FY10E incremental supplies are likely to be much lower than stated capacities. Regulatory delays for new projects, capacity constraints by equipment suppliers and lack of availability of civil contractors are key factors for increase in average project execution time to 30-36 months at present from 24 months a couple of years ago. We estimate an incremental supply of 16mnte for FY09E and ~29mnte for FY10E vis-à-vis the stated capacity additions of 31mnte for FY09E and 33mnte for FY10E.

Demand growth of 11-12% achievable Cement demand is likely to remain quite robust for the next five years mainly driven by housing and infrastructure sectors. Higher disposable income, rising population, changing demographics and reduction in average size of household will aid housing demand. We expect ~584mnte of cement to be consumed by the housing sector over the next five years. Roads, ports, power, urban infrastructure and irrigation are likely to boost infrastructure demand. Historically, cement demand has high correlation with GDP. Over the past 10 years, cement-to-GDP has been 1.3x. However, with planned infrastructure investment in the XI FYP to be more-than-double vis-à-vis X FYP, we expect the ratio to increase. Also, we expect cement demand to post CAGR of 11.6% over the next five years.

Pricing pressure unlikely till FY11E Cement prices have moved up with rising operating rates. Our assessment of the demand-supply scenario for the next two years suggests that the industry will see supply tightness in both FY09E and FY10E. Consequently, high operating rates would ensure ruling out any possibility of pricing pressure. However, despite the expected supply shortage, we do not envisage aggressive price increases from cement players. With Government intervention at regular intervals since January ’06, cement players have been cautious about attracting Government interest. Consequently, we expect price increases to pass on major impact of rising input costs. We have assumed allIndia average prices to improve ~4% for FY09E and remain flat for FY10E.

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Cement sector, April 21, 2008 Chart 1: Utilisation versus cement prices 255

Capacity Utilisation (RHS)

All India Avg Price per bag (LHS)

120

235 110

215

100

175

(%)

(Rs)

195 155

90

135 115

80

95 Feb-08

Aug-07

Feb-07

Aug-06

Feb-06

Aug-05

Feb-05

Aug-04

Feb-04

Aug-03

Feb-03

Aug-02

70 Feb-02

75

Source: CMA, I-Sec Research

Cost escalations to be passed on Power and fuel constitute a significant 18-22% of cement companies’ revenues. The cement industry is dependant on domestic coal, imported coal and pet coke as the main fuels used in kilns and CPPs. While Coal India (CIL) has raised prices of domestic coal 10-15% on an average since December ’07, prices of international coal have seen sharp rise since September ’08 (~70%, currently higher than September ’07 levels). This coupled with rising bulk freight rates would result in substantial increase in landed cost of imported coal. Companies such as India Cements (ICL), ACL and UTCL would be impacted by imported coal prices. Similarly, pet coke prices have risen in line with crude oil prices, thereby affecting companies such as SCL, Grasim and JK Cement (JKCL). However, cement companies have endeavoured to moderate impact of higher fuel costs by shifting to captive power sources. Freight costs, which constitute 12-18% of cement companies’ revenues, have also been rising with increasing cost of diesel. Cement companies have started setting up split grinding units closer to fly ash sources or to markets to achieve savings in freight as transportation of clinker is cheaper than that of cement. Overall, rising costs of fly ash, coal and pet coke remain a serious concern for cement companies. However, given the anticipated short supply expected in FY09E and FY10E, we expect such cost pressures to be passed on to consumers.

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ICICI Securities

Cement sector, April 21, 2008

Attractive valuations Based on Government intervention that is a regular feature at present, we do not envisage substantial price hikes despite expected shortage in supply. However, we believe that the impact of cost increase would be passed on to consumers. Consequently, we prefer stocks that have volume upside and/or are expected to register cost reduction. Hence, we recommend a BUY on Grasim, UTCL, SCL and JKCL on the back of impressive earnings growth and cheaper valuations. We recommend SELL on ACC and ACL due to expensive valuations and sluggish bottomline growth. Grasim and SCL are our top picks in the sector. Table 1: Relative valuations CMP EPS (Rs) (Rs) FY09E FY10E ACC 799 73.2 78.4 Grasim 2,574 299.2 361.7 Ambuja Cement 113 9.6 10.8 UltraTech Cement 784 105.3 122.3 India Cements 180 26.2 30.3 JK Cement 150 51.8 60.6 Shree Cement 1,078 175.1 235.4 Source: Company data, I-Sec Research

P/E (x) FY09E FY10E 10.9 10.2 8.6 7.1 11.8 10.5 7.4 6.4 6.9 5.9 2.9 2.5 6.2 4.6

EV/E (x) FY09E FY10E 6.7 6.2 5.8 4.6 7.0 6.0 5.4 4.4 5.1 4.3 3.2 2.4 3.1 2.2

EV/ton (US$) 165 130 222 130 129 101 97

Reco Sell Buy Sell Buy Hold Buy Buy

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Cement sector, April 21, 2008

Oversupply fears hyped Announced capacities likely to be delayed The Indian cement industry has seen rising prices since ’04 due to slowdown in capacity additions and rising operating rates. Buoyed by higher prices and consequent strong cash accruals, cement players started announcing capacity additions ’05-06 onwards. While total announced capacities are over 100mnte at present, we believe incremental cement supplies are likely to be significantly lower than official company announcements. Based on our interaction with cement equipment manufacturers and cement companies for assessing effect of capacity additions going forward, average project set-up time has increased to 30-36 months from ~24 months a couple of years ago. Further, most announced capacities are likely to be delayed by at least six months mainly due to: •

delay in land acquisition and acquiring mining leases,

•

delay in obtaining various regulatory and environmental clearances,

•

increase in lead time for delivery of machinery, with equipment suppliers boasting of full order books at present, and

•

delays due to lack of availability of quality civil contractors that may result in a longer stabilisation period.

There are only few players worldwide that have the capability of supplying key equipment for cement plants. Amongst these, Polysius, KHD Humboldt Wedag and FLSmidth are the main players in India. Further, there are other players such as Loesche and GBER Pfeiffer that specialise in other equipment such as vertical roller mills and gear boxes. Chart 2: Key cement equipment suppliers and market share (excl. China)

Others 16%

Sinoma 24%

FLSmidth 29%

Polysius 19% KHD Humboldt Wedag 12%

Source: FLSmidt

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Cement sector, April 21, 2008

While India saw demand for new capacities ’05 onwards, construction boom in the Middle East resulted in strong cement equipment order inflow from ’03 itself. Besides India and the Middle East, demand for fresh kiln capacity is seen in Asia and North America. Chart 3: Global contracted kiln capacity trend (excl. China)

Source: FLSmidth

Chart 4: Order inflow and backlog trend of key companies 20,000

FLS DK Kmn

700

KHD US$mn (RHS)

18,000

600

16,000

500

14,000 12,000

400

10,000 8,000

300

6,000

200

4,000 100

2,000 0

0 2004

2005

2006

2007

Source: FLSmidth, KHD Humboldt Wedag

With demand for new capacities seeing a sharp rise not just in India, most equipment suppliers are facing capacity constrains for implementing new orders. Consequently, lead time for delivery of key equipment has been increasing and is expected to rise going forward.

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Cement sector, April 21, 2008

Incremental supply overstated We have attempted to estimate incremental supplies for FY09E, FY10E and FY11E based on our interaction with equipment suppliers. It usually takes 3-4 months for a new plant to stabilise, during which output is minimal. Further, for capacities getting commissioned mid year, incremental supply would only be for operational months for that year (adjusted for stabilisation time), which in turn would be significantly lower than the stated capacity. Further, with ~136mnte announced as on date, ~37mnte (including Reliance ADAG Group’s 20mnte) has not been ordered out yet. Chart 5: Expected incremental supplies over the next three years Stated capacity

35

Incremental Supply

30

(mn te)

25 20 15 10 5 0 FY09E

FY10E

FY11E

Source: I-Sec Research

Thereby, we estimate that only 16mnte of incremental cement supply is likely in FY09E as against stated capacity of ~32mnte. Similarly, only 28mnte of incremental supplies are likely in FY10E as against stated capacity additions of 33mnte. Further, incremental supply of 29mnte is expected in FY11E. Hence, we believe that the market has considerably over-estimated the incremental supply scenario for the next couple of years.

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Cement sector, April 21, 2008

12% demand growth achievable Cement demand in India has registered ~8% CAGR for the past ten years. Housing continues to be the main driver, constituting ~60% of overall demand. However, we believe that with Government thrust on infrastructure, the cement sector could see increase in share of overall demand in the next five years. Chart 6: Production and consumption trend 180

Producion

Domestic consumption

160

(mn te)

140 120 100 80 60

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

40

Source: CMA, I-Sec Research

Cement demand – High correlation with GDP Cement demand is directly linked to economic activity. Since infrastructure investments and construction activity, which are the main drivers of cement demand, are key components of GDP, cement demand growth has high correlation to GDP growth. Further, housing (both rural and urban), also a determinant of cement demand, depends on agricultural productivity and income levels, which are again a key components of GDP. Based on past 10-year data (FY1998-07) on cement consumption growth versus GDP growth, the cement-to-GDP stands at 1.3x. With planned investment in infrastructure to more-than-double in the XI FYP vis-à-vis X FYP, we may see an improvement in the cement-to-GDP. Consequently, with GDP expected to grow 8.5-9%, we believe cement demand would grow 11-12% till FY12E. We expect housing, infrastructure, corporate capex, commercial construction and SEZs to be key demand drivers going forward.

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Cement sector, April 21, 2008 Chart 7: GDP versus cement demand growth 17

GDP grow th

Cement consumption grow th

(%)

12

7

2

FY07

FY06

FY05

FY04

FY03

FY02

FY01

FY00

FY99

FY98

-3

Source: CMA, Bloomberg

Housing to remain largest demand contributor Housing constitutes ~60% of total cement demand. Main factors driving housing demand are: •

rise in disposable income levels

•

continued growth in population and change in population profile

•

changing demographics (migration from rural to urban areas)

•

decrease in number of people per household (average size of household) with breakdown of the joint family system into nuclear families

•

fiscal incentives provided by the Government and easy availability of finance

Higher income levels. Strong economic growth helps boost disposable income. This coupled with easy availability of finance enables households to migrate from nonpucca houses to urban pucca housing and results in increase in demand for larger houses, thereby raising average size of dwelling units. Shift in population profile. Based on decline in average age of home purchasers coupled with higher income levels, we believe that the population within the 25-44yr age group is critical to the growth in housing demand. As per the Census of India ’01 report, ~27.7% of India’s population in ’01 that was in the 25-44yr age group is likely to increase to ~32% in ’26, which implies an annual addition of ~6.5mn people to this age bracket.

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Cement sector, April 21, 2008

Chart 8: Share of the 25-44yr age group in total population 1,600

Total Population

% share of 25-44 age group (RHS)

33 32

1,400

31 30

(%)

(mn)

1,200 1,000 29 800

28

600

27 2001

2006

2011

2016

2021

2026

Source: Census of India ’01, I-Sec Research

Nuclear families and urbanisation. The joint family system in India has been gradually moving towards nuclear families. Migration of population towards urban areas due to better job opportunities coupled with rapid urban infrastructure development would effect the decline in average size of an Indian household. Hence, with the ever-growing population, expected reduction in the size of an average Indian household, outlook for housing demand remains extremely positive. Fiscal incentives to continue boosting cement demand. Fiscal incentives granted by the Central Government have provided boost to housing demand. Fiscal benefits, existent since the FY00 Budget, give tax incentives on both interest payments and principal repayments on mortgage loans, thereby reducing effective cost of financing and stimulating housing demand. Table 2: Housing demand projection Estimated housing stock (mn) Housing stock (bn sqft) Average size (sqft)

2008 133.8 90.3 675

2009 138.3 94.8 685

2010 142.9 99.4 696

2011 147.8 104.3 706

2012 152.8 109.5 717

Incremental demand (bn sqft)

4.2

4.4

4.7

4.9

5.1

105.9

111.2

116.6

122.4

128.4

Cement demand (mnte) Source: CRISIL, I-Sec Research

As per CRISIL, housing stock is expected to post 3.4% CAGR over the next five years. Further, housing stock in terms of area in square feet is expected to rise at a higher 4.9% CAGR over the same period, given the expected increase in average size of dwelling units. Hence, we expect ~584mnte of cement to be consumed by the housing sector over the next five years.

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Cement sector, April 21, 2008

Infrastructure share to rise The Planning Commission has projected Rs20,271bn investment in infrastructure for the XI FYP, 2.3x higher than infrastructure investment anticipated in X FYP. Main sectors that would drive cement demand are roads, power, ports, airports, irrigation and urban infrastructure. Chart 9: Infrastructure spending in X & XI FYPs 25,000

Pow er Irrigation Airports

Roads Urban Infrastructure Others

Railw ays Ports

(Rs bn)

20,000

15,000

10,000

5,000

0 Xth Plan

XIth plan

Source: Planning Commission

Road Projects. Various road projects under the National Highway Development Programme (NHDP) that include phases II-VII are expected to generate cement demand of ~42.5mnte till end XI FYP. Table 3: Road projects under NHDP

Project NHDP – Phase II Port connectivity Phase III Phase IV Phase V Phase VI

Description NSEW Corridor Connects major ports Connecting state capital & places of economic and tourist importance to phases I & II Upgradation of existing highways to twolane Six-laning of the Golden Quadrilateral (GQ) and high-density corridor Expressways Ring roads, bypasses and flyovers and selected stretches

Completion 27% 44%

Length (km) 7,142 1,342

Cement consumption* (mnte) 6.65 0.96

3%

12,109

14.98

-

20,000

12.75

-

6,500 1,000 Not yet decided

4.14 3.00

Phase VII Total *Cement demand, assuming 25% of roads made of concrete Source: National Highway Authority of India (NHAI), Committee on Infrastructure, I-Sec Research

42.5

Additionally, various State Governments too have undertaken road projects including repair and upgradation of existing roads. Total investment in such projects is expected to be ~Rs1,000bn, with ~18mnte demand expected over the next five years. Further, investments of ~Rs790bn in rural roads are likely to generate further 14mnte demand. Overall, we expect ~75mnte demand from Central, state and rural road projects over the next five years.

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Cement sector, April 21, 2008

ICICI Securities

Power projects. The XI FYP envisages total capacity addition of ~78,577MW, of which 16,500MW would be hydro projects where cement consumption is significantly higher than other projects. We expect ~46mnte of cement consumption for power generation projects over the next five years. Table 4: Demand from power projects Capacity Construction Demand (MW) component (%) (mnte) Thermal coal 54,355 20 14.3 Thermal gas 4,289 10 0.4 Hydro 16,553 70 29.4 Nuclear 3,380 30 2.3 Total 78,577 46.4 Source: Central Electricity Authority (CEA), National Institute For Construction Management & Research (NICMAR), I-Sec Research

Based on investments projected in the XI FYP, we estimate total cement requirement of 248mnte over the next five years. Further, we expect share of cement demand from infrastructure to rise to ~23% in the XI FYP from ~17% of total demand in the X FYP. Table 5: Demand from infrastructure X FYP XI FYP Power 2,919 6,165 Roads 1,449 3,118 Railways 1,197 2,580 Irrigation 1,115 2,231 Urban Infrastructure 648 1,991 Ports 41 739 Airports 68 347 Others 1,369 3,099 Total 8,805 20,272 Source: NHAI, CEA, NICMAR, Planning Commission, I-Sec Research

Construction component (%)

42 60 60 50 42 10

Demand (mnte) 46.4 75.0 31.0 38.3 34.1 10.6 4.2 8.9 248.4

Corporate capex Backed by healthy growth of the Indian economy, most industries are operating at peak utilisation levels. With demand expected to remain firm from various sectors, most industries have announced large capacity expansion plans. CRISIL estimates an investment of ~Rs6,900bn over the next five years for various industrial projects. Consequently, we expect cement demand of ~69mnte for these projects.

SEZs, commercial construction Commercial construction includes malls, multiplexes, office space, hotels, hospitals etc. Demand for office space is largely driven by the IT/ITES industry, which comprises 75-80% of commercial demand at present. The sector is expected to grow 25-30% annually over the next few years and would be the key driver of commercial demand.

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Cement sector, April 21, 2008

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SEZs are areas notified under the SEZ Act ’05, with benefit of fiscal incentives from both Central and State Governments along with minimal regulatory requirements and quality infrastructure for boosting economic growth. Approvals for 439 SEZs have been granted by the Government as on date, of which ~63% relate to the IT/ITES sector. Quality infrastructure requirement for SEZs would be the main driver for cement demand. We expect aggregate cement demand of 1.08bnte over the next five years, an 11.6% CAGR over FY08-12E. Table 6: Sector-wise projected cement demand (FY08-12E) Housing Infrastructure Commercial, SEZ, Defence etc Industrial capex Exports Total Source: I-Sec Research

14

Demand (mnte) 585 248 160 69 21 1,083

Share (%) 54.0 22.9 14.8 6.4 1.9 100.0

ICICI Securities

Cement sector, April 21, 2008

Demand-supply parity likely in FY10 Despatches for FY08 were depressed due to capacity constrains. While overall 31mnte is expected to be added in FY09, we believe incremental supplies are likely to be ~16mnte. Thereby, demand for FY09 would also be restricted to 16mnte even though incremental demand would have been ~20mnte at 12% growth rate. In such a scenario, the remaining ~4mnte demand not met in FY09 would get deferred to FY10. Consequently, total demand for FY10 would be the incremental demand of 23mnte (assuming 12% growth rate) coupled with the ~4mnte (from FY09E, mentioned above) totalling to 27mnte. As per our estimates, incremental supplies for FY10E would be ~29mnte. Hence, despite the expected commissioning of 33mnte capacity, we expect to see demand-supply parity in FY10E too. Table 7: Demand/supply (’000 te) FY05 153,590 7,428 146,162 127,571 8.6 1.23 83.1 127,571

FY06 159,800 7,428 152,372 141,805 11.2 1.25 88.7 141,805

FY07 166,740 7,430 159,310 155,655 9.8 1.31 93.4 155,655

FY08E 180,030 7,430 172,600 166,940 7.3 1.31 92.7 166,940

FY09E 211,830 4,843 206,987 183,300 9.8 1.35 86.5 183,300

FY10E 245,130 4,843 240,287 212,628 16.0 1.38 86.7 212,628

Total despatches 127,150 Change (%) 8.5 Exports 4,072 Change (%) 21.1 Domestic consumption 123,078 Change (%) 8.2 Source: CMA, I-Sec Research

141,594 11.4 6,007 47.5 135,587 10.2

155,262 9.7 5,892 (1.9) 149,370 10.2

166,518 7.3 3,750 (36.4) 162,768 9.0

182,837 9.8 4,118 9.8 178,719 9.8

212,091 16.0 4,323 5.0 207,767 16.3

Capacity Inoperative capacity Effective capacity Production Change (%) Blending ratio (x) Utilisation (%) Total availability

Table 8: Regional demand/supply scenario (mnte) Incremental demand & supply North Demand Supply Surplus/(deficit) Central Demand Supply Surplus/(deficit) West Demand Supply Surplus/(deficit) East Demand Supply Surplus/(deficit) South Demand Supply Surplus/(deficit) Source: I-Sec Research

FY09E

FY10E

FY11E

3.9 7.9 3.95

4.4 9.0 4.61

4.9 5.9 0.97

3.0 0.9 (2.08)

3.3 4.0 0.71

3.7 2.2 (1.56)

3.8 (3.79)

4.2 1.3 (2.95)

4.8 5.6 0.80

3.2 0.2 (3.05)

3.6 3.7 0.11

4.0 3.1 (0.93)

5.8 7.3 1.55

6.4 10.7 4.25

7.2 11.8 4.61

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Cement sector, April 21, 2008

Pricing pressure unlikely, but upside limited too Upsurge in cement prices was marked by rising operating rates aided by slowdown in capacity additions. This, coupled with significant jump in road freight costs following the Supreme Court’s ban on overloading, forced cement manufacturers to raise prices ~Rs45/bag within three months, January ’06 onwards; thereafter, prices in most regions have touched all-time highs. Chart 10: Rising utilisation levels and prices 235

12 month rolling capacity utilisation (RHS)

220

12 month rolling prices

105 102 99 96 93

190

90 175

87

(%)

(Rs/50kg)

205

84

160

81

145

78

130 Jun-04

75 Dec-04

Jun-05

Dec-05

Jun-06

Dec-06

Jun-07

Dec-07

Source: CMA, I-Sec Research

Chart 11: All-India average cement price trend 240 220

(Rs/bag)

200 180 160 140

Feb-08

Sep-07

Apr-07

Nov-06

Jul-06

Feb-06

Sep-05

Apr-05

Nov-04

Jun-04

Jan-04

Sep-03

Apr-03

Nov-02

Jun-02

Jan-02

Sep-01

120

Source: Cement Manufacturers Association (CMA), I-Sec Research

While our analysis indicates that the industry would continue to witness supply shortage in FY09E, we do not envisage substantial increase in price levels despite sharp rise in various input costs for cement companies. Aggressive price increases in January ’06 managed to catch Government attention, post which the administration has undertaken various steps to moderate cement prices.

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Cement sector, April 21, 2008

Government intervention impacts sentiment Table 9: Calendar of events (since January ’07) Date Jan-07 Feb-07

Mar-07 Apr-07

Government action Reduction of import duty from 12.5% to NIL Excise duties raised for cement sold for over Rs190/bag and lowered for cement sold at/below Rs190/bag Commerce Minister announces price freeze for one year CVD and SAD on cement imports abolished

May-07 Jun-07

Three-tier excise duty announced Finance Minister denies existence of price freeze

Aug-07

Government mandates MMTC to import cement from Pakistan

Dec-07

MRTP finds cartelisation between cement companies for a legal case in 1990 Excise duties on bulk cement and clinker raised Withdrawal of DEPB scheme for cement exports Government bans export of cement

Feb-08 Mar-08 Apr-08

Impact No impact, international prices still higher Cement companies pass on the hike instead of reducing prices to avail lower excise rate Price freeze operational in most regions except South No impact, absence of bulk storage and handling facilities at ports prevents large quantities of cement imports No impact Prices remain stable in most regions except the south where they were up Rs35-40/bag despite price freeze operating earlier No impact, port infrastructure still the problem – quantities of cement imported not enough to impact prices Cease and desist order issued – No impact Impact of higher excise passed on No impact – only 2% of cement output exported Prices not likely to come under pressure. However, upside likely to be capped in coastal Gujarat and Maharashtra

Source: I-Sec Research

Various actions by the Government have had minimal real impact. While the announcement of a price freeze saw cement prices remain largely static in most regions, the South saw significant prices hikes of Rs35-40/bag during the operation of the freeze. Similarly, Government initiatives for encouraging imports with reduction of import duties, abolition of counter veiling duty (CVD) and easing of Bureau of India Standards (BIS) procedures for cement imported from Pakistan through Metals & Mineral Trading Corporation (MMTC) have also not impacted cement prices. Construction activity in the Middle East has resulted in higher cement prices in its market. Consequently, export realisations (FOB) have also improved for Pakistani cement players from US$60-65/te to US$70-75/te at present. Based on FOB imports at US$70/te, we estimate landed cost of cement at Rs216/bag assuming just 100km of lead distance from the port. However, lack of bulk storage and handling facilities at our ports act as the biggest barrier for import of large quantities of cement. The recent Government action to ban exports of cement and clinker is not likely to have any major impact on domestic prices as only 3.6% of total cement production is exported. However, pricing upside may be capped in coastal Gujarat and Maharashtra. We feel that the Government’s excessive focus on maintaining cement prices due to inflation concerns is unjustified. Cement constitutes just 1.7% weightage in the wholesale price index (WPI). Hence, moderated price hikes are likely to impact inflation minimally.

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Cement sector, April 21, 2008

ICICI Securities

Table 10: Landed cost of cement from Pakistan (per tonne) FOB (US$) Freight (US$) CIF (US$) US$ rate Total (Rs) Import duty Special additional duty – 4% Finance charges (Rs) Handling charges (Rs) Packing charges (Rs) CVD (Rs) Freight for minimum 100km Total

70 8 78 40 3,120 40 250 115 3,525 140 3,665

Dealer margin – 5% (Rs) Subtotal (Rs) VAT (Rs)

183 3,848 481

Landed costs Landed costs (Rs/bag) Source: I-Sec Research

4,329 216

However, repeated Government intervention has created uncertainty as regards sector prospects and cement players themselves have become more cautious while exercising price increases. We believe that the recent rise in various input costs of coal, fly ash, pet coke etc will force cement companies to pass them on to consumers. However, we expect cement companies to desist from aggressive price hikes, as seen in January ’06, despite expected supply shortage in FY09E to avoid Government attention. Consequently, we expect average prices to grow 4% in FY09E and remain flat in FY10E.

18

ICICI Securities

Cement sector, April 21, 2008

Cost pressures a concern, but to be passed on Power and fuel Power and fuel costs constitute 18-22% of cement companies’ revenues. Indian cement companies largely depend on domestic coal, imported coal and pet coke as a source of fuel. Fuel is primarily used in kilns and CPPs. While CIL raised average prices of coal 10-15% in December ’08, international coal and pet coke prices have seen a sharper rise since October ’08 (whence international coal up ~60%). This coupled with hardening of bulk freight rates has resulted in substantial rise in landed cost of imported coal. Cement companies such as ACL, ICL and UTCL use imported coal. Lower cost of captive power for both ACL and UTCL would partly offset impact of fuel costs. ICL has endeavoured to minimise international freight rates via purchase of two bulk freight carriers. Other companies such as SCL, Grasim and JKCL that use pet coke are also likely to face steep rise in fuel costs. However, both Grasim and JKCL will manage offsetting this impact through commissioning of CPPs. Companies such as ACC that have high dependence on domestic coal are likely to face lower cost escalation compared with peers. However, due to the current coal shortage, cement companies are entitled to only 70% of the linkages. For the remaining requirement, they have to purchase the fuel from open markets, where costs are 30-40% higher than linkage coal.

130 115 100 85 70 55 40 Mar-08

Dec-07

Sep-07

Jun-07

Mar-07

Dec-06

Sep-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

Mar-05

25 Dec-04

Coal Spot (Richard Bays SA Index) - US$/te

Chart 12: International coal price movement

Source: Bloomberg

19

ICICI Securities

Cement sector, April 21, 2008 Chart 13: Baltic dry freight index 12000

(Baltic Dry Freight Index)

10000 8000 6000 4000 2000

Mar-08

Nov-07

Jul-07

Apr-07

Dec-06

Aug-06

Apr-06

Dec-05

Aug-05

Apr-05

Dec-04

Aug-04

Apr-04

Dec-03

Aug-03

Apr-03

0

Source: Bloomberg

Freight costs Freight costs constitute 12-18% of cement companies’ revenues and depend on lead distances to markets, freight mix between road, rail & sea as well as proximity to source of raw material such as fly ash. Freight costs have also seen rising trend on account of rising diesel prices. However, companies are planning to split grinding units located closer to key markets or to fly ash sources to reduce impact of higher freight costs. Table 11: Freight mix for cement companies (%) ACC Grasim Ambuja Cement India Cements JK Cement Shree Cement UltraTech Cement Source: CMA, I-Sec Research

Rail 50 47 23 26 22 29 37

Road 50 53 60 74 78 71 52

Sea 17 11

We believe that cost escalations would be easily passed on to consumers, with the scenario of excess supply not likely till FY10E.

Cost comparison – Key cement companies Amongst cement companies in the I-Sec universe, ACC, Ambuja Cement (ACL) and SCL have the lowest per-tonne power & fuel costs. ACC’s lower power & fuel costs are on account of high dependence on domestic coal. SCL uses 100% pet coke that has the least ash content and high calorific value, resulting in higher efficiencies. However, whilst most companies are expected to see higher energy costs in FY09 vis-à-vis FY08, we expect JKCL and UTCL to register lower energy costs per tonne as benefits of captive power start kicking in.

20

ICICI Securities

Cement sector, April 21, 2008 Chart 14: Power fuel costs for key companies (FY08) 850 800 750

(Rs/te)

700 650 600 550 500 450 400 350 ACC

ACL

Grasim

ICL

JKCL

SCL

UTCL

Source: I-Sec Research

SCL has the advantage of the lowest lead distance to markets and, hence, the lowest freight cost per tonne. Usually, regional players (SCL and ICL) have lower freight costs as their markets are spread over a smaller area. However, JKCL’s higher freight costs are on account of higher lead distances to markets and higher share of road freight. Chart 15: Freight costs for key companies (FY08) 800 700

(Rs/te)

600 500 400 300 200 ACC

ACL

Grasim

ICL

JKCL

SCL

UTCL

Source: I-Sec Research

21

ICICI Securities

Cement sector, April 21, 2008

Attractive valuations Poor performance of cement stocks since December ’07 was mainly on account of expectations on price hikes not materialising, fear of oversupply and overall negative market sentiment. Consequently, most stocks have declined 16-25% from their January ’08 levels. Fear of Government intervention has further dampened sentiment in the sector. However, given strong sector fundamentals with demand-supply parity likely in FY10E too, we do not see any risk to cement prices for the next two years. Hence, we feel that the current inexpensive valuations are inexpensive and we are Overweight on the sector. Table 12: Relative valuations Company/price (Rs) ACC 799

Grasim 2,574

Ambuja Cement 113

UltraTech 784

India Cements 180

Shree Cement 1,078

JK Cement 150

Source: I-Sec Research

22

Year CY05 CY06 CY07P CY08E CY09E

Net sales (Rs mn) 32,034 58,035 70,072 78,880 88,065

Adj. PAT (Rs mn) 2,732 10,810 12,640 13,754 14,727

EPS (Rs) 19.6 56.9 66.5 73.2 78.4

P/E (x) 40.7 14.0 12.0 10.9 10.2

EV/Sales (x) 4.9 2.6 2.2 1.9 1.7

EV/E (x) 30.3 9.4 7.9 6.7 6.2

RoCE (%) 18.0 38.2 35.9 33.2 30.3

Reco & EV/te (US$) Sell

FY06 FY07 FY08E FY09E FY10E

101,919 140,952 163,573 194,492 163,573

10,365 19,675 27,436 33,162 36,447

113.0 214.6 299.2 361.7 397.5

22.8 12.0 8.6 7.1 6.5

2.7 2.0 1.8 1.5 1.2

13.0 7.1 5.8 4.6 3.9

17.8 31.0 31.0 30.3 30.1

Buy

CY05 CY06 CY07P CY08E CY09E

26,058 62,683 57,049 62,769 69,745

4,358 15,033 13,047 14,568 15,896

3.2 9.9 8.6 9.6 10.5

35.1 11.4 13.2 11.8 10.8

6.3 2.9 2.8 2.4 2.1

22.8 8.4 7.9 7.0 6.0

15.8 20.7 38.4 34.7 31.6

Sell

FY06 FY07 FY08E FY09E FY10E

32,995 49,108 55,692 67,544 78,683

2,298 7,823 10,373 13,109 15,226

18.5 62.8 83.3 105.3 122.3

42.4 12.5 9.4 7.4 6.4

3.6 2.4 2.1 1.8 1.5

21.1 8.3 6.8 5.4 4.4

12.0 36.0 37.0 37.4 36.0

Buy

FY06 FY07 FY08E FY09E FY10E

15,417 22,552 30,628 38,221 44,710

357 4,788 7,023 7,650 8,852

1.6 20.7 24.0 26.2 30.3

110.8 8.7 7.5 6.9 5.9

3.5 2.7 2.3 1.9 1.6

20.9 8.1 6.2 5.1 4.3

7.9 21.7 27.6 28.6 27.9

Hold

FY06 FY07 FY08E FY09E FY10E

6,948 14,055 19,575 27,490 33,353

396 1,575 2,869 6,099 8,200

11.4 45.2 82.4 175.1 235.4

94.7 23.8 13.1 6.2 4.6

6.0 3.1 2.1 1.3 0.9

18.8 7.3 5.1 3.1 2.2

8.8 17.0 26.7 44.4 44.4

Buy

FY06 FY07 FY08E FY09E FY10E

8,737 12,333 14,901 16,761 21,872

326 1,786 2,926 3,625 4,236

4.7 25.5 41.8 51.8 60.6

32.1 5.9 3.6 2.9 2.5

1.6 1.2 1.0 1.1 0.7

10.3 4.4 3.2 3.2 2.4

13.4 31.4 35.6 32.7 30.5

Buy

165

130

222

141

129

97

101

Cement sector, April 21, 2008

ICICI Securities

Cement companies get divergent valuations based on parameters such as plant location, diversified businesses, efficiently levels and EBITDA margin. Historically, ACL was valued at a premium over peers due to efficiency levels while Grasim always received a conglomerate discount on account of diversified businesses. However, over time, with capacity expansion and foray into new markets, ACL has gradually lost its competitive edge. Hence, we feel that the current valuation premium to peers is unjustified. Similarly, we believe that companies (such as JKCL and UTCL) that have been registering sustainable improvement in efficiencies are likely to get re-rated. Further, current valuations of SCL do not seem to factor its high efficiency levels.

We prefer stocks with volume upside and/or cost savings Our expectation of 4% and 0% growth in average realisations for the next two years would mean that companies that are likely to show strong volume growth and/or significant cost savings would register higher earnings growth. We expect Grasim, UTCL and SCL to report higher volumes from fresh capacities commissioned recently, while UTCL and JKCL would benefit from lower cost of captive power. ACC and ACL are expected to register lower earnings growth on account of volume growth restriction, although impact of rising costs would partly be offset by captive power capacities. ACC and ACL are most expensive in the I-Sec Cement universe and, hence, we initiate coverage on them with a SELL. We initiate coverage on Grasim, UTCL, JKCL and SCL with a BUY, with Grasim and SCL being our top picks in the sector.

23

Cement sector, April 21, 2008

ICICI Securities

Key risks Estimates – Incremental supply and demand Our FY09 and FY10 incremental supply estimates are based on our interaction with cement equipment suppliers and are at variance with claims of cement companies. Should large number of capacities get commissioned before schedule, an oversupply could result in pricing pressures from FY09 itself. Further, with housing and infrastructure being key demand drivers, significant slowdown in infrastructure project implementation could affect demand estimates.

Government pressure We have assumed a conservative 4% and 0% growth in prices for FY09E and FY10E respectively, despite our belief of supply shortage during the period. We expect cement companies to avoid aggressive price hikes to evade Government intervention. However, given the current inflationary pressures, the Government may compel cement players to cut prices or avoid future price increases. Such a scenario (such as a price freeze in March ’07) could impact our forecast as well as dampen valuations and sentiment.

Input cost pressure While cement companies have been facing sharp cost increases since the past six months, they have recently begun passing on the increases via price hikes. Our forecast assumes fuel prices at the current high levels. However, should price of pet coke and international coal rise substantially from current levels, inability of effecting price hikes from fear of Government intervention could put severe pressure on margins.

24

Cement sector, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Relative valuations..................................................................................................5 Table 2: Housing demand projection ..................................................................................11 Table 3: Road projects under NHDP ..................................................................................12 Table 4: Demand from power projects................................................................................13 Table 5: Demand from infrastructure ..................................................................................13 Table 6: Sector-wise projected cement demand (FY08-12E).............................................14 Table 7: Demand/supply .....................................................................................................15 Table 8: Regional demand/supply scenario........................................................................15 Table 9: Calendar of events (since January ’07) ................................................................17 Table 10: Landed cost of cement from Pakistan ................................................................18 Table 11: Freight mix for cement companies......................................................................20 Table 12: Relative valuations..............................................................................................22

Charts Chart 1: Utilisation versus cement prices .............................................................................4 Chart 2: Key cement equipment suppliers and market share (excl. China) .........................6 Chart 3: Global contracted kiln capacity trend (excl. China).................................................7 Chart 4: Order inflow and backlog trend of key companies..................................................7 Chart 5: Expected incremental supplies over the next three years ......................................8 Chart 6: Production and consumption trend .........................................................................9 Chart 7: GDP versus cement demand growth ....................................................................10 Chart 8: Share of the 25-44yr age group in total population...............................................11 Chart 9: Infrastructure spending in X & XI FYPs ................................................................12 Chart 10: Rising utilisation levels and prices ......................................................................16 Chart 11: All-India average cement price trend ..................................................................16 Chart 12: International coal price movement ......................................................................19 Chart 13: Baltic dry freight index.........................................................................................20 Chart 14: Power fuel costs for key companies (FY08) .......................................................21 Chart 15: Freight costs for key companies (FY08) .............................................................21

25

Cement sector, April 21, 2008

ICICI Securities

This page has been intentionally left blank

26

Equity Research INDIA

April 21, 2008 BSE Sensex: 16481

ACC Lacking strength

Cement

Rs799

Reason for report: Initiating coverage

Shareholding pattern Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

SELL

Sep '07 43.0

Dec '07 43.0

Mar '08 43.0

36.3 1.8 15.5 18.8 20.7

36.4 2.0 15.8 18.4 20.6

36.2 3.1 17.8 15.1 20.8

ACC, the largest cement player in India, will likely witness muted volume growth in the next two years. While the company is expected to add ~1.5mnte capacity towards end-CY08E, larger expansions at Wadi and Chanda (3mnte each) would be operational only in H2CY09E and CY10E respectively. Overall, ACC will post slower earnings growth versus peers. At the current market price, it is amongst the most expensive stocks in the I-Sec Cement universe. We initiate coverage with SELL rating and Rs769/share price target in the next 12-18 months. f Muted topline growth. ACC plans capacity additions of 1.28mnte at Bargarh, Orissa and 0.22mnte at Madukkarai, Tamil Nadu, both to be operational by endCY08. While these capacities are small, the benefits would only accrue in CY09. Further, benefits of larger capacity additions at Wadi and Chanda would accrue mainly in CY10E. Hence, the company’s topline growth will face capacity constraints.

Price chart

f Lower impact of rising fuel costs. ~90% of ACC’s fuel requirements are met through domestic coal, for which price hikes are much lower than international coal or pet coke. However, the company will need to buy 20% of its requirement from open market at higher rates. We believe that the impact from this will be lower than peers with higher share of pet coke or imported coal. Consequently, ACC could witness margin expansion, primarily aided by moderate realisations.

1,400

(Rs)

1,200 1,000 800

Jan-08

Apr-08

Nov-07

Sep-07

Jun-07

Apr-07

600

f Earnings slowdown. We expect ACC to post earnings CAGR of 8% in the next two years, mainly owing to volume constraints and higher fixed costs. Strong free cashflow (FCF) of over Rs14bn would help lower D/E to 0.4x in CY08E and further to 0.3x in CY09E. f Expensive valuations. ACC trades at CY08E & CY09E P/E of 10.9x and 10.2x respectively and EV/te of US$165. The company is the second most expensive stock in the I-Sec Cement universe and, given the muted earnings growth, we initiate coverage with SELL and fair value of Rs769/share in the next 12-18 months.

Market Cap

Rs863.3bn/US$21.6bn

Reuters/Bloomberg

ACC.BO/ACC IN

Shares Outstanding (mn) 52-week Range (Rs)

1315/608

Free Float (%) FII (%)

Novonil Guha [email protected] +91 22 6637 7385

188

Year to Dec

CY06

CY07P

CY08E

CY09E

Revenue (Rs mn)

58,035

70,072

78,880

88,065

Net Income (Rs mn)

10,810

12,640

13,754

14,727

56.9

66.5

73.2

78.4

190.0

16.9

10.0

7.1

EPS (Rs)

57.0

% Chg YoY

15.1

P/E (x)

14.0

12.0

10.9

10.2

CEPS (Rs)

71.1

81.5

88.9

96.4

EV/E (x)

9.4

7.9

6.7

6.2

1.0

2.5

2.5

2.6

Daily Volume (US$'000)

16,730

Absolute Return 3m (%)

(7.4)

Absolute Return 12m (%)

(21.9)

Dividend Yield

Sensex Return 3m (%)

(13.3)

RoCE (%)

38.2

35.9

33.2

30.3

Sensex Return 12m (%)

(18.8)

RoE (%)

41.0

34.7

29.7

26.2

Please refer to important disclosures at the end of this report

ICICI Securities

ACC, April 21, 2008

Largest player, but volume growth muted While ACC added ~1.7mnte capacity in CY07 mainly through de-bottlenecking, it would be adding another ~1.5mnte in CY08. Capacity additions in CY08 are not large and will materialise at end year. Consequently, volume growth in CY08 is expected to be benign as benefits from capacity augmentation will largely accrue in CY09. Table 1: Capacity addition plans CY07 0.31 0.90 0.50

Tikaria (Uttar Pradesh) Lakheri (Rajasthan) Kymore (Madhya Pradesh) Bargarh (Orissa) Madukkarai (Tamil Nadu) Wadi (Karnataka) Chanda (Maharashtra) Total Source: Company data

CY08E

CY09E

CY10E

1.28 0.22 3.00

1.71

1.50

3.00

3.00 3.00

ACC’s 3mnte expansion at Wadi and its split grinding unit will likely be commissioned only in mid-CY09E. At present, most capacity additions are lagging behind their original timelines and even a three-month delay in this project would erode substantial volume benefits for CY09E. However, in our forecasts, we have assumed that the plant will be commissioned as per schedule.

Continues to be largest player in India Table 2: Key markets and market share Market share (%)

% of total despatches

9-yr consumption CAGR (%)

Share of total consumption (%)

20.2 1.9 30.9 6.50 45.7

19.8 1.0 10.9 2.0 4.6

8.9 9.9 6.0 12.2 14.4

12.2 6.1 4.4 3.8 1.3

35.8 14.0

0.8 13.7

0.7 7.2

6.8 12.2

2.6 16.0 11.9 4.7

1.8 9.6 4.5 3.1

7.4 11.2 6.8 8.5

8.6 7.5 4.7 8.2

15.9 20.5 18.9

5.9 7.9 4.5

6.7 10.1 10.9

4.6 4.8 3.0

11.0

6.2

9.6

7.0

Total 12.4 96.3 Source: Cement Manufacturers Association (CMA), I-Sec Research

8.1

100.0

North Uttar Pradesh & Uttaranchal Rajasthan Punjab Haryana Himachal Pradesh West Goa Maharashtra South Tamil Nadu Karnataka Kerala Andhra Pradesh East West Bengal Bihar & Jharkhand Orissa Central Madhya Pradesh and Chhattisgarh

28

ICICI Securities

ACC, April 21, 2008

ACC remains the largest cement player with pan-India presence. The company’s allIndia presence helps it insulate itself from regional variations in demand and prices. However, ACC’s market share has been eroding gradually (excluding FY04, when it acquired IDCOL Cement) due to slower pace of capacity additions compared with peers. We expect market share erosion to continue in the next couple of years till Wadi and Chanda expansions go onstream. Chart 1: Market share trends in key regions All India

22

Norh

East

20

(%)

18 16 14 12 10 FY03

FY04

FY05

FY06

FY07

Source: CMA, I-Sec Research

29

ICICI Securities

ACC, April 21, 2008

Lower impact of fuel costs versus peers ~90% of ACC’s coal requirements are sourced domestically. Imported coal is primarily used at its 1mnte plant in Tamil Nadu. However, Coal India (CIL) has raised coal prices by an average of 10-15% in December ’07. Further, of the total domestic coal consumed, ~20-25% has to be sourced from open markets (due to shortage of domestic coal), where prices are ~25-30% higher than CIL rates. This exposes the company to significant variations in the coal cost depending on the share of coal purchased from open markets. However, we believe that ACC’s fuel costs are going to be more benign than most of its peers who use imported coal or pet coke.

Savings in power costs unlikely ~70% of ACC’s power requirements are met captively. This share has risen post commissioning of a 25MW captive power plant (CPP) at Lakheri, Rajasthan along with capacity augmentation in CY07. Another 30MW CPP in Orissa and the Bargarh expansion is expected by end CY08 following which, we expect share of captive power to be ~82%. ACC would continue to purchase power from the grid for its Himachal Pradesh plant as it is inexpensive hydro power. We believe CPP additions are too small to have substantial impact on power cost savings. Chart 2: Power and fuel costs trend Pow er & Fuel Average per unit cost of pow er (RHS)

800 700

3.5 3.0

600 (Rs/te)

2.0

400 1.5

300

1.0

200

0.5

100 0

0.0 9M2006

CY06

Source: Company data, I-Sec Research

30

CY07P

CY08E

CY09E

(Rs/kWh)

2.5

500

ICICI Securities

ACC, April 21, 2008

Sharp surge in SG&A, likely to sustain During CY07, ACC’s administrative and other expenses surged sharply due to various management initiatives such as marketing excellence, ERP implementation and other HR initiatives. While some costs (such as part of ERP-implementation costs) are onetime expenses, we expect other costs to remain high without any commensurate financial benefit. Chart 3: SG&A expenses SG&A expenses

1,100

SG&A (RHS)

5,000

1,000

4,500

900

4,000

800

3,500

700

3,000

600

2,500

500

2,000

400

1,500

(Rs/te)

(Rs mn)

5,500

300 1Q06

2Q06

3Q06

4Q06

1Q07

2Q07

3Q07

4Q07

Source: Company data, I-Sec Research

31

ICICI Securities

ACC, April 21, 2008

Earnings growth unimpressive Table 3: Performance trend and forecast assumptions (’000 te} CY06 19,909 18,733 94.1 18,357 45.4 2,893 32.1

Capacity Production Capacity utilisation (%) Sales Growth (%) Realisations (Rs/te) Growth (%) Source: I-Sec Research

CY07 21,619 19,876 91.9 19,876 8.3 3,299 14.0

CY08E 23,039 21,267 92.3 21,267 7.0 3,480 5.5

CY09E 26,039 23,819 91.5 23,819 12.0 3,480 -

CY10E 29,039 26,201 90.2 26,201 10.0 3,236 (7.0)

Moderate topline growth. We expect ACC to post topline CAGR of 12% over the next two years. The company’s volumes are likely to improve 7% and 12% in CY08E and CY09E respectively. We expect ACC to add just 1.5mnte as of end-CY08E and another 3mnte at Wadi by mid-CY09E. Hence, substantial benefits from capacity additions are likely to come only in CY09E, resulting in lower volume growth in CY08E. We have assumed average realisations to grow 5.5% in CY08E and remain flat for CY09E. Chart 4: Sales, EBITDA and EBITDA margin movement Net sales

EBITDA

EBITDA Margin (RHS)

30

90,000

28

80,000

26

70,000

24

60,000

22

50,000

20

40,000

18

30,000

16

20,000

14

10,000

12

0

(%)

(Rs mn)

100,000

10 9M2006

CY06

CY07P

CY08E

CY09E

Source: Company data, I-Sec Research

Margin improvement in CY08. Rising fuel cost would have relatively lower impact on ACC’s operations versus peers as 90% of the company’s coal requirements are met from domestic sources. While cost of international coal has risen ~50-60%, domestic coal prices surged just 10-15% in December ’07. While ACC will also have to purchase coal from the open markets for ~20% of its requirements, the net increase in the cost of fuel for the company would be lower than peers using international coal or pet coke. Hence, the expected growth in realisations for CY08E would more-thanoffset impact of higher input costs (coal, fly ash etc) and SG&A costs. Consequently, we expect 120bps rise in margins for CY08E. In CY09E, however, margins are expected to decline 112bps on account of flat realisations. ACC’s EBITDA/te is expected to improve to Rs1,060 in CY08E from Rs965 in CY07, before falling to Rs1,015 in CY09E.

32

ICICI Securities

ACC, April 21, 2008

Slower topline growth, margin contraction in CY09 and higher interest costs would result in moderate earnings growth of 8% in the next two years. Chart 5: Key costs and EBITDA/te 1,200

Pow er & Fuel

Freight

EBITDA/tonne

1,000

(Rs/te)

800 600 400 200 0 9M2006

CY06

CY07P

CY08E

CY09E

Source: I-Sec Research

Chart 6: FCF and D/E Free cashflow

1.5

D/E (RHS)

14,000

1.0

9,000

0.5

4,000

0.0

(1,000)

-0.5

(x)

(Rs mn)

19,000

(6,000)

-1.0 9M2006

CY06

CY07P

CY08E

CY09E

Source: I-Sec Research

ACC is likely to generate FCF in excess of Rs14bn in the next two years despite substantial capex of ~Rs29bn for Wadi (3mnte) and Chanda (3mnte). Therefore, we expect ACC’s D/E to remain benign at 0.4x & 0.3x in CY08E & CY09E respectively.

33

ICICI Securities

ACC, April 21, 2008 Chart 7: RoCE and RoE trends 45 RoCE

RoE

40

(%)

35

30

25

20 9M2006

CY06

CY07P

CY08E

CY09E

Source: I-Sec Research

ACC’s return ratios are expected to witness a declining trend, mainly owing to earnings growth slowdown and large capex plan (6mnte), the returns from which are only expected H2CY09E onwards.

34

ICICI Securities

ACC, April 21, 2008

Expensive valuations At the current market price, ACC is valued at CY08E & CY09E P/E of 10.9x and 10.2x and EV/E of 6.7x & 6.2x respectively. On EV/te, the company is valued at US$165. ACC is among the most expensive companies under our coverage universe (second only to Ambuja Cement). However, with volume growth likely to be restricted, cost escalation will result in lower earnings growth in the next two years. Consequently, we believe that the current valuations are expensive. Our target price of Rs769 assumes CY08E P/E & EV/E of 10.5x & 6.5x respectively. We initiate coverage with SELL. Chart 8: Rolling P/E bands 1,600 1,400 18x

1,200

14x

(Rs)

1,000 800

10x

600 400 200 Apr-08

Dec-07

Sep-07

Jun-07

Feb-07

Jul-06

Nov-06

Apr-06

Dec-05

Sep-05

Feb-05

May-05

Jul-04

Nov-04

Apr-04

Dec-03

Sep-03

Feb-03

May-03

Jul-02

Oct-02

Apr-02

0

Source: Bloomberg, I-Sec Research

Chart 9: Rolling EV/E bands 400,000 350,000

(Rs mn)

300,000

15x

250,000 200,000

10x

150,000 5x

100,000 50,000

Apr-08

Oct-07

Apr-07

Oct-06

Apr-06

Oct-05

Apr-05

Oct-04

Apr-04

Oct-03

Apr-03

Oct-02

Apr-02

0

Source: Bloomberg, I-Sec Research

35

ICICI Securities

ACC, April 21, 2008

Financial Summary Table 4: Profit and Loss Statement

Table 6: Cash Flow Statement

(Rs mn, year ending Dec 31)

(Rs mn, year ending Dec 31)

CY06 Operating Revenues (Sales) 58,035 of which Domestic 58,035 Operating Expenses 41,803 EBITDA 16,232 % margins 28 Depreciation & Amortisation 2,543 Gross Interest 752 Other Income 1,560 Recurring PBT 14,498 Add: Extraordinaries 1,508 Less: Taxes 3,688 - Current tax 3,740 - Deferred tax (52) Less: Minority Interest Net Income (Reported) 12,318 Recurring Net Income 10,810 Source: Company data, I-Sec Research

CY07 70,072 70,072 50,897 19,175 27 2,668 808 1,857 17,556 1,748 4,917 4,565 351 14,388 12,640

CY08E 78,880 78,880 56,347 22,533 29 2,950 974 1,920 20,529 6,774 5,337 1,437 1 13,754 13,754

CY09E 88,065 88,065 63,898 24,168 27 3,373 1,062 2,248 21,980 7,254 5,715 1,539 2 14,727 14,727

Table 5: Balance Sheet (Rs mn, year ending Dec 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Total Assets

CY06

CY07

CY08E

CY09E

19,683 6,202

21,494 6,202

23,869 6,822

26,471 7,504

14,890 4,792 5,035 789 4,247 29,225

12,790 8,704 7,147 780 6,367 36,661

13,074 10,795 8,778 819 7,959 34,961

13,396 13,075 10,410 860 9,551 47,188

4,734 43,787

5,920 58,432

16,433 70,967

10,416 81,089

13,633 3,271 1,878 10 39,656 7 41,527 58,432

16,532 3,435 1 1,878 10 49,127 5 51,000 70,967

16,252 3,607 2 1,878 10 59,356 4 61,230 81,089

Liabilities Borrowings 9,160 Deferred Tax Liability 3,207 Minority Interest Equity Share Capital 1,878 Face value per share (Rs) 10 Reserves & Surplus* 29,552 Less: Misc. Exp n.w.o. 9 Net Worth 31,420 Total Liabilities 43,787 Source: Company data, I-Sec Research *excluding revaluation reserves

36

CY06 Operating Cash flow 12,744 Working Capital changes 461 Capital Commitments (4,358) Net Operating FCF 8,848 Investing Activities (633) Issue of Share Capital 22 Buyback of shares Inc(Dec) in Borrowings (2,602) Dividend paid (1,713) Extraordinary Items 1,508 Chg. in Cash & Bank 5,174 Source: Company data, I-Sec Research

CY07 12,498 (2,607) (11,281) (1,391) (264) 1 4,474 (4,283) 1,748 -

CY08E 16,470 (1,719) (11,802) 2,948 328 2,899 (4,283) 620

CY09E 17,676 (1,883) (9,623) 6,170 656 (280) (4,498) 682

Table 7: Key Ratios (Year ending Dec 31) CY06

CY07 CY08E CY09E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

65.6 56.9 71.1 8.0 167.3

76.6 66.5 81.5 20.0 221.1

73.2 73.2 88.9 20.0 271.5

78.4 78.4 96.4 21.0 326.0

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

81.2 213.1 295.7 190.0 201.6

20.7 18.1 16.9 16.9 14.6

12.6 17.5 8.8 10.0 9.1

11.6 7.3 7.1 7.1 8.3

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

14.0 11.2 4.8 9.4 2.6 11.5

12.0 9.8 3.6 7.9 2.2 15.3

10.9 9.0 2.9 6.7 1.9 10.3

10.2 8.3 2.5 6.2 1.7 9.5

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (x) Receivables (days) Payable (days) D/E Ratio (x)

15.4 4.3 10.8 22.8 (0.0) 4.9 11.7 71.0 0.4

15.0 5.0 10.6 25.0 0.0 5.2 11.3 58.3 0.4

14.6 5.0 9.4 33.0 0.1 4.8 12.0 50.0 0.4

14.6 5.0 10.2 33.0 0.1 4.7 12.5 44.1 0.3

Profitability Ratios (%) Rec. Net Income Margins 18.1 RoCE 38.2 RoNW 41.0 Dividend Payout 14.1 Source: Company data, I-Sec Research

17.6 35.9 34.7 30.1

17.0 33.2 29.7 27.3

16.3 30.3 26.2 26.8

ICICI Securities

ACC, April 21, 2008

Index of Tables and Charts Tables Table 1: Capacity addition plans.........................................................................................28 Table 2: Key markets and market share.............................................................................28 Table 3: Performance trend and forecast assumptions ......................................................32 Table 4: Profit and Loss Statement ....................................................................................36 Table 5: Balance Sheet.......................................................................................................36 Table 6: Cash Flow Statement............................................................................................36 Table 7: Key Ratios.............................................................................................................36

Charts Chart 1: Market share trends in key regions.......................................................................29 Chart 2: Power and fuel costs trend ...................................................................................30 Chart 3: SG&A expenses....................................................................................................31 Chart 4: Sales, EBITDA and EBITDA margin movement ...................................................32 Chart 5: Key costs and EBITDA/te .....................................................................................33 Chart 6: FCF and D/E .........................................................................................................33 Chart 7: RoCE and RoE trends...........................................................................................34 Chart 8: Rolling P/E bands..................................................................................................35 Chart 9: Rolling EV/E bands ...............................................................................................35

37

ACC, April 21, 2008

ICICI Securities

This page has been intentionally left blank

38

Equity Research INDIA

April 21, 2008 BSE Sensex: 16481

Ambuja Cement Shedding sheen

Cement

Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Sep '07 37.8

Dec '07 46.5

Mar '08 46.5

44.8 2.6 14.6 27.6 17.4

37.6 0.6 13.5 23.5 16.0

36.7 0.3 13.4 23.1 16.8

160 150 140 130 120 110 Apr-08

Jan-08

Nov-07

Sep-07

100 Jun-07

Ambuja Cement (ACL), which previously featured amongst the most efficient cement companies, has gradually lost its cost advantage on account of expansion and foray into new markets. With large capacity addition (6mnte) expected to come onstream only in mid-to-late CY09, capacity constraints and cost pressure would slowdown earnings growth in the next two years. At the current market price, ACL is the most expensive stock in the I-Sec Cement universe and we believe these premium valuations are unjustified. We initiate coverage with SELL rating and price target of Rs109/share. f Topline growth subdued. ACL’s expansions in Bhattapara, Chhattisgarh and Rauri (in Himachal Pradesh) at 3mnte each are expected to be operational in mid-to-late CY09. Though the company is adding a 4mnte grinding unit, increase in output would be insignificant. Consequently, capacity constraints would slowdown topline growth.

Price chart

Apr-07

Rs113

Reason for report: Initiating coverage

Shareholding pattern

(Rs)

SELL

f Cost pressure to affect margins. ACL depends on imported coal for ~40% of its fuel requirements, the cost of which has risen sharply. ACL plans to commission ~178MW of captive power by end-CY08, of which 60MW has already been commissioned in Gujarat. However, impact of imported coal would be partly offset by the commissioning of captive power, resulting in margin contraction. f Earnings growth slowdown. We expect ACL’s earnings CAGR at 10% in the next two years, mainly owing to cost escalations and volume constraints. ACL should generate free cashflows (FCFs) of ~Rs18bn despite large capex plans. We expect ACL’s CY08E D/E to be benign at 0.11x but further dip to 0.08x in CY09E. f Expensive valuations. ACL trades at CY08E & CY09E P/E of 11.8x & 10.8x and EV/te of US$222 ACL is the most expensive stock in the I-Sec Cement universe and the current premium to peers is unjustified. Consequently, we initiate coverage with SELL rating and Rs109/share fair value.

Market Cap

Rs171.6bn/US$4.3bn

Reuters/Bloomberg

ABUJ.BO/ACEM IN

Shares Outstanding (mn) 52-week Range (Rs)

161/96

Free Float (%) FII (%)

Novonil Guha [email protected] +91 22 6637 7385

1,517

Year to Dec

CY06

CY07P

CY08E

CY09E

Revenue (Rs mn)

62,683

57,049

62,769

69,745

Net Income (Rs mn)

15,033

13,047

14,568

15,896

9.9

8.6

9.6

10.5

207.4

(13.2)

11.7

9.1

EPS (Rs)

53.5

% Chg YoY

23.1

P/E (x)

11.4

13.2

11.8

10.8

12.1

10.2

11.3

12.5

Daily Volume (US$'000)

8,261

CEPS (Rs)

Absolute Return 3m (%)

(14.3)

EV/E (x)

8.4

7.9

7.0

6.0

Absolute Return 12m (%)

(23.0)

Dividend Yield

1.4

1.5

1.5

1.5

Sensex Return 3m (%)

(13.3)

RoCE (%)

20.7

38.4

34.7

31.6

Sensex Return 12m (%)

(18.8)

RoE (%)

35.4

31.7

26.6

23.2

Please refer to important disclosures at the end of this report

ICICI Securities

Ambuja Cement, April 21, 2008

New capacity addition only in CY09; volume growth muted ACL is currently implementing two projects that are expected to be commissioned only in CY09 – 3mnte plant at Bhatapara, Chhattisgarh, likely to be operational by Q2CY09 and 3mnte plant at Rauri, Himachal Pradesh, expected to be commissioned in Q4CY09. In the interim, ACL is expected to set up four grinding units at Surat, Panipat, Ahmedabad and Dadri totalling 5mnte. Two additional grinding units at Nalagarh (Himachal Pradesh, 1.5mnte) and Barh (Bihar, 1mnte) are scheduled to be operational only in CY10. These grinding units are strategically located close to power plants which will allow cheaper sourcing of fly ash. Table 1: Capex plans Capex plans Rajasthan (Clinker) Farakka, West Bengal (Grinding) Rourkee, Uttar Pradesh (Grinding) Surat, Gujarat (Grinding) Dadri, Uttar Pradesh (Grinding) Panipat, Haryana (Grinding) Rauri, Himachal Pradesh (Clinker) Bhatapara, Chhattisgarh, (Clinker) Ahmedabad, Gujarat (Grinding) Total Source: Company data

CY07 0.4 1.0 1.0

CY08

CY09

1.0 1.5 1.0

2.4

2.0

3.0 3.0 1.5 7.5

Given that substantial capacities are expected only in CY09, volume growth in CY08 is likely to be muted. Even for CY09, only part of the benefit from new capacities will flow in as the plants will be operational during the course of the year. While ACL has already commissioned two grinding units in CY07 and would commission a 4.5mnte grinding unit in CY08, these will only marginally enhance production capacity though help in freight and logistic benefits. ACL is likely to see market erosion till CY09. Chart 1: Market share trend 22

All India

Norh

West

East

20 18

(%)

16 14 12 10 8 6 FY03

FY04

FY05

Source: Cement Manufacturers Association (CMA), I-Sec Research

40

FY06

FY07

ICICI Securities

Ambuja Cement, April 21, 2008

Previously, ACL primarily focused on western and northern regions. However, with the acquisition of Ambuja Cement Eastern (erstwhile Modi Cement) and its subsequent merger with ACL, the company now has strong foothold in the East. Since FY06, only the East has seen market share improvement. Table 2: Key markets and market share Market share (%)

% of total despatches

9-yr consumption CAGR (%)

Share of total consumption (%)

North Uttar Pradesh & Uttaranchal Rajasthan Punjab Haryana Himachal Pradesh Chandigarh (UT)

3.5 14.0 28.7 14.1 48.3 20.6

5.0 8.7 12.7 5.3 6.1 0.5

8.9 9.9 6.0 12.2 14.4

12.2 6.1 4.4 3.8 1.3 0.2

West Gujarat Maharashtra

19.7 19.7

13.5 24.4

4.5 7.2

6.8 12.2

8.9

6.3

9.6

7.0

19.2 8.1 3.8

9.0 0.6 1.2

6.7 7.4 10.9

4.64 0.70 2.99

9.88

93.2

8.1

100.0

Central Madhya Pradesh and Chhattisgarh East West Bengal Assam Orissa Total Source: CMA, I-Sec Research

Efficiencies to be affected by rising fuel cost ACL was previously amongst the most efficient companies in India due to use of captive and cheap power as well as lower freight costs from sea transport. However, over the years, with rising diesel cost, capacity expansion in new markets, reduction in share of sea freight and increase in average lead distances, the company has gradually lost its key cost advantages. To address the rising diesel cost concern and ensure reliability and quality of power, ACC is currently implementing fresh thermal capacities totalling 178MW. We expect average Re1/unit savings from captive power plant (CPP) operations. Table 3: Capex on captive power Location Ambujanagar (Gujarat) Ambujanagar (Gujarat) Ambujanagar (Gujarat) Bhattapara (Chhattisgarh) Bhatapara (Chhattisgarh) Rabariyawas (Rajasthan) Chandrapur (Maharashtra) Ropar (Punjab) Total Source: Company data, I-Sec Research

Power (MW) 30 30 30 15 33 19 15 6 178

Time of commissioning Q1CY07 Q4CY07 Q4CY08 Q2CY08 Q4CY08 Q1CY08 Q1CY08 Q2CY07

41

ICICI Securities

Ambuja Cement, April 21, 2008 Chart 2: Power and fuel costs trend Pow er & Fuel Average per unit cost of pow er (RHS)

3.5

600

3.0

500

2.5

400

2.0

300

1.5

200

1.0

100

0.5

0

(Rs/kWh)

(Rs/te)

700

0.0 FY05

CY06

CY07P

CY08E

CY09E

Source: Company data, I-Sec Research

While the commissioning of CPPs is likely to bring down the unit cost of power in the next two years, it would only partly offset the impact of rising fuel costs. ACL imports ~40% of its total coal requirements at present and the sharp rise in international coal prices along with bulk freight rates is bound to affect overall energy costs. Further, power plants located in Gujarat would have to use international coal for operations, thereby reducing potential savings from captive power. Chart 3: Key cost trend 1,400

Pow er & Fuel

Freight

EBITDA/te

1,200

(Rs/te)

1,000 800 600 400 200 0 FY05

CY06

Source: Company data, I-Sec Research

42

CY07P

CY08E

CY09E

ICICI Securities

Ambuja Cement, April 21, 2008

Lower earnings growth versus peers Table 4: Performance trend and forecast assumptions (’000 te) CY06 23,450 22,633 96.5 22,602 77.7 3,102 30.5 2,503 42.6

Capacity Production Capacity utilisation (%) Sales Growth (%) Realisation (Rs/te) Growth (%) Exports Growth (%) Source: I-Sec Research

CY07P 17,050 16,839 98.8 16,839 (25.5) 3,842 23.9 1,600 (36.1)

CY08E 17,300 17,512 101.2 17,512 4.0 4,071 6.0 1,401 (12.4)

CY09E 23,300 19,439 83.4 19,439 11.0 4,080 0.2 1,361 (2.9)

CY10E 23,300 22,355 95.9 22,355 15.0 3,806 (6.7) 1,565 15.0

Muted topline growth. We expect ACL to face volume growth constraints in CY08 and in some part of CY09. While the company’s grinding units at Surat and Panipat will help achieve freight and logistic benefits, incremental volumes will only flow in from clinkerisation units at Bhatapara and Rauri that are expected to be commissioned in H2CY09. Consequently, we expect volume growth of 4% and 11% in CY08E and CY09E respectively. This coupled with 5.5% higher realisations in CY08E and flat realisation growth in CY09E will result in revenue growth of 10.6% in the next two years. Chart 4: Sales, EBITDA and EBITDA margin movement 80,000

Net sales

EBITDA

EBITDA Margin (RHS)

70,000

40 35 30

50,000 40,000

25

30,000

(%)

(Rs mn)

60,000

20

20,000 15

10,000 0

10 FY05

CY06

CY07P

CY08E

CY09E

Source: Company data, I-Sec Research

Captive power to partly offset rising input costs. The rising cost of international coal along with bulk freight rates is bound to affect ACL’s efficiencies (~40% of the company’s coal requirements are imported). However, the company is implementing ~178MW of CPPs (60MW already commissioned), which should be commissioned by end-CY08 and help partly offset the impact of rising imported coal. However, the 60MW plant, which has already been commissioned, would rely on imported coal as fuel, thereby minimising the benefits of captive power.

43

ICICI Securities

Ambuja Cement, April 21, 2008

With Holcim acquiring management control over ACL, the management is implementing various programmes across the company, which include HR-related programmes and building robust business systems & processes through ERP implementation. These initiatives would result in higher SG&A expenses without an immediate financial benefit. Consequently, we expect ~92bps decline in EBITDA margin to 34.8% in CY08E and further 32bps decline to 34.4% in CY09E. Chart 5: EBITDA/te 1,400 1,200

(Rs/te)

1,000 800 600 400 200 0 FY05

CY06

CY07P

CY08E

CY09E

Source: Company data, I-Sec Research

Lower topline growth coupled with cost pressures will slowdown earnings growth for ACL in the next two years. Consequently, we expect ACC to post bottomline CAGR of 10% in the next two years, much lower than most of peers. ACL, which exports ~7-8% of its output at present, is likely to be affected by the recent export ban. However, the impact could be marginal as export quantities are expected to be absorbed by the western markets, given the acute supply shortage expected in FY09. Further, domestic realisations, which are ~Rs250/te higher than export rates, are likely to part compensate for the loss of export volumes. While the export ban is unlikely to be a long-term measure, ACL’s earnings would be affected ~2-6% if the ban continues through the year. Chart 6: FCF and D/E Free cashflow

18,000

D/E (RHS)

16,000

0.7

14,000

0.6 0.5

10,000 0.4

8,000

0.3

6,000 4,000

0.2

2,000

0.1

0

0.0 FY05

Source: Company, I-Sec Research

CY06

CY07P

CY08E

CY09E

(x)

(Rs mn)

12,000

44

0.8

ICICI Securities

Ambuja Cement, April 21, 2008

ACL is a cash-rich company and a significant part of its capex (till CY09) will be largely met via internal accruals. Hence, despite the current capex plan, the company is likely to generate FCFs of ~Rs17.9bn in the next two years. The company’s D/E would be as low as 0.11x in CY08E and further decline to 0.08x in CY09E. ACL is currently net cash positive and will continue to remain so in CY09E. ACL’s return ratios are expected to decline, mainly due to significant capex, the benefits of which can be expected only after commissioning of the 6mnte capacity post H2CY09E. Chart 7: RoCE and RoE trends 45

RoCE

RoE

40

(%)

35 30 25 20 15 FY05

CY06

CY07P

CY08E

CY09E

Source: Company data, I-Sec Research

45

ICICI Securities

Ambuja Cement, April 21, 2008

Expensive valuations At the current market price, ACL is trading at CY08E & CY09E P/E of 11.8x & 10.8x and EV/E of 7.0x and 6.0x respectively. On EV/te, the company is valued at US$222. ACL is the most expensive company under the I-Sec Cement universe. Historically, the company has been valued at a premium to peers given its high efficiency and freight cost advantages. ACL is also likely to see volume growth restriction in the next two years and only part of its cost escalations would be offset by captive power. Over the years, owing to rising fuel costs, expansion and foray in new markets, the company has gradually lost its key cost advantages. Consequently, we believe that current substantial premiums to peers are likely to shrink. Our target price of Rs109 assumes CY08E P/E and EV/E of 11.5x and 6.9x respectively. We initiate coverage with SELL. Chart 8: Rolling P/E bands 200 18x

180 160 140

13x

(Rs)

120 100 80 8x

60 40 20

Apr-08

Dec-07

Jul-07

Mar-07

Nov-06

Jun-06

Feb-06

Oct-05

May-05

Jan-05

Aug-04

Apr-04

Dec-03

Aug-03

Mar-03

Nov-02

Jul-02

0

Source: Bloomberg, I-Sec Research

Chart 9: Rolling EV/E bands 300,000 12x 250,000 9x

(Rs mn)

200,000 150,000

6x

100,000 50,000

Source: Bloomberg, I-Sec Research

46

Apr-08

Oct-07

Apr-07

Oct-06

Apr-06

Oct-05

Apr-05

Oct-04

Apr-04

Oct-03

Apr-03

Oct-02

Apr-02

0

ICICI Securities

Ambuja Cement, April 21, 2008

Financial Summary Table 5: Profit and Loss Statement

Table 7: Cash Flow Statement

(Rs mn, year ending Dec 31)

(Rs mn, year ending Dec 31)

CY06 Operating Revenues (Sales) 62,683 of which Exports 5,146 of which Domestic 57,537 Operating Expenses 41,352 EBITDA 21,331 % margins 34 Depreciation & Amortisation 3,261 Gross Interest 1,132 Other Income 1,479 Recurring PBT 18,416 Add: Extraordinaries Less: Taxes 3,384 - Current tax 3,353 - Deferred tax 31 Less: Minority Interest Net Income (Reported) 15,033 Recurring Net Income 15,033 Source: Company data, I-Sec Research

CY07 57,049 3,898 53,152 36,695 20,354 36 2,363 590 1,697 19,098 4,644 6,050 6,059 (9) 17,691 13,047

CY08E 62,769 3,485 59,284 40,957 21,812 35 2,546 363 2,210 21,113 3,082 6,545 5,278 1,267 17,650 14,568

CY09E 69,745 3,224 66,521 45,732 24,012 34 3,104 271 2,739 23,376 7,480 5,844 1,636 15,896 15,896

Table 6: Balance Sheet (Rs mn, year ending Dec 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Total Assets

CY06

CY07

CY08E

CY09E

11,776 3,781

23,175 14,396

26,210 16,584

28,898 18,243

7,016 4,760 11,331 9,861 1,470 31,241

8,898 14,277 8,558 4,146 4,411 32,333

8,909 17,301 9,229 1,289 7,940 42,100

9,482 19,416 17,170 1,289 15,880 44,390

6,349 47,333

6,124 55,167

14,804 68,631

1,500 80,976

3,941 3,877 3,034 2 44,392 77 47,349 55,167

2,657 3,916 1 3,034 2 59,101 77 62,058 68,631

2,008 3,955 2 3,034 2 72,056 77 75,013 80,976

Liabilities Borrowings 8,654 Deferred Tax Liability 3,839 Minority Interest Equity Share Capital 3,034 Face value per share (Rs) 2 Reserves & Surplus* 31,883 Less: Misc. Exp n.w.o. 77 Net Worth 34,840 Total Liabilities 47,333 Source: Company data, I-Sec Research *excluding revaluation reserves

CY06 Operating Cash flow 20,098 Working Capital changes (543) Capital Commitments (14,095) Net Operating FCF 5,460 Investing Activities 1,991 Issue of Share Capital 330 Buyback of shares Inc(Dec) in Borrowings (2,621) Dividend paid (2,768) Extraordinary Items 523 Chg. in Cash & Bank 2,916 Source: Company data, I-Sec Research

CY07 15,441 (639) 2,260 17,063 (1,244) (4,713) (2,941) (2,194) 10,615

CY08E 16,181 (845) (9,457) 5,879 (1,319) (1,285) (2,941) (1,228) 2,188

CY09E 17,908 (467) (5,394) 12,047 (5,202) (649) (2,941) (1,597) 1,658

Table 8: Key Ratios (Year ending Dec 31) CY06

CY07 CY08E CY09E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

9.9 9.9 12.1 1.6 23.0

11.7 8.6 10.2 1.7 31.2

11.6 9.6 11.3 1.7 40.9

10.5 10.5 12.5 1.7 49.4

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

140.6 194.6 245.0 207.4 158.3

(9.0) (4.6) (13.2) (13.2) (15.8)

10.0 7.2 11.7 11.7 11.1

11.1 10.1 9.1 9.1 11.0

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

11.4 9.4 4.9 8.4 2.9 9.1

13.2 11.1 3.6 7.9 2.8 10.8

11.8 10.0 2.8 7.0 2.4 10.0

10.8 9.0 2.3 6.0 2.1 2.9

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (x) Receivables (days) Payable (days) D/E Ratio (x)

9.4 3.3 8.0 18.4 0.0 7.7 3.5 29.3 0.4

9.8 3.5 8.9 31.7 (0.0) 5.2 4.8 44.5 0.2

10.7 3.4 10.5 31.0 0.0 5.1 4.3 40.2 0.1

10.2 3.3 11.7 32.0 0.0 5.0 4.3 37.9 0.1

Profitability Ratios (%) Rec. Net Income Margins 23.4 RoCE 20.7 RoNW 35.4 Dividend Payout 16.1 Source: Company data, I-Sec Research

22.2 38.4 31.7 19.8

22.4 34.7 26.6 17.7

21.9 31.6 23.2 16.2

47

Ambuja Cement, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Capex plans .......................................................................................................... 40 Table 2: Key markets and market share............................................................................. 41 Table 3: Capex on captive power ....................................................................................... 41 Table 4: Performance trend and forecast assumptions ...................................................... 43 Table 5: Profit and Loss Statement .................................................................................... 47 Table 6: Balance Sheet....................................................................................................... 47 Table 7: Cash Flow Statement............................................................................................ 47 Table 8: Key Ratios............................................................................................................. 47

Charts Chart 1: Market share trend ................................................................................................ 40 Chart 2: Power and fuel costs trend ................................................................................... 42 Chart 3: Key cost trend ....................................................................................................... 42 Chart 4: Sales, EBITDA and EBITDA margin movement ................................................... 43 Chart 5: EBITDA/te ............................................................................................................. 44 Chart 6: FCF and D/E ......................................................................................................... 44 Chart 7: RoCE and RoE trends........................................................................................... 45 Chart 8: Rolling P/E bands.................................................................................................. 46 Chart 9: Rolling EV/E bands ............................................................................................... 46

48

Equity Research April 21, 2008 BSE Sensex: 16481

INDIA

Grasim

BUY

Bedrock of strength Cement Shareholding pattern Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Jun Sept '07 '07 25.2 25.2

Dec '07 25.2

44.1 7.9 13.2 23.0 30.7

43.2 10.2 10.7 22.4 31.6

43.3 9.2 10.6 23.4 31.5

4,000 3,500 3,000 2,500

Jan-08

Apr-08

Nov-07

Jun-07

Sep-07

2,000 Apr-07

Reason for report: Initiating coverage We expect Grasim’s key divisions, cement and viscose staple fibre (VSF), to drive the topline growth supported by capacity additions. While revenue growth is likely to be impressive, impact of rising input costs would largely be offset by commissioning of captive power plants (CPPs). Based on this and UltraTech Cement’s (UTCL, Grasim’s recent acquisition) impressive performance, Grasim is likely to post earnings CAGR of 15% in the next two years. Our sum-of-the-parts (SOTP) valuations indicate Rs3,638 fair value with 42% upside from current levels. We initiate coverage with BUY rating. f Cement to be key growth driver. We expect Grasim’s cement division growth to be boosted with the commissioning of two plants (Shambhupura: 4.5mnte, Kotputli: 4.4mnte) in Rajasthan. Further, while cement companies are troubled by rising input costs, commissioning of two CPPs with 75MW total capacity will help moderate cost pressures. Improvement in UTCL’s parameters will also boost the overall performance of the cement division.

Price chart

(Rs)

Rs2,569

f VSF to see margins pressure. While the division’s revenue growth is expected to be impressive owing to 64,000te capacity addition, realisations could come under pressure with VSF prices already reaching peak levels. This along with rising cost of pulp would result in EBITDA margin contraction in FY09. However, sponge iron division, with lower operating rates, could benefit from improvement in gas supplies in June-July ’08 f Consolidated earnings growth to impress. We expect Grasim to report a strong 15% bottomline growth over FY08E-10E, aided partly by cost-reduction measures and strong performance from UTCL. Grasim is expected to generate free cashlow (FCF) of Rs53bn on standalone basis in the next two years. Consequently, D/E is likely to decline to 0.4x in FY09E and further to 0.2x in FY10E. f Inexpensive valuations. At FY09E and FY10E P/E of 7.2x and 6.5x respectively, Grasim’s valuations remain inexpensive. At the current market price, the cement division is valued at EV/te of US$128, a significant discount to peers though with better efficiency parameters. Our SOTP valuations indicate Rs3,638/share fair value with 42% upside from current levels. Grasim is our top pick in the sector. Initiate coverage with BUY. Market Cap

Rs235.5bn/US$5.9bn

Year to March

Reuters/Bloomberg

GRASIM.BO/GRASIM IN

Revenue (Rs mn)

Shares Outstanding (mn) 52-week Range (Rs)

91.7 4074/2326

Net Income (Rs mn) EPS (Rs)

FY07

FY08E

FY09E

FY10E

140,952

163,573

194,492

215,008

19,675

27,436

33,162

36,447

214.6

299.2

361.7

397.5

Free Float (%)

74.8

% Chg YoY

89.8

39.4

20.9

9.9

FII (%)

22.4

P/E (x)

12.0

8.6

7.1

6.5

Daily Volume (US$'000)

9,600

CEPS (Rs)

9.2

7.0

5.8

5.1

Absolute Return 3m (%)

(22.8)

EV/E (x)

7.1

5.8

4.6

3.9

Absolute Return 12m (%)

(29.4)

Dividend Yield

1.6

1.8

2.0

2.2

Novonil Guha

Sensex Return 3m (%)

RoCE (%)

[email protected] +91 22 6637 7385

(13.3)

31.0

31.0

30.3

30.1

Sensex Return 12m (%)

(18.8)

RoE (%)

34.4

34.4

31.3

27.4

Please refer to important disclosures at the end of this report

ICICI Securities

Grasim, April 21, 2008

Large conglomerate with cement as key driver On a consolidated basis, Grasim is the largest domestic player in the cement industry with pan-India presence. The company is also the largest VSF manufacturer in India, enjoying near-monopoly. Grasim’s gas-based sponge iron division with annual capacity of 0.9mnte is a standalone plant located in Raigad, Maharashtra.

Cement division – Impressive growth Grasim’s capex plan includes 4.5mnte capacity expansion in Shambhupura, Rajasthan and another 4.4mnte increase at Kotputli, Rajasthan. A 1.5mnte split grinding unit at Panipat, Haryana has also been set up. Shambhupura and Panipat have just been commissioned, while Kotputli should be operational by SeptemberOctober ’08. Consequently, the company’s volume growth, which was restricted in the past two years by the installed capacity, is likely to post robust growth in the next two years. Table 1: Key markets and market share Market share (%)

% of total despatches

9-yr consumption CAGR (%)

Share of total consumption (%)

North Uttar Pradesh & Uttaranchal Rajasthan Punjab Haryana

6.9 17.0 17.9 18.0

4.4 5.4 4.1 3.5

8.9 9.9 6.0 12.2

12.2 6.1 4.4 3.8

West Gujarat Maharashtra

38.6 34.9

10.9 21.2

4.5 7.2

6.8 12.2

South Tamil Nadu Karnataka Kerala Andhra Pradesh

14.0 29.9 8.9 9.9

6.3 11.6 2.2 4.2

7.4 11.2 6.8 8.5

8.6 7.5 4.7 8.2

East West Bengal Bihar & Jharkhand Orissa

24.1 11.8 26.4

5.8 2.9 4.1

6.7 10.1 10.9

4.6 4.8 3.0

Central Madhya Pradesh & Chhattisgarh

26.0

9.5

9.6

7.0

8.1

100.0

Total 20.0 100.0 Source: Cement Manufacturers Association (CMA), I-Sec Research

Since the acquisition of UTCL, Grasim has become the largest player in India on consolidated basis with market share of ~20%. Grasim and UTCL are market leaders in Orissa (26.4%), Gujarat (38.6%), Goa (52.5%), Maharashtra (34.9%), Madhya Pradesh (21.7%), Chhattisgarh (33.2%) and Karnataka (30%).

50

ICICI Securities

Grasim, April 21, 2008 Chart 1: Key market share trends (Standalone) 15.0

All India

Norh

FY04

FY05

West

South

(%)

13.0

11.0

9.0

7.0 FY03

FY06

FY07

Source: CMA, I-Sec Research

Grasim’s market share has remained stable in the key northern markets, while in other regions it has gradually dipped owing to the gap in capacity additions. However, we expect the company’s market share in the North to surge significantly, while market share erosion is possible in the West. On a consolidated basis, the company would gain market share in the South with UTCL’s 4.9mnte capacity just being commissioned.

Captive power to reduce impact of sharp fuel cost rise As regards costs, Grasim is setting up a 50MW CPP in Jawad, Madhya Pradesh and another 25MW plant in Raipur, Chhattisgarh. While 50MW thermal power plant (TPP) should be operational in beginning-Q1FY08, the 25MW plant is expected to be commissioned by September ’08. We expect ~Rs2/unit savings from the plant at Madhya Pradesh, which currently uses diesel generator (DG) sets. However, the company’s TPP in Raipur, which currently uses grid power, we estimate ~Rs1/unit savings from the use of coal middlings (leftovers from coal washery), the lower calorific value of which is more-than-offset by its inexpensive cost. Chart 2: Power and fuel cost trend 800

Pow er & Fuel

Average per unit cost of pow er (RHS)

700

4.5 4.0

600 (Rs/te)

400

3.0

300

(Rs/kWh)

3.5

500

2.5

200 2.0

100 0

1.5 FY06

FY07

FY08E

FY09E

FY10E

Source: CMA, I-Sec Research

51

ICICI Securities

Grasim, April 21, 2008

We expect Grasim to save Rs685bn in power costs in the next two years. However, this will only partially offset the impact of higher fuel costs. Grasim relies on domestic coal for ~50% of its total fuel requirement, while the balance is a mix of domestic pet coke, imported pet coke, international coal and alternate fuels. While Coal India (CIL) has raised prices 10-15% in December ’07, prices of international coal and pet coke have risen steeply.

Grinding units to aid better logistics and freight cost savings Grasim will set up another 1.3mnte grinding unit at Dadri in Uttar Pradesh. The grinding units at Panipat and Dadri will help the company source cheaper fly ash and would reduce the lead distances to the markets, aiding savings in freight costs. Chart 3: Key cost trends 1,400

Pow er & Fuel

Freight

EBITDA/te

1,200

(Rs/te)

1,000 800 600 400 200 0 FY06

FY07

FY08E

FY09E

FY10E

Source: CMA, I-Sec Research

Stake sale in Shree Digvijay Cement positive Grasim has sold its 54% stake in Shree Digvijay Cement (SDCL) to Cempor for Rs3.22bn, which implies EV/te of US$161. SDCL had inherent cost disadvantages such as high lead distances from limestone mines, higher power cost due to captive DG sets and lack of investment for efficiency improvements. Hence, despite cement prices at all-time highs, there was no substantial improvement in margins (Q2FY08 EBITDA margin just 3.7%). Consequently, we believe that the decision to divest stake in SDCL was a step in the right direction.

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ICICI Securities

Grasim, April 21, 2008

VSF to benefit from volumes but prices may dip The VSF division’s performance has been impressive in the past two years with demand being strong and prices continuously uptrending. VSF demand is likely to remain firm going forward owing to: i) shift in textile manufacturing hubs to the East, ii) rising consumer preference for natural comfort fabrics due to global warming, iii) availability of advanced spinning technologies aiding the use of VSF and iv) slowdown of cotton production worldwide. Table 2: Global cotton production and consumption Year (August-July) Production Consumption Ending stocks Source: CMA, I-Sec Research

06-07 26.7 26.6 12.7

07-08 25.7 27.2 11.2

07-09 26.9 27.5 10.7

YTDFY08, Grasim has been operating above its rated capacity to meet the rising demand. However, the company is expected to commission another 64,000te capacity in Kharach, Gujarat in April ’08, which will ensure robust volume growth in FY09 too. Chart 4: VSF – Quarterly realisations trend 110 105

(Rs/kg)

100 95 90 85 80 75 70 Q306

Q406

Q107

Q207

Q307

Q407

Q108

Q208

Q308

Source: Company data

Strong VSF demand implies that Grasim easily passed on any rise in input costs (specifically pulp) to the consumers in the past three years. However, while VSF demand is expected to remain robust, we expect Grasim to face pricing pressure going forward. Most domestic textile manufacturers have been affected by the US slowdown and dollar depreciation. Hence, as a strategy, the company is expected to offer discounts to its customers so as to not burden them with higher input costs. Consequently, we have assumed a decline in VSF prices for FY09E. This coupled with rising pulp cost and sharp jump in prices of other inputs such as sulphur would pressurise the division’s margins, though absolute EBITDA is likely to remain flat, mainly owing to higher output from the new 64,000te plant at Kharach, Gujarat.

53

ICICI Securities

Grasim, April 21, 2008 Chart 5: International pulp prices 900

FOEX PIX Pulp Europe NBSK Price

850 800 750 700 650 600 Mar-08

Jan-08

Nov-07

Sep-07

Jul-07

May-07

Jan-07

Mar-07

Nov-06

Sep-06

Jul-06

Mar-06

May-06

Jan-06

Nov-05

Sep-05

Jul-05

May-05

Jan-05

Mar-05

Nov-04

Sep-04

Jul-04

550

Source: Bloomberg

In order to address the problem of pulp shortage, Grasim has focused on backward integration. The company would require additional supplies of pulp for its new plant in Kharach. For this, Grasim had acquired 45% stake in AV Nackawic Pulp Mill in Canada at end-FY05. This mill, which initially produced paper grade pulp, was converted for producing rayon grade pulp with total capacity of ~200,000te. Grasim would be entitled to ~90,000te, which would meet the requirements of its new Kharach plant. As a long-term strategy to secure pulp supplies, Grasim has initiated a pulp-cumplantation project in Laos. About 2,000 hectares (ha) have been planted till date, while another 7,000ha will be planted in the next year. However, pulp output is expected only in FY12-13. Table 3: Sources of Rayon Grade Wood Pulp for Grasim (%) Captive AV Cell AP Rayon Sapi and others AV Nackawic Total Source: CMA, I-Sec Research

54

FY08 25.5 14.6 32.8 27.0 0.0 100.0

FY09 22.3 12.7 28.7 15.9 20.3 100.0

FY10 20.6 11.8 26.5 14.7 26.5 100.0

ICICI Securities

Grasim, April 21, 2008

Sponge iron – Operations affected due to gas shortage The sponge iron division constitutes only 8% of the total standalone revenues. It has the largest gas-based merchant power plant in India with flexibility of using multiple feedstock. Historically, this plant faced gas supply shortage from GAIL resulting in lower operating rates. But with sponge iron prices uptrending, Grasim has been able to use more expensive feedstock such as naphtha and propane in order to improve capacity utilisation rates. Chart 6: Sponge iron realisations 16,500 15,500

(Rs/te)

14,500 13,500 12,500 11,500 10,500 Q406

Q107

Q207

Q307

Q407

Q108

Q208

Q308

Source: Company data, I-Sec Research

Sponge iron prices are expected to remain firm owing to higher global scrap prices and record bulk freights rates. While gas supplies are expected to improve from June ’08, uncertainty over gas pricing remains a cause for concern.

55

ICICI Securities

Grasim, April 21, 2008

Consolidated PAT to grow 15% Table 4: Performance trend and forecast assumptions Cement Capacity (’000 te) Production (’000te) Capacity utilisation (%) Sales (’000 te) Growth (%) Realisation (Rs/te) Growth (%) VSF Capacity (te) Production (te) Capacity utilisation Sales (te) Growth (%) Realisation (Rs/te) Growth (%) Sponge Iron Capacity (’000 te) Production (’000 te) Capacity utilisation (%) Sales (’000 te) Growth (%) Realisation (Rs/te) Growth (%) Source: I-Sec Research

FY06

FY07

FY08E

FY09E

FY10E

13,115 13,826 105 14,328 16.7 2,516 8.8

13,115 14,418 110 14,849 3.6 3,385 34.6

14,115 15,283 108 15,283 2.9 3,961 17.0

23,015 19,104 83 19,104 25.0 4,119 4.0

24,015 21,492 89 21,492 12.5 4,119 -

257,325 228,981 89 242379 6.9 80,377 (9.8)

270,100 246,833 91 246540 1.7 91,795 14.2

270,100 270,000 100 265493 7.7 113,826 24.0

333,975 307,591 92 302457 13.9 109,842 (3.5)

333,975 337,315 101 331684 9.7 113,137 3.0

900 506 56 478 (38.1) 14,335 0.6

900 525 58 571 19.4 14,693 2.5

900 576 64 576 0.9 17,338 18.0

900 675 75 675 17.2 16,817 (3.0)

900 702 78 702 4.0 17,154 2.0

On a standalone basis, Grasim would post topline CAGR of 15% in the next two years, mainly aided by strong cement performance and stable VSF demand. While we expect VSF volumes to post impressive growth supported by additional capacity at Kharach, Gujarat, VSF prices will likely come under pressure. While we expect the company’s cement division to register revenue CAGR of 21% in the next two years, we believe that its VSF and sponge iron divisions would post revenue CAGR of 11% each over the same period. Overall operating margins are expected to decline marginally 64bps in FY09E, mainly on account of lower VSF prices and higher cost of pulp, sulphur, coal fly ash etc. We expect VSF margins to decline ~400bps owing to lower realisations and cost pressures. However, we estimate 50bps and 10bps improvement in cement and sponge iron margins respectively in FY09E. Overall, EBITDA margin is expected to improve 43bps in FY10E, mainly aided by the VSF division. We expect Grasim to post 14% standalone earnings CAGR in the next two years. On a consolidated basis, we expect Grasim’s PAT to grow 15% in the next two years, partly helped by strong UTCL earnings.

56

ICICI Securities

Grasim, April 21, 2008 Chart 7: Sales, EBITDA and EBITDA margin movement Net sales

160,000

EBITDA

EBITDA Margin (RHS)

35

140,000 30

100,000

25 (%)

(Rs mn)

120,000

80,000 20

60,000 40,000

15

20,000 0

10 FY06

FY07

FY08E

FY09E

FY10E

Source: I-Sec Research

Grasim had planned significant capex since ’06, which included 8.9mnte cement capacity and ~64,000te VSF capacity. While 4.5mnte cement capacity has already been commissioned, the balance 4.4mnte and the VSF expansion are expected in FY09E. Consequently, we expect the company’s FCF to turn negative in FY08. However, strong FCF generation of Rs53bn is likely in the next two years. Consequently, D/E is likely to decline to 0.4x in FY09E and further to 0.2x in FY10E. Chart 8: FCF and D/E Free cashflow

40,000

D/E (RHS)

0.8

30,000 0.6

10,000

0.4

(x)

(Rs mn)

20,000

0 0.2 (10,000) (20,000)

0.0 FY06

FY07

FY08E

FY09E

FY10E

Source: I-Sec Research

57

ICICI Securities

Grasim, April 21, 2008

Attractive valuations At the current market price, Grasim is trading at FY09E & FY10E P/E of 7.2x and 6.5x and EV/E of 4.6x and 3.9x respectively. On EV/te, the company is valued at US$128. The company has historically quoted at a significant discount to peers due its diversified business. However, with 70% of its revenues coming from the cement division (post the acquisition of UTCL) and its exit from non-core business such as textiles, we believe a re-rating is imminent. Chart 9: Rolling P/E bands 4,500 4,000 3,500

(Rs)

3,000 11x

2,500 2,000 8x

1,500 1,000

5x

500

Source: Bloomberg, I-Sec Research

Chart 10: Rolling EV/E bands 600,000 500,000

(Rs mn)

400,000

8x

300,000

6x

200,000 4x 100,000

Source: Bloomberg, I-Sec Research

58

Apr-08

Oct-07

Apr-07

Oct-06

Apr-06

Oct-05

Apr-05

Oct-04

Apr-04

Oct-03

Apr-03

Oct-02

Apr-02

0

Apr-08

Dec-07

Sep-07

Jun-07

Feb-07

Nov-06

Jul-06

Apr-06

Dec-05

Sep-05

Feb-05

May-05

Nov-04

Jul-04

Apr-04

Dec-03

Sep-03

May-03

Oct-02

Feb-03

Jul-02

Apr-02

0

ICICI Securities

Grasim, April 21, 2008 Table 5: SOTP valuations

Current price

Target Price

VSF Operating profits (Rs mn) EV/EBITDA (x) Value of VSF (Rs mn)

10,909 5.2 56,728

10,909 8.5 92,729

Chemicals Operating profits (Rs mn) EV/EBITDA (x) Value of VSF (Rs mn)

1,045 3.5 3,656

1,045 4.0 4,178

24.2 128 123,495

24.2 180 174,096

1,725 2.0 3,450

1,725 3.0 5,175

Textiles Operating profits (Rs mn) EV/EBITDA (x) Value of Textiles business (Rs mn)

64 1.5 95

64 1.5 95

Others Operating profits (Rs mn) EV/EBITDA (x) Value of business (Rs mn)

438 1.0 438

438 1.0 438

187,863 5,513 182,350 92 1,989

276,712 5,513 271,198 92 2,958

21.9 123,326 141 25,776 97,550 235,515 2,569

21.9 140,160 160 25,776 114,384 333,538 3,638

Cement Capacity (Mn tonnes) EV/tonne US$ Value of Cement business (Rs mn) Sponge Iron Operating profits (Rs mn) EV/EBITDA (x) Value of Sponge Iron business (Rs mn)

Total value of business (Rs mn) Net debt (Rs mn) Net value (Rs mn) No of shares (mn) Value per share (Rs mn) UltraTech Capacity (mnte) EV (Rs mn) UltraTech – Ev/te (Rs mn) Less net debt (Rs mn) Market cap (Rs mn) Grasim – Consolidated market cap (Rs mn) Value per share (Rs) Source: I-Sec Research

We have valued Grasim’s VSF division at 20% premium to Lenzing (the largest VSF player in the world with 375,000te capacity) as Grasim’s VSF margins are 2x Lenzing’s. We have assumed ~40% discount to Tata Steel for the sponge iron division as Tata Steel is a large integrated player with cost advantages. Grasim’s cement division is valued at US$180, at a slight premium to ACC’s valuations as Grasim’s cement margins are significantly better than ACC’s. Our SOTP valuations give us a target price of Rs3,638 with 42% upside from current levels. Grasim is our top pick in the sector. Initiate coverage with BUY.

59

ICICI Securities

Grasim, April 21, 2008

Financial Summary (Consolidated) Table 6: Profit and Loss Statement

Table 8: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31)

Operating Revenues (Sales)

FY07 FY08E FY09E FY10E 140,952 163,573 194,492 215,008

Operating Expenses 101,228 111,635 132,118 146,938 EBITDA 39,723 51,938 62,375 68,070 % margins 28 32 32 32 Depreciation & Amortisation 6,100 6,133 7,577 9,818 Gross Interest 2,286 2,482 3,342 2,221 Other Income 3,177 3,812 4,024 4,578 Recurring PBT 34,515 47,135 55,479 60,608 Add: Extraordinaries Less: Taxes 10,921 14,925 16,185 17,774 - Current tax 10,971 13,763 14,804 16,266 - Deferred tax (51) 1,161 1,381 1,507 Less: Minority Interest (3,919) (4,774) (6,132) (6,387) Net Income (Reported) 19,675 27,436 33,162 36,447 Recurring Net Income 19,675 27,436 33,162 36,447 Source: Company data, I-Sec Research

Table 7: Balance Sheet (Rs mn, year ending March 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Goodwill Total Assets

FY07

FY08E

FY09E

FY10E

33,216 3,692

33,511 2,285

43,659 3,545

50,671 7,357

24,632 6,523 22,719 22,719 65,001

28,671 8,585 24,730 24,730 88,710

19,721 19,217 135,242

Liabilities Borrowings 48,793 Deferred Tax Liability 11,526 Minority Interest 8,587 Equity Share Capital 917 Face value per share (Rs) 10 Reserves & Surplus* 65,419 Less: Misc. Exp n.w.o. Net Worth 66,336 Total Liabilities 135,242 Source: Company data, I-Sec Research *excluding revaluation reserves

60

33,548 36,623 4,840 10,111 29,495 35,214 29,495 35,214 136,146 143,239

47,869 19,217 185,366

7,451 3,701 19,217 19,217 202,420 215,419

68,776 11,804 11,456 917 10 92,413 93,330 185,366

54,920 34,087 12,282 12,777 16,484 21,721 917 917 10 10 117,818 145,916 118,735 146,833 202,420 215,419

FY07 Operating Cash flow 20,204 Working Capital changes 464 Capital Commitments (34,729) Net Operating FCF (14,061) Investing Activities 3,177 Issue of Share Capital Buyback of shares Inc(Dec) in Borrowings 11,532 Dividend paid (4,283) Extraordinary Items 4,952 Chg. in Cash & Bank 1,318 Source: Company data, I-Sec Research

FY08E 32,737 (3,431) (56,052) (26,745) 3,812 19,983 (5,654) 7,198 (1,407)

FY09E FY10E 39,279 43,890 (5,194) (820) (19,360) (18,879) 14,724 24,191 4,024 4,578 (13,856) (20,832) (6,290) (6,867) 2,657 2,743 1,259 3,812

Table 9: Key Ratios (Year ending March 31) FY07 FY08E FY09E Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

FY10E

214.6 299.2 361.7 397.5 214.6 299.2 361.7 397.5 281.1 366.1 444.3 504.6 41.0 47.5 52.3 56.5 723.5 1,017.9 1,295.0 1,601.4

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

38.3 91.2 89.8 89.8 61.1

16.0 30.7 39.4 39.4 30.2

18.9 20.1 20.9 20.9 21.4

10.5 9.1 9.9 9.9 13.6

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

12.0 9.2 3.6 7.1 2.0 13.6

8.6 7.0 2.5 5.8 1.8 10.3

7.1 5.8 2.0 4.6 1.5 8.4

6.5 5.1 1.6 3.9 1.2 6.1

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (x) Receivables (days) Payable (days) D/E Ratio (x)

20.3 2.9 10.4 35.7 3.6 5.6 16.5 48.2 0.9

19.4 3.3 9.0 35.2 1.4 5.4 16.9 49.6 0.9

20.6 3.0 8.2 32.8 3.2 5.6 16.5 46.2 0.6

19.9 3.0 8.4 32.8 3.1 5.5 17.3 48.7 0.3

Profitability Ratios (%) Rec. Net Income Margins 13.7 RoCE 31.0 RoNW 34.4 Dividend Payout 19.1 Source: Company data, I-Sec Research

16.4 31.0 34.4 15.9

16.7 30.3 31.3 14.4

16.6 30.1 27.4 14.2

ICICI Securities

Grasim, April 21, 2008

Financial Summary Table 10: Profit and Loss Statement

Table 12: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31) FY07 FY08E FY09E FY10E 86,036 103,400 123,842 137,043

Operating Revenues (Sales)

Operating Expenses 62,663 EBITDA 23,372 % margins 27 Depreciation & Amortisation 3,179 Gross Interest 1,118 Other Income 2,818 Recurring PBT 21,893 Add: Extraordinaries 371 Less: Taxes 6,906 - Current tax 6,924 - Deferred tax (18) Less: Minority Interest Net Income (Reported) 15,358 Recurring Net Income 14,987 Source: Company data, I-Sec Research

70,204 33,196 32 3,520 1,344 2,690 31,023 39 9,927 8,997 931 21,134 21,095

84,874 38,968 31 4,547 1,723 2,886 35,583 11,102 10,034 1,067 24,481 24,481

93,331 43,712 32 5,922 1,152 3,247 39,884 12,364 11,168 1,197 27,520 27,520

(Rs mn, year ending March 31) FY07

FY08E

FY09E

FY10E

23,424 1,164

25,819 1,300

29,704 1,820

34,855 5,460

14,501 8,923 42,747 26,247 16,500 45,971

19,598 6,221 43,724 25,763 17,961 87,321

22,414 7,291 47,185 25,763 21,421 79,678

24,491 10,364 51,337 25,763 25,574 81,506

12,067 97,642

32,056 137,266

2,841 1,250 134,154 143,208

51,875 5,971 917 10 78,502 79,419 137,266

28,755 15,333 6,150 6,335 917 917 10 10 98,332 120,623 99,249 121,540 134,154 143,208

Liabilities Borrowings 29,516 Deferred Tax Liability 5,826 Minority Interest Equity Share Capital 917 Face value per share (Rs) 10 Reserves & Surplus* 61,384 Less: Misc. Exp n.w.o. Net Worth 62,300 Total Liabilities 97,642 Source: Company data, I-Sec Research *excluding revaluation reserves

FY08E FY09E FY10E 26,839 27,846 31,970 (1,145) (1,186) (11) (44,385) 3,095 (7,750) (18,692) 29,755 24,209 1,230 (575) (906) 22,360 (23,121) (13,422) (4,016) (4,651) (5,229) (785) (888) (1,012) 136 520 3,640

Table 13: Key Ratios (Year ending March 31) FY07 FY08E FY09E

Table 11: Balance Sheet Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Total Assets

FY07 Operating Cash flow 13,651 Working Capital changes (571) Capital Commitments (17,455) Net Operating FCF (4,375) Investing Activities (3,229) Issue of Share Capital Buyback of shares Inc(Dec) in Borrowings 9,719 Dividend paid (3,720) Extraordinary Items 841 Chg. in Cash & Bank (392) Source: Company data, I-Sec Research

FY10E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

163.5 167.5 198.1 27.5 679.5

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

30.0 68.6 88.2 88.2 66.9

20.2 42.0 40.8 40.8 35.5

19.8 17.4 16.1 16.1 17.9

10.7 12.2 12.4 12.4 15.2

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

15.7 13.0 3.8 11.3 3.1 20.2

11.2 9.6 3.0 8.6 2.8 11.2

9.6 8.1 2.4 6.7 2.1 9.9

8.6 7.1 1.9 5.6 1.8 7.7

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (days) Receivables (days) Payable (days) D/E Ratio (x)

26.0 2.8 12.9 31.0 7.9 5.9 18.8 47.9 0.6

25.5 3.4 8.7 32.0 3.6 5.6 19.5 49.8 0.7

26.7 3.0 8.1 31.2 4.1 5.8 19.4 48.1 0.4

25.8 3.2 8.1 31.0 3.4 5.8 20.2 50.8 0.2

Profitability Ratios (%) Rec. Net Income Margins 16.9 RoCE 26.6 RoNW 26.7 Dividend Payout 16.8 Source: Company data, I-Sec Research

19.9 27.6 29.8 12.9

19.3 27.5 27.4 12.9

19.6 29.6 24.9 12.9

230.1 267.0 300.1 230.5 267.0 300.1 268.5 316.6 364.7 29.7 34.4 38.7 866.2 1,082.4 1,325.6

61

ICICI Securities

Grasim, April 21, 2008

Index of Tables and Charts Tables Table 1: Key markets and market share............................................................................. 50 Table 2: Global cotton production and consumption .......................................................... 53 Table 3: Sources of Rayon Grade Wood Pulp for Grasim.................................................. 54 Table 4: Performance trend and forecast assumptions ...................................................... 56 Table 5: SOTP valuations ................................................................................................... 59 Table 6: Profit and Loss Statement .................................................................................... 60 Table 7: Balance Sheet....................................................................................................... 60 Table 8: Cash Flow Statement............................................................................................ 60 Table 9: Key Ratios............................................................................................................. 60 Table 10: Profit and Loss Statement .................................................................................. 61 Table 11: Balance Sheet..................................................................................................... 61 Table 12: Cash Flow Statement.......................................................................................... 61 Table 13: Key Ratios........................................................................................................... 61

Charts Chart 1: Key market share trends (Standalone) ................................................................. 51 Chart 2: Power and fuel cost trend ..................................................................................... 51 Chart 3: Key cost trends ..................................................................................................... 52 Chart 4: VSF – Quarterly realisations trend........................................................................ 53 Chart 5: International pulp prices ........................................................................................ 54 Chart 6: Sponge iron realisations........................................................................................ 55 Chart 7: Sales, EBITDA and EBITDA margin movement ................................................... 57 Chart 8: FCF and D/E ......................................................................................................... 57 Chart 9: Rolling P/E bands.................................................................................................. 58 Chart 10: Rolling EV/E bands ............................................................................................. 58

62

Equity Research April 21, 2008 BSE Sensex: 16481

Cement

INDIA

India Cements

HOLD

Mixed bag

Rs180

Reason for report: Initiating coverage

Shareholding pattern Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Sep '07 30.4

Dec '07 28.1

Mar '08 28.1

45.4 10.6 8.5 26.3 24.2

50.9 9.9 8.8 32.2 21.1

48.3 7.8 9.1 31.4 23.6

India Cements (ICL) is the largest South-based cement player with ~9mnte capacity. The company intends to enhance its capacity to 14mnte by December ’08 to ensure continued volume growth. However, with 70% of its fuel being based on imported coal, ICL is bound to face input cost pressures. This coupled with rise in effective tax rate is likely to slowdown earnings growth despite robust revenues in the next two years. This coupled with uncertainty over Indian Premier League (IPL) investments will likely impact stock performance. Consequently, we initiate coverage with HOLD rating. f Revenue growth to be impressive. ICL is expected to add additional 5mnte by December ’08 through a mix of new line additions, kiln upgrades and improvement in blending ratios. The 5mnte expansion, which is planned at significantly lower captive cost of ~US$50/te, would help boost volumes. f Higher share of imported coal to affect margins. ICL imports 70% of its coal requirement, leading to substantial surge in power and fuel costs. The company has acquired two bulk freight carriers to minimise the impact of rising international bulk freight rates, thereby reducing the landed cost of coal. However, these initiatives are likely to partially offset the impact of rising input costs, resulting in margin contraction.

Price chart 350

(Rs)

300 250 200

Apr-08

Jan-08

Nov-07

Sep-07

Jun-07

Apr-07

150

f Muted earnings growth. We expect ICL to register earnings CAGR of 12% in the next two years despite robust revenue growth, mainly due to cost pressures and higher effective tax rate. The company’s free cashflow (FCF) will be marginal in FY09, albeit jumping sharply in FY10E to Rs2.3bn. Consequently, FY10E D/E should be down to 0.5x. f Valuations. ICL trades at FY09E & FY10E P/E of 6.9x and 5.9x and EV/te of US$129. While these valuations may seem inexpensive, slower-than-expected earnings growth and uncertainty over investments in IPL may hamper stock performance. Consequently, we initiate coverage with HOLD rating. Market Cap

Rs50.5bn/US$1.26bn

Reuters/Bloomberg

ICMN.BO/ICEM IN

Shares Outstanding (mn) 52-week Range (Rs)

281.2 333/161

Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs)

Free Float (%)

71.9

% Chg YoY

FII (%)

31.4

P/E (x)

FY07

FY08E

FY09E

FY10E

22,489

30,563

38,154

44,641

4,788

7,023

7,650

8,852

20.7

24.0

26.2

30.3

1,175.9

16.1

8.9

15.7

8.7

7.5

6.9

5.9

Daily Volume (US$'000)

9,900

CEPS (Rs)

22.3

29.2

32.1

36.8

Absolute Return 3m (%)

(28.6)

EV/E (x)

8.1

6.2

5.1

4.3

Absolute Return 12m (%)

(42.0)

Dividend Yield

0.6

0.8

1.0

1.0

Novonil Guha

Sensex Return 3m (%)

RoCE (%)

[email protected] +91 22 6637 7385

(13.3)

21.7

27.6

28.6

27.9

Sensex Return 12m (%)

(18.8)

RoE (%)

43.0

40.0

30.6

26.7

Please refer to important disclosures at the end of this report

ICICI Securities

India Cements, April 21, 2008

Leading player in South but diversification on cards ICL is the largest player in the South with total installed capacity of ~9mnte. It enjoys 18% total market share in the South and is a market leader in Andhra Pradesh, Tamil Nadu and Kerala. ICL, which was suffering losses in FY04 and FY05, managed a successful turnaround buoyed by higher cement prices and a CDR (corporate debt restructuring) package from lenders. With cement prices remaining firm, the consequent robust cash generation has helped ICL plan capacity increases to maintain market share. Chart 1: Market share trends 25

Andhra Pradesh

Tamil Nadu

Karnataka

Kerela

(%)

21

17

13

9 FY03

FY04

FY05

FY06

FY07

Source: Cement Manufacturers Association (CMA), I-Sec Research

ICL proposes to raise its capacity to ~14mnte by December ’08 from 9mnte at present at a lower capital cost of US$50/te. The company is set to achieve capacity augmentation through kiln upgrades at Yerraguntla (400te/day-TPD), Malkapur (350TPD), Raasi (1,300TPD) and Sankarnagar (300TPD). ICL is also planning a new line at Malkapur and two 1-mnte grinding units in Chennai (Tamil Nadu) and Parli (Maharashtra). Table 1: Capex plans Plant Sankaridurg Sankarnagar Dalavoi Chimalkur Yerraguntla Raasi Malkapur Grinding units Total Source: Company data

64

Location Tamil Nadu Tamil Nadu Tamil Nadu Andhra Pradesh Andhra Pradesh Andhra Pradesh Andhra Pradesh

Capacity (mnte) 0.3 0.5 0.6 0.2 0.2 0.2 1.0 2.2 5.2

Time of commissioning September ’07 September ’08 December ’07 December ’08 September ’08 June ’08 December ’08 June ’08

ICICI Securities

India Cements, April 21, 2008 Table 2: Key markets and market share Market share (%)

% of total despatches

9-yr consumption CAGR (%)

Share of total consumption (%)

20.1 14.2 19.3 17.9 29.3

29.8 18.3 15.5 25.1 1.31

7.4 11.2 6.8 8.5 19.4

8.62 7.46 4.68 8.18 0.26

3.9

8.2

7.2

12.21

0.7

98.2

8.1

100.0

South Tamil Nadu Karnataka Kerala Andhra Pradesh Pondicherry (UT) West Maharashtra Total Source: CMA, I-Sec Research

ICL to foray in new markets As a part of its phase II of expansion plans, ICL is foraying into new markets for panIndia presence and diversifying to avoid the risk of being a regional player. The company is primarily active in the North, where it proposes to set up a 3.5mnte plant. For this, ICL has already signed a memorandum of understanding (MoU) for a plant at Himachal Pradesh and has secured mining leases in Rajasthan. The company is also exploring to acquire limestone deposits in Madhya Pradesh; we expect this project to cost ~Rs1.2bn and likely be commissioned by mid-FY11.

65

ICICI Securities

India Cements, April 21, 2008

Dependence on imported coal to pressurise margins Rising input costs, a concern ICL sources only 30% power from the grid. Most of its power requirements are fulfilled from low cost sources such as wind farms, waste heat recovery power and a group company, Coromandel Electric Company. Table 3: Power sources % 39.1 9.1 24.5 20.0 7.3 100.0

Grid Wind farms Coromandel Electric Company Andhra Pradesh Gas Power Corporation (APGPCL) Waste heat recovery Total requirement Source: Company data

However, ICL imports ~70% of its coal requirements. Sharp rise in international coal prices and international freight rates in the past quarters have been serious concerns. Hence, to temper the impact of higher fuel prices, the company has purchased two bulk-cargo carriers from Essar Shipping at US$57mn. The two ships with 41,824DWT (dead weight tonne) & 38,002DWT capacity respectively would be able to meet ICL’s entire imported coal requirement. While current international freight rates vary from US$25/te to US$40/te, freight cost is likely to be lower at ~US$12-15/te if ICL operates its own ships. Chart 2: Power and fuel costs 1,000

4.0

Pow er & Fuel

900

Average per unit cost of pow er (RHS) 3.6

800

600

3.2

500 400

2.8

(Rs/kWh)

(Rs/te)

700

300 200

2.4

100 0

2.0 FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

ICL is also actively mulling to invest in coal mines abroad to secure high-quality coal at reasonable prices.

66

ICICI Securities

India Cements, April 21, 2008 Chart 3: Key cost trends 1,400

Pow er & Fuel

Freight

EBITDA/tonne

1,200

(Rs/te)

1,000 800 600 400 200 0 FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

IPL – Marketing strategy ICL won the IPL franchise for the Chennai team at ~Rs3.6bn (US$91mn) payable over 10 years. Hence, the yearly cash outflow would be just US$9mn. Also, the company will have to incur the players’ costs, team maintenance, marketing, administration, travel and accommodation. These expenses are likely to be ~US$5mn per year. On the other hand, the teams will be entitled to their share of television rights, which have been sold to Sony for US$1bn for the next 10 years. 80% of these revenues will be distributed among the franchises for the first five years and this share would come down to 60% in the next five years. In addition, the franchises are also entitled to ~60% of title sponsorship revenues. ICL will be entitled to 100% of local revenues (gate collection, sale of logos, stadium advertising, merchandising etc). While the yearly outflow of Rs360mn may not be very significant, the success of revenue streams other than television rights and title sponsorship revenues would depend on the success of the 20-20 game format used for IPL. With other local cricket tournaments not being much of a success on account of limited viewership, we believe that a clear picture would emerge after the first season of tournaments. We have not factored in the implications of the IPL investment in our model.

67

ICICI Securities

India Cements, April 21, 2008

12% earnings CAGR through FY08-10E Table 4: Performance trend and forecast assumptions FY07 8,530 8,424 98.8 8,414 15.9 3,090 25.1

Capacity (’000 te) Production (’000 te) Capacity utilisation (%) Sales (mnte) Growth (%) Realisations (Rs/te) Growth (%) Source: I-Sec Research

FY08E 9,430 9,284 98.5 9,284 10.3 3,847 24.5

FY09E 13,930 11,141 80.0 11,141 20.0 4,001 4.0

FY10E 13,930 13,035 93.6 13,035 17.0 4,001 -

Revenues to be driven by timely expansion. We expect ICL’s topline to be boosted by incremental volumes from debottlenecking and capacity expansion. ICL is expected to raise its installed capacity to 14mnte by December ’08. Consequently, we expect cement volumes to surge 20% and 17% in FY09E and FY10E respectively. This coupled with 4% growth in average realisations in FY09E and flat prices in FY10 would aid revenue CAGR at 21% in the next two years. Chart 4: Sales, EBITDA and EBITDA margin movement Net sales

50,000

EBITDA

EBITDA Margin (RHS)

45,000

35%

40,000

30%

35,000 (Rs mn)

40%

30,000

25%

25,000

20%

20,000

15%

15,000

10%

10,000

5%

5,000 0

0% FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Rising fuel costs to affect margins. Since 70% of ICL’s coal requirements are imported, the company will face sharp rise in coal costs. However, purchase of two bulk-freight carriers will help contain the impact with savings in freight. Hence, despite an expected 4% increase in average realisations, we expect the company’s EBITDA margin to contract 36bps to 37% in FY09E. In FY10E, EBITDA margin is likely to decline further 84bps to 36.1%.

68

ICICI Securities

India Cements, April 21, 2008 Chart 5: EBITDA/te 1,400 1,200

(Rs/te)

1,000 800 600 400 200 0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

ICL is expected to post interest cost CAGR of 10% through FY08-10E, mainly on account of planned capex in the South and the North going forward. The company’s effective tax rate is expected to jump to 33% from the current ~23% as the company has exhausted all tax shelters in FY08. As a result, earnings are expected to grow a moderate 12% in the next two years. Chart 6: Positive FCF from FY08 5,000

Free Cashflow

2.5

D/E (RHS)

4,000 2.0

3,000

1.5

1,000

(x)

(Rs mn)

2,000

0

1.0

(1,000) (2,000)

0.5

(3,000) (4,000)

0.0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

ICL’s FCF is expected to turn positive FY08 onwards. Further, in FY10E, FCF is likely to rise sharply post completion of significant capex. Robust cash generation will aid repayment of debt, which will bring down D/E to ~0.5x in FY10E. ICL, similar to most other cement companies, will see a decline in return ratios owing to large capex plans, limited cement pricing upside and cost pressures.

69

ICICI Securities

India Cements, April 21, 2008 Chart 7: RoCE and RoE trends 50

RoCE

RoE

40

(%)

30

20 10 0 FY06

FY07

Source: Company data, I-Sec Research

70

FY08E

FY09E

FY10E

ICICI Securities

India Cements, April 21, 2008

Valuations ICL is valued at FY09E & FY10E P/E of 6.9x and 5.9x with EV/E of 5.1x and 4.3x respectively. On EV/te, the company is valued at US$129. Though ICL’s topline growth is likely to be impressive, input cost pressures (primarily international coal) and higher effective tax rate would slowdown earnings growth. Though we have not factored in the impact of IPL investment in our estimates, uncertainly over the success of IPL is likely to limit stock performance going forward. Hence, despite inexpensive valuations, we initiate coverage with HOLD. Chart 8: Rolling P/E bands 400 12x

300

(Rs)

8x 200 5x 100

Apr-08

Jan-08

Oct-07

Jul-07

May-07

Feb-07

Nov-06

Aug-06

May-06

Mar-06

Dec-05

Sep-05

Apr-05

Jun-05

0

Source: Bloomberg, I-Sec Research

Chart 9: Rolling EV/E bands 140,000 120,000 9x

(Rs mn)

100,000 80,000 7x

60,000 40,000

5x

20,000

Apr-08

Dec-07

Aug-07

Apr-07

Dec-06

Aug-06

Apr-06

Dec-05

Aug-05

Apr-05

Dec-04

Aug-04

Apr-04

Dec-03

Aug-03

Apr-03

0

Source: Bloomberg, I-Sec Research

71

ICICI Securities

India Cements, April 21, 2008

Financial Summary Table 5: Profit and Loss Statement

Table 7: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31)

FY07 Operating Revenues (Sales) 22,552 of which Domestic 22,552 Operating Expenses 15,209 EBITDA 7,343 % margins 3,256 Depreciation & Amortisation 1,026 Gross Interest 1,498 Other Income 101 Recurring PBT 4,920 Add: Extraordinaries Less: Taxes 131 - Current tax 17 - Deferred tax 114 Less: Minority Interest 1 Net Income (Reported) 4,788 Recurring Net Income 4,788 Source: Company data, I-Sec Research

FY08E 30,628 30,628 19,195 11,432 3,733 1,196 1,400 224 9,061 2,039 1,359 680 2 7,023 7,023

FY09E 38,221 38,221 24,094 14,127 3,696 1,368 1,577 235 11,418 3,768 2,626 1,142 3 7,650 7,650

FY10E 44,710 44,710 28,560 16,149 3,612 1,505 1,680 247 13,211 4,360 3,039 1,321 4 8,852 8,852

(Rs mn, year ending March 31) FY07

FY08E

FY09E

FY10E

17,175 2,302

17,819 552

19,069 662

21,395 795

4,340 12,835 551 497 54 27,958

4,630 13,189 658 497 161 29,543

5,350 13,719 900 497 403 36,888

5,774 15,621 1,504 497 1,007 35,883

1,428 34,952

4,847 40,967

5,055 49,843

9,910 56,749

19,372 443 2,812 10 26,011 400 21,153 40,967

20,609 456 2,812 10 33,086 400 28,777 49,843

18,677 470 2,812 10 41,362 401 37,602 56,749

Liabilities Borrowings 20,588 Deferred Tax Liability 430 Minority Interest Equity Share Capital 2,604 Face value per share (Rs) 10 Reserves & Surplus* 19,482 Less: Misc. Exp n.w.o. 331 Net Worth 13,934 Total Liabilities 34,952 Source: Company data, I-Sec Research *excluding revaluation reserves

72

FY08E FY09E FY10E 8,862 10,007 11,432 (2,293) (502) (1,771) (6,199) (8,921) (5,355) 370 583 4,306 117 (6) (357) 208 (1,216) 1,238 (1,932) (493) (576) (576) (735) (1,129) (1,308) (1,750) 110 132

Table 8: Key Ratios (Year ending March 31) FY07 FY08E FY09E

Table 6: Balance Sheet Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Total Assets

FY07 Operating Cash flow 6,520 Working Capital changes 119 Capital Commitments (9,853) Net Operating FCF (3,214) Investing Activities 101 Issue of Share Capital 696 Buyback of shares Inc(Dec) in Borrowings 5,085 Dividend paid (501) Extraordinary Items (302) Chg. in Cash & Bank 1,866 Source: Company data, I-Sec Research

FY10E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

18.4 20.7 22.3 1.0 23.5

25.0 24.0 29.2 1.5 49.4

27.2 26.2 32.1 1.8 78.5

31.5 30.3 36.8 1.8 111.8

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

46.3 181.4 1,239.5 1,175.9 271.7

35.8 55.7 46.7 16.1 30.9

24.8 23.6 8.9 8.9 9.7

17.0 14.3 15.7 15.7 14.8

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

8.7 8.0 7.7 8.1 2.7 9.0

7.5 6.1 3.6 6.2 2.3 10.8

6.9 5.6 2.3 5.1 1.9 7.6

5.9 4.9 1.6 4.3 1.6 7.2

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (days) Receivables (days) Payable (days) D/E Ratio (x)

10.6 8.3 2.1 2.7 0.3 4.5 35.1 31.2 1.5

9.4 6.8 2.5 22.5 0.3 4.2 34.6 30.9 0.9

10.1 6.3 2.1 33.0 0.3 4.1 35.0 30.9 0.7

10.3 6.1 1.9 33.0 0.3 3.9 35.0 31.9 0.5

Profitability Ratios (%) Rec. Net Income Margins 21.1 RoCE 21.7 RoNW 43.0 Dividend Payout 4.8 Source: Company data, I-Sec Research

22.8 27.6 40.0 6.2

19.9 28.6 30.6 6.7

19.7 27.9 26.7 5.8

India Cements, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Capex plans ..........................................................................................................64 Table 2: Key markets and market share.............................................................................65 Table 3: Power sources ......................................................................................................66 Table 4: Performance trend and forecast assumptions ......................................................68 Table 5: Profit and Loss Statement ....................................................................................72 Table 6: Balance Sheet.......................................................................................................72 Table 7: Cash Flow Statement............................................................................................72 Table 8: Key Ratios.............................................................................................................72

Charts Chart 1: Market share trends ..............................................................................................64 Chart 2: Power and fuel costs.............................................................................................66 Chart 3: Key cost trends .....................................................................................................67 Chart 4: Sales, EBITDA and EBITDA margin movement ...................................................68 Chart 5: EBITDA/ te ...........................................................................................................69 Chart 6: Positive FCF from FY08........................................................................................69 Chart 7: RoCE and RoE trends...........................................................................................70 Chart 8: Rolling P/E bands..................................................................................................71 Chart 9: Rolling EV/E bands ...............................................................................................71

73

India Cements, April 21, 2008

ICICI Securities

This page has been intentionally left blank

74

Equity Research April 21, 2008 BSE Sensex: 16481

INDIA

JK Cement Cement

BUY

Cost-pruning to fructify

Rs150

Reason for report: Initiating coverage Shareholding pattern Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Sept '07 61.6

Dec '07 61.6

Mar '08 61.6

24.2 5.4 3.9 14.8 14.3

23.5 4.4 4.0 15.1 14.9

21.4 4.0 4.0 13.4 17.1

f Volume upside. JKCL is expected to register robust volumes even in the face of imminent supply shortage. The company is expected to add 0.4mnte from April ’08. Further, the company’s 3mnte Karnataka project is likely to be operational by mid FY10E. Consequently, the company would continue posting impressive volumes in both FY09E and FY10E.

Price chart

Apr-08

Jan-08

Nov-07

Sep-07

Jun-07

260 240 220 200 180 160 140 120 Apr-07

(Rs)

Rajasthan-based JK Cement (JKCL) primarily caters to northern Indian markets. The company was incorporated post restructuring of JK Synthetics and is engaged in the production of both grey and white cement at present. JKCL is likely to see improvement in both volume growth and cost savings in the next couple of years. The stock is attractively valued on an EV/te of US$101 and FY09E P/E of 2.9x. We initiate coverage with BUY recommendation.

f Cost control initiatives to bear fruit. JKCL has invested ~Rs2.5bn towards costcutting measures, which involve a 20MW pet coke-based captive power plant and 13.2MW waste-heat recovery plant as well as replacement of its 7.5MW turbine with a 10MW one. The company is expected to operate with 100% captive power on the back of these measures. Full benefits from captive power would start flowing from beginning FY09E, thereby minimising impact of rising fuel costs. f Earnings growth to impress. We expect JKCL to register a strong 20% bottomline growth over FY08-10E, aided primarily by cost-reduction measures. However, freecash flows (FCFs) are expected to turn negative in FY09E as the 3mnte plant at Karnataka would require an investment of Rs10.5bn. Despite borrowing Rs5.5bn for the plant, the D/E is expected to rise only marginally to 0.7x in FY09E before falling to 0.4x in FY10E. f High prospects of re-rating. JKCL’s valuations seem attractive at FY09E and FY10E P/E of 2.9x and 2.5x respectively. The company is likely to see a re-rating, with savings from power expected to improve margins. We estimate fair value of Rs209/share (FY09E P/E of 4x), implying a 39% potential upside. Initiate coverage with BUY recommendation. Market Cap

Rs10.5bn/US$260mn

Reuters/Bloomberg

JKCE.BO/JKCE IN

Shares Outstanding (mn) 52-week Range (Rs)

257/123

Free Float (%) FII (%)

Novonil Guha [email protected] +91 22 6637 7385

69.9

Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs)

38.4

% Chg YoY

13.4

P/E (x)

FY07

FY08E

FY09E

FY10E

12,333

14,901

16,761

21,872

1,786

2,926

3,625

4,236

25.5

41.8

51.8

60.6

448.0

63.8

23.9

16.8

5.9

3.6

2.9

2.5

30.3

47.7

58.5

70.9

EV/E (x)

4.4

3.2

3.2

2.4

Dividend Yield

2.3

3.3

3.5

3.0

(13.3)

RoCE (%)

31.4

35.6

32.7

30.5

(18.8)

RoE (%)

41.2

45.1

38.1

32.1

Daily Volume (US$'000)

9,850

CEPS (Rs)

Absolute Return 3m (%)

(18.4)

Absolute Return 12m (%)

(30.6)

Sensex Return 3m (%) Sensex Return 12m (%)

Please refer to important disclosures at the end of this report

ICICI Securities

JK Cement, April 21, 2008

Key player in supply-deficit market North to continue seeing impressive demand JKCL is a key player in northern Indian markets, with an installed capacity of ~4mnte of grey cement and 0.5mnte of white cement. JKCL’s plants, located in Nimbehera and Mangrol in Rajasthan, primarily cater to the northern markets, where the company has ~7% market share, with Haryana, Rajasthan and Delhi being key markets. In FY07, the northern region (including Uttar Pradesh) consumed ~46mnte of cement. We expect the region to grow over 10%, driven by the strong boom in real estate, hydro power projects and incremental demand for the Common Wealth Games 2010. While the region is facing supply shortage (YTDFY08; capacity utilisation including inoperative capacities in the region was 101%) at present, we feel that the market would easily absorb recently commissioned capacities (of Grasim, Shree Cement), with some supplies moving to Gujarat. Consequently, we expect prices in the region to remain firm.

Volume growth expected from acquisition of Nihon Nirman JKCL added 0.5mnte in August ’06 and is expected to add a further 0.4mnte by April ’08 via Nihon Nirman, a 0.1mnte white cement plant acquired by JKCL in January ’07. JKCL expects to convert it into a 0.4mnte grey cement plant and commission it by April ’08, thereby ensuring volume growth in the face of supply tightness in the industry. Table 1: Key markets and market share Market share (%)

% of total despatches

9-yr consumption CAGR (%)

Share of total consumption (%)

3.4 20.0 4.3 8.9 14.5 0.6

16.8 30.7 7.8 22.4 11.9 0.2

8.9 12.2 6.0 9.9 3.2 13.0

12.2 3.8 4.4 6.1 2.0 0.8

West Gujarat

1.6

4.4

4.5

6.8

Central Madhya Pradesh

3.3

5.8

9.8

7.0

8.1

100.0

North Uttar Pradesh & Uttaranchal Haryana Punjab Rajasthan Delhi Jammu & Kashmir

Total 2.4 100.0 Source: Cement Manufacturers Association (CMA), I-Sec Research

76

ICICI Securities

JK Cement, April 21, 2008

Efficiency improvement and capex on track Cost-cutting measures to bear fruit in FY09E JKCL’s high dependence on grid power led to enhanced power and fuel costs, resulting in lower margins than peers. Consequently, the company undertook an aggressive restructuring exercise to reduce its dependence (by setting up captive power plants) and planned a 20MW pet coke-based power plant and a 13.5MW waste-heat recovery-based power plant at Nimbehera. Further, the company is likely to replace its 7.5MW turbine at its power plant in Bamania, Rajasthan with a 10MW one. While the pet coke-based power plant has already been commissioned in Q3FY08, the waste-heat recovery plant would be commissioned in a phased manner in Q3/Q4FY08 as it would have to be hooked up with kilns inline with scheduled maintenance shutdowns. Table 2: Captive power consumption and per unit rate

13MW waste heat recovery CPP 20MW pet coke-based CPP Total/average rate Source: I-Sec Research

FY08E mn units (MU) 7 53 60

FY09E MU 84 127 210

rate/unit 0.35 2.71 2.44

rate/unit 0.35 2.75 1.80

Post commissioning of the plants, we expect significant reduction in the per-unit cost of power. While the average cost is ~Rs4.5/unit at present, cost of power from the pet coke unit is expected to be just Rs2.75/unit (initially, expected at ~Rs2.25/unit but, following sharp rise in pet coke prices, cost of generation is also expected to increase). Further, at the waste-heat recovery plant, costs are even lower at ~Rs0.35/unit. Consequently, average cost of power from the company’s captive units would be below Rs2/unit. We believe that the lower cost of power along with the strong cement-price outlook would significantly contribute to margin improvement. Chart 1: Power and fuel costs 850

5.0

Pow er & Fuel Average per unit cost of pow er (RHS)

800

4.5

750

(Rs/te)

650 3.5 600 550

3.0

500 2.5

450 400

2.0 FY06

FY07

Source: Company data, I-Sec Research

FY08E

FY09E

FY10E

(Rs/KwH)

4.0

700

ICICI Securities

JK Cement, April 21, 2008 Chart 2: Key cost trend 1,400

Pow er & Fuel Rs/tonne

Freight

EBITDA/tonne

1,200

(Rs/te)

1,000 800 600 400 200 0 FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Also, the company’s power plants would be entitled to income-tax exemption under Section 80IA for the next ten years, which would reduce effective tax rate for the company to 24% from ~33% at present.

Capex plans and funding on track JKCL has already announced plans to set up a 3mnte plant in Karnataka, to be located in Mugdol and in proximity to the Bangalore market. Further, the nearest cement plant is located at 600km from the proposed location. We expect the plant to be commissioned in Q2FY10E. The unit would have clinker capacity of 2.3mnte and, based on the blend of fly ash and slag, production could increase to as high as 3.5mnte. We expect the blending ratio to be conservative at 1.3x. Total cost of the Karnataka project is expected to be ~Rs10.5bn. With prices reigning at all-time highs and expected to rise further, JKCL is likely to generate operating cashflows of ~Rs12.2bn over the next three years. Hence, despite expected borrowings of ~Rs5.5bn, the company’s D/E is likely to remain benign till FY10. While the cost of setting up CPPs (~Rs 2.5bn) would be met via the equity issue in February ‘06, operating cash flows for FY07 (~Rs1.7bn) would be used to part finance the Nihon Nirman acquisition & upgradation (~Rs1.1bn).

78

ICICI Securities

JK Cement, April 21, 2008

White cement – Low growth but stable business JKCL is the country’s second-largest producer of white cement, with a 0.4mnte capacity, located at Gotan in Rajasthan. The white cement industry has grown ~4% over the past ten years. It is seen as a high-end product, primarily for aesthetic use. Further, unlike grey cement that has no substitute, white cement constantly faces threat from substitutes such as marble and the ceramic-tile industry. The white cement production process is slightly different from that of grey cement and involves higher cost of production. •

Impurities such as iron, manganese, titanium and chromium have to be physically removed from limestone (involving higher mining costs) as against mechanised mining, which is not viable

•

China clay is then mixed with limestone and ground before being fed to the kiln

•

Coal-based fuels cannot be used to heat kilns as ash residue would affect the ‘whiteness’ of clinker. Hence, petroleum-based fuels (that are costlier), are used in kilns

•

Cooling of clinker needs absence of oxygen to prevent colour addition to the clinker due to oxidisation

Despite only two major players (Grasim and JKCL) in the white cement industry, it is expected to see only moderate rise in both volumes and prices mainly due to stiff competition from substitutes. JKCL plans to focus on value-added products such as wall putty that would help it achieve higher realisations. Table 3: White cement operating parameters (’000 te) Capacity Production Sales Gross realisations (Rs/te) Source: I-Sec Research

FY06 350 227 221 7,219

FY07 400 249 247 7,342

FY08E 400 254 254 7,599

FY09E 400 262 262 7,751

FY10E 400 268 268 7,751

We expect white cement volumes to grow ~3% and 2% in FY09 and FY10 respectively. Further, we believe that white cement realisations would rise ~2% in FY09 and remain flat in FY10.

ICICI Securities

JK Cement, April 21, 2008

Estimate 20% earnings CAGR through FY08-10E Table 4: Performance trend and forecast assumptions (’000 te) FY07 4,000 3,641 91 3,640 4 3,554 35

Capacity Production Capacity utilisation (%) Sales (mnte) Growth (%) Realisations (Rs/te) Growth (%) Source: I-Sec Research

FY08E 4,400 3,806 87 3,806 5 4,186 18

FY09E 4,400 4,136 94 4,136 9 4,354 4

FY10E 7,400 5,542 75 5,542 34 4,354 0

Volumes – Main revenue driver. JKCL acquired Nihon Nirman, a white cement plant with 0.1mnte capacity, in January ’07. The company is in the process of converting this plant into a 0.4mnte capacity grey cement one by April ’07. This would help boost volumes in FY09E. Further, JKCL’s Karnataka plant is expected to be commissioned by Q4FY09E; however, we have assumed a six-month delay for its commissioning, given delays in fresh capacities at present. Consequently, we expect ~9% and 34% rise in volumes in FY09E and FY10E respectively. We estimate realisations to rise 4% in FY09E and remain flat in FY10E. Overall, topline is expected to post CAGR of 21% over the next two years. JKCL’s installed capacity is likely to be 4.4mnte by April ’08. However, this rated capacity is on the basis of a 70:30 PPC-to-OPC mix. Since the company is receiving Government orders (that include only OPC cement) at present at Rs20/bag higher prices than market price of PPC, it has raised share of OPC production to 50%. Consequently, despite an effective capacity of 4.4mnte (including Nihon Nirman) in FY09E, we have assumed sales of only 4.1mnte. Chart 3: Sales, EBITDA and EBITDA margin movement line light 25,000

Net sales

EBITDA

EBITDA Margin (RHS)

35 30

20,000

15,000

20

10,000

15 10

5,000 5 0

0 FY06

FY07

Source: Company data, I-Sec Research

80

FY08E

FY09E

FY10E

(%)

(Rs mn)

25

ICICI Securities

JK Cement, April 21, 2008

Cost savings to help margin expansion. Cost savings along with cement price improvements are likely to boost FY09E margins despite sharp rise in fuel costs. With pet coke and waste-heat recovery plants already commissioned in September ’07 and February ’08 respectively, a substantial part of the benefit from lower costs would accrue in FY09E too. However, margins would be under pressure in FY10E due to limited upside on prices. We expect JKCL’s EBITDA/te to jump to Rs1,249 in FY09E from Rs1,091 in FY08 before declining to Rs1,177 in FY10E. Chart 4: EBITDA/te 1,400 1,200

(Rs/te)

1,000 800 600 400 200 0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

JKCL is expected to register interest cost CAGR of 29% over FY08-10E, mainly on account of borrowings for the expansion at Karnataka. The company will benefit from lower effective tax rate via exemptions under Section 80IA for power plants. Consequently, with effective tax rate at 24% over the next two years, we expect PAT to post an impressive CAGR of 20% over FY08-10E. Chart 5: Negative FCF from FY08 due to capex for Karnataka plant

(Rs mn)

D/E (RHS)

1.8

1,000

1.6

0

1.4

(1,000)

1.2

(2,000)

1.0

(3,000)

0.8

(4,000)

0.6

(5,000)

0.4

(6,000)

0.2

(7,000)

0.0 FY06

FY07

Source: Company data, I-Sec Research

FY08E

FY09E

FY10E

(x)

Free Cashflow

2,000

ICICI Securities

JK Cement, April 21, 2008

The cost of the Karnataka project is ~Rs10.5bn, which includes a 50MW captive power plant. While JKCL is expected to borrow Rs5.5bn for the project, the balance would be met via internal accruals. However, we have assumed a ~six-month delay in commissioning of the plant. This would enable further cash accruals of six months for the company. Consequently, the FCF would turn negative in FY09E before turning positive in FY10E, thereby leading to D/E rising to 0.7x in FY09E before falling to 0.4x in FY10E. Chart 6: RoCE and RoE trends 50

40

(%)

30

20

10

0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Buoyed by robust cement prices over the past couple of years, JKCL’s return ratios saw significant jump till FY07. However, large capex for the Karnataka plant would result in return ratios dipping as return from investments in Karnataka would start flowing in only from FY10E.

82

ICICI Securities

JK Cement, April 21, 2008

Inexpensive valuations We value JKCL at FY09E and FY10E P/E of 2.9x and 2.5x and EV/E of 3.2x and 2.4x respectively. On the EV/te front, the company is valued at US$101. Historically, the company’s poor operational efficiencies have been reflected in valuations. However, with the company expected to achieve operating margins of over 30% supported by cost-cutting initiatives coupled with 20% CAGR over the next two years, we expect it to get re-rated. Based on FY09E P/E of 4x, we target a price of Rs208, an upside of 39% from current levels. We initiate coverage with a BUY rating. Chart 7: P/E bands 400 350 7x

300 (Rs)

250 5x

200 150 3x 100 50

Apr-08

Jan-08

Oct-07

Aug-07

May-07

Feb-07

Nov-06

Aug-06

Jun-06

Mar-06

Dec-05

Sep-05

Jun-05

0

Source: Bloomberg, I-Sec Research

Chart 8: EV/EBITDA bands 30,000 9x

(Rs mn)

25,000 7x

20,000 15,000

5x

10,000

Source: Bloomberg, I-Sec Research

Apr-08

Jan-08

Nov-07

Sep-07

Jul-07

May-07

Mar-07

Jan-07

Nov-06

Sep-06

Jul-06

May-06

Mar-06

Jan-06

Nov-05

Sep-05

Jun-05

5,000

ICICI Securities

JK Cement, April 21, 2008

Summary financials Table 5: Profit and Loss Statement

Table 7: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31) FY04 12,333

Operating Income (Sales) of which Domestic 12,333 Operating Expenses 9,042 EBITDA 3,292 % margin 26.7 Depreciation & Amortisation 332 Gross Interest 529 Other Income 288 Recurring PBT Add: Extraordinaries Less: Taxes 934 - Current tax 718 - Deferred tax 215 Less: Minority Interest (3) Net Income (Reported) 1,786 Recurring Net Income 1,786 Source: Company data, I-Sec Research

FY05E 14,901

FY06E 16,761

FY07E 21,872

14,901 10,472 4,429 29.7 411 438 171 825 675 150 (2) 2,926 2,926

16,761 11,267 5,495 32.8 463 430 169 108 1,145 906 239 (1) 3,625 3,625

21,872 15,032 6,840 31.3 725 738 196 522 1,338 1,059 279 4,236 4,236

Table 6: Balance Sheet (Rs mn, year ending March 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Capital Work-in-Progress Goodwill Total Assets

FY04

FY05E

FY06E

FY07E

5,311

4,335

4,635

5,447

1,925 2,146 3,165 159 53 106 9,224

616 2,641 1,694 212 53 160 10,950

647 2,563 2,072 292 53 239 11,024

841 2,670 2,777 412 53 359 20,835

1,644 11,145

2,500 12,422

8,798 19,364

750 22,067

7,699 467 699 10 13,337 17 11,198 19,364

6,349 486 699 10 17,258 17 15,232 22,067

Liabilities Borrowings 5,577 4,147 Deferred Tax Liability 432 449 Minority Interest Equity Share Capital 699 699 Face value per share (Rs) 10 10 Reserves & Surplus* 7,502 10,078 Less: Misc. Exp # 17 17 Net Worth 5,136 7,826 Total Liabilities 11,145 12,422 Source: Company data, I-Sec Research *excluding revaluation reserves; # = not written off

FY04 FY05E Operating Cash flow 2,461 3,350 Working Capital changes (1,214) 92 Capital Commitments (1,830) (2,956) Net Operating FCF (583) 486 Investing Activities 182 117 Issue of Share Capital Buyback of shares Inc(Dec) in Borrowings (245) (1,430) Dividend paid (245) (350) Extraordinary Items (39) (133) Chg. in Cash & Bank (929) (1,309) Source: Company data, I-Sec Research

Table 8: Key Ratios (Year ending March 31) FY04

FY05E

FY06E

FY07E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

25.5 25.5 30.3 3.5 29.9

41.8 41.8 47.7 5.0 70.0

51.8 51.8 58.5 5.3 119.8

60.6 60.6 70.9 4.5 179.1

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

41.2 149.3 448.0 448.0 233.0

20.8 34.6 63.8 63.8 57.6

12.5 24.1 23.9 23.9 22.5

30.5 24.5 16.8 16.8 21.3

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

5.9 4.9 5.0 3.2 1.0 4.2

3.6 3.1 2.1 3.2 1.1 4.7

2.9 2.6 1.2 2.4 0.7 3.6

2.5 2.1 0.8 1.7 0.4 1.8

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (days) Receivables (days) Payable (days) D/E Ratio (x)

9.8 2.5 10.6 34.3 11.1 5.9 13.9 41.7 1.2

9.5 2.5 4.5 22.0 8.7 5.4 14.6 39.4 0.6

8.9 2.5 3.5 24.0 7.4 5.0 15.3 42.7 0.7

9.7 2.5 3.5 24.0 8.8 5.9 14.3 32.8 0.4

19.4 35.6 45.1 11.9

21.4 32.7 38.1 10.1

19.2 30.5 32.1 7.4

Profitability Ratios (%) Rec. Net Income Margins 14.2 RoCE 31.4 RoNW 41.2 Dividend Payout 13.7 Source: Company data, I-Sec Research

84

FY06E FY07E 4,146 4,961 (371) (466) (6,798) (2,452) (3,023) 2,043 89 76 3,552 (1,350) (367) (315) (221) (260) 31 194

JK Cement, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Key markets and market share.............................................................................76 Table 2: Captive power consumption and per unit rate ......................................................77 Table 3: White cement operating parameters.....................................................................79 Table 4: Performance trend and forecast assumptions ......................................................80 Table 5: Profit and Loss Statement ....................................................................................84 Table 6: Balance Sheet.......................................................................................................84 Table 7: Cash Flow Statement............................................................................................84 Table 8: Key Ratios.............................................................................................................84

Charts Chart 1: Power and fuel costs.............................................................................................77 Chart 2: Key cost trend .......................................................................................................78 Chart 3: Sales, EBITDA and EBITDA margin movement line light.....................................80 Chart 4: EBITDA/te .............................................................................................................81 Chart 5: Negative FCF from FY08 due to capex for Karnataka plant.................................81 Chart 6: RoCE and RoE trends...........................................................................................82 Chart 7: P/E bands..............................................................................................................83 Chart 8: EV/EBITDA bands.................................................................................................83

JK Cement, April 21, 2008

ICICI Securities

This page has been intentionally left blank

86

Equity Research April 21, 2008 BSE Sensex: 16481

INDIA

Shree Cement Cement

Proficient performer

Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Sept '07 63.7

Dec '07 63.7

Mar '08 63.7

14.1 6.3 0.8 7.0 22.2

14.4 5.8 1.3 7.3 21.9

14.8 6.5 0.7 7.7 21.5

Price chart 1,700 1,500 1,300 1,100

Jan-08

Apr-08

Nov-07

Jun-07

Sep-07

Apr-07

900

Shree Cement (SCL) is the most efficient cement manufacturer in India at present, with inherent cost advantages from lower lead distances to markets and usage of 100% pet coke as fuel. SCL has regularly augmented capacities over the past couple of years, which would help it post the highest topline growth amongst cement companies in the I-Sec universe. Despite an expected earnings CAGR of 70% over the next two years, the company is valued at FY09E and FY10E EV/E of 3.1x and 2.2x respectively. We initiate coverage with a BUY recommendation, targeting a price of Rs1,686/share over next 12-18 months. f Highest volume growth amongst peers. SCL has added 3mnte capacity since September ’07, taking its total installed capacity to 9mnte. The company has also commissioned a 3mnte grinding unit at Khushkhera, Rajasthan over the same period. This would help it register volume growth of 31% and 21% in FY09E and FY10E respectively as well as push up overall revenues 31% over the next two years. f Margins to be under pressure. SCL is the only cement company in India to use 100% pet coke at its kilns and captive power plants (CPPs). While pet coke has the least amount of ash content and high calorific value that enhances operating efficiencies, the raw material prices have seen sharp rise in line with rising crude prices. While the split grinding unit at Khushkhera should help savings in freight, overall margins are likely to see marginal contraction. f Earnings growth to impress. SCL’s strong topline growth would directly help post PAT CAGR of 70% over the next two years. Also, the company is expected to generate free cash flows (FCFs) of ~Rs13.3bn over FY08-10E, with substantial capex plans already reaching completion. Strong cash generation should aid a sharp fall in D/E to ~0.6x in FY10E from 1.7x in FY08. f Attractive valuations. At FY09E and FY10E EV/E of 3.1x and 2.2x respectively and EV/te of US$106, SCL’s valuations are inexpensive. The company is expected to register the highest earnings growth amongst peers, which should drive stock rerating. We estimate fair value of Rs1,686/share (FY09E EV/E of 5.1x), implying a 56% potential upside. Initiate coverage with BUY recommendation. Market Cap

Rs37.6bn/US$939mn

Reuters/Bloomberg

SHCM.BO/SRCM IN

Shares Outstanding (mn) 52-week Range (Rs)

[email protected] +91 22 6637 7385

34.8 1700/900

Free Float (%)

Novonil Guha

Rs1,078

Reason for report: Initiating coverage

Shareholding pattern

(Rs)

BUY

36.3

Year to March Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY

FII (%)

7.7

P/E (x)

Daily Volume (US$'000)

203

CEPS (Rs)

Absolute Return 3m (%)

(15.7)

Absolute Return 12m (%)

(22.4)

Sensex Return 3m (%) Sensex Return 12m (%)

FY07

FY08E

FY09E

FY10E

14,055

19,575

27,490

33,353

1,575

2,869

6,099

8,200

45.2

82.4

175.1

235.4

297.3

82.1

112.6

34.4

23.8

13.1

6.2

4.6

169.5

214.6

268.5

322.7

EV/E (x)

7.3

5.1

3.1

2.2

Dividend Yield

0.6

2.3

2.8

3.3

(13.3)

RoCE (%)

17.0

26.7

44.4

44.4

(18.8)

RoE (%)

42.0

51.7

67.2

54.4

Please refer to important disclosures at the end of this report

ICICI Securities

Shree Cement, April 21, 2008

Timely capex to boost growth Only player to commission capacities prior to schedule In the current scenario, where most cement equipment manufacturers boast of full order books, large capacity additions are expected to get delayed. However, over the past couple of years, SCL has consistently managed to commission its expansions on or before the scheduled date. SCL follows a strategy of planning relatively smaller capacities that aid quicker implementation as many ancillary components such as mills, switch gears etc can be sourced from various suppliers, thus avoiding delay in supply. On the other hand, larger capacities would require components from few suppliers that have specific capabilities; this could delay overall project implementation. Table 1: Capacity additions Plants Unit III Unit IV Unit V Grinding units Grinding units Unit VI Unit VII Source: Company data

Location Ras, Rajashtan Ras, Rajashtan Ras, Rajashtan Khushkhera, Rajashtan Khushkhera Rajashtan Ras, Rajashtan Ras, Rajashtan

Time of commissioning February ’06 March ’07 September ’07 September ’07 December ’07 March ’08 H2FY10

Capacity (mnte) 1.5 1.5 1.5 2.0 1.5 1.5 1.0

SCL’s unit V along with phase I of the grinding unit at Khushkhera was commissioned almost three months prior to schedule. Further, commissioning of its unit VI, which was moved forward ~six months, recently got commissioned. Post addition of unit VI, SCL’s installed capacity has increased to ~9mnte from ~4.5mnte at end FY06. Also, the company is implementing another 1mnte expansion, expected to be operational by Q2FY10. Whilst most cement players have witnessed muted volume growth due to capacity constraints, SCL has and would take full advantage of the robust cement demand.

SCL to continue gaining market share in key markets SCL is amongst the largest players in northern India and the market leader in Rajasthan and Delhi. Further, the company is the second-largest supplier in Haryana. With commissioning of its Khushkhera grinding unit (located near Gurgaon, Haryana), we expect the company to gain market leadership in Haryana too by FY09E. With the company’s timely capacity additions, market share in other key markets is also likely to see further boost.

88

ICICI Securities

Shree Cement, April 21, 2008 Table 2: Key markets and market share Market share (%) North Uttar Pradesh & Uttaranchal Haryana Punjab Rajasthan Delhi Jammu & Kashmir Total Source: Company data, I-Sec Research

% of total despatches

9-yr consumption CAGR (%)

share of consumption (%)

16.9 22.1 9.9 38.7 11.1 1.2 99.8

8.9 12.2 6.0 9.9 3.2 13.0 8.1

12.2 3.8 4.4 6.1 2.0 0.8 100.0

4.5 19.0 7.3 20.4 17.9 4.5 3.2

Cement demand in northern India is expected to see substantial growth from various infrastructure projects, especially hydro power and the Common Wealth Games 2010. SCL will likely benefit from the robust demand and also register the highest volume growth amongst peers in FY09E. Chart 1: Key market share trends 24

Haryana

Punjab

Rajasthan

Delhi

20

(%)

16

12 8 4 FY05

FY06

Source: Cement Manufacturers Association (CMA), I-Sec Research

FY07

ICICI Securities

Shree Cement, April 21, 2008

Remains most efficient player Power & fuel costs advantage SCL is the only company in India to use 100% pet coke as fuel for its kilns and power plants. Pet coke has the advantage of being the cheapest in terms of cost per kcal compared with domestic/imported coal. Further, pet coke has the lowest percentage of ash content, thus resulting in higher kiln efficiency. SCL’s major power requirement is met via captive pet coke-based power plants. Whilst cost of pet coke has seen significant rise in line with cost of petroleum products, per unit cost would still be cheaper than domestic or imported coal, the cost of which has also risen. Chart 2: Power & fuel costs trend 800

Pow er & Fuel

700

Average per unit cost of pow er (RHS)

3.0 2.5

600 (Rs/te)

400

1.5

300

(Rs/kWh)

2.0

500

1.0

200 0.5

100 0

0.0 FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Locational advantage helps lower freight cost SCL has the distinct advantage of its plants being located in proximity to its key markets. Consequently, average lead distances for the company are much lower visà-vis competitors. However, rising fuel costs are expected to translate into higher road freight for all cement players in FY09. Commissioning of the company’s 3.5mnte grinding unit at Khushkhera, Rajasthan is expected to partly mitigate impact of higher freight costs. Fly ash would be sourced from the Panipat Thermal Station nearby, reducing cost of fly ash. Cement from this unit would primarily cater to the Haryana market.

90

ICICI Securities

Shree Cement, April 21, 2008 Chart 3: Key cost trend 1,600

Pow er & Fuel

Freight

EBITDA/tonne

1,400 1,200 (Rs/te)

1,000 800 600 400 200 0 FY05

FY06

Source: Company data, I-Sec Research

FY07

FY08E

FY09E

FY10E

ICICI Securities

Shree Cement, April 21, 2008

Estimate 70% earnings CAGR over FY08-10E Table 3: Performance trend and forecast assumptions (’000 te) FY07 6,000 4,799 80 4,833 51 3,338 30

Capacity Production Capacity utilisation (%) Sales (mnte) Growth (%) Realisations (Rs/te) Growth (%) Source: I-Sec Research

FY08E 7,500 5,985 80 5,985 24 3,889 17

FY09E 9,000 7,830 87 7,830 31 4,044 4

FY10E 10,000 9,500 95 9,500 21 4,044 0

Volumes boost strong revenue growth. SCL is likely to see very impressive volume growth aided by capacity additions (3mnte) in FY08. The company’s strategy of planning smaller capacities and commissioning them prior than scheduled would help it post highest volume growth amongst peers. We expect the company to post 31% and 21% rise in volumes in FY09E and FY10E respectively. We have assumed 4% and 0% improvement in realisations in FY09E and FY10E respectively. We expect the company’s topline to post CAGR of 31% over the next two years. Chart 4: Sales, EBITDA and EBITDA margin movement 40,000

Net sales

EBITDA

EBITDA Margin (RHS)

35,000

45% 40%

(Rs mn)

30,000 35%

25,000 20,000

30%

15,000

25%

10,000 20%

5,000 0

15% FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Margins to come under pressure. While SCL’s topline is likely to see an impressive rise, higher input costs (especially pet coke) and rising freight costs are expected to pressurise operating margins. Consequently, we expect EBITDA margin to decline marginally ~67bps to 40.4% in FY09E and further 68bps to 39.7% in FY10E. We estimate the company’s EBITDA/te to rise to Rs1,418 in FY09E, before falling to Rs1,394 in FY10E.

92

ICICI Securities

Shree Cement, April 21, 2008 Chart 5: EBITDA/te 1,600 1,400 1,200 (Rs/te)

1,000 800 600 400 200 0 FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

SCL’s interest cost is expected to rise with the commissioning of units V & VI and the grinding unit at Khushkhera at end-FY08. SCL has been charging depreciation on the WDV (written down value) as per the Income Tax Act, 1961. Thereby, depreciation should see substantial decline in FY09E and FY10E. Post assuming an effective tax rate of ~25% for the next couple of years, we expect the company to post earnings CAGR of 70% over the next two years. Chart 6: Strong FCF over next couple of years 7,000

Free Cashflow

2.5

D/E (RHS)

6,000 2.0

5,000

3,000

1.5 (x)

(Rs mn)

4,000

2,000 1,000

1.0

0 (1,000)

0.5

(2,000) (3,000)

0.0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

SCL should see robust cash generation over the next two years, partly aided by firm cement prices and incremental volumes. We expect the company to generate FCFs of ~Rs13.3bn over the next two years. The company’s D/E should also see a sharp fall to ~0.6x in FY10 from 1.7x in FY08.

ICICI Securities

Shree Cement, April 21, 2008 Chart 7: RoCE and RoE trends 80

RoCE

RoE

70 60

(%)

50 40 30 20 10 0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Buoyed by rising cement prices over the past couple of years, most cement companies saw a sharp jump in their return ratios over the period. SCL would see its RoCE stabilising over the next two years, while return-on-equity could decline in FY10E.

94

ICICI Securities

Shree Cement, April 21, 2008

Inexpensive valuations SCL is valued at FY09 and FY10 P/E of 6.2x and 4.6x and EV/E of 3.1x and 2.2x respectively. On the EV/te front, the company is valued at US$97. SCL is the most efficient cement manufacturer in India. SCL is likely to post the highest earnings growth (70%) amongst cement companies under I-Sec coverage. Hence, we believe that the current valuations are inexpensive, with the stock likely to get re-rated. Our target price of Rs1,686/share, which is a 56% upside from current levels, assumes an EV/E of 5.1x our FY09 estimates. Consequently, we initiate coverage with a BUY rating. SCL is our top pick in the sector. Chart 8: P/E bands 3,500 3,000 20x

(Rs)

2,500 2,000

13x

1,500 1,000 8x

500

Apr-08

Dec-07

Jun-07

Sep-07

Mar-07

Nov-06

Aug-06

May-06

Jan-06

Jul-05

Oct-05

Apr-05

Dec-04

Sep-04

Jun-04

Mar-04

Nov-03

Aug-03

May-03

Jan-03

Oct-02

Jul-02

Apr-02

0

Source: Bloomberg, I-Sec Research

Chart 9: EV/EBITDA bands 200,000 180,000 160,000 36x

(Rs mn)

140,000 120,000 100,000 80,000

28x

60,000 20x

40,000 20,000

Source: Bloomberg, I-Sec Research

Apr-08

Oct-07

Apr-07

Oct-06

Apr-06

Oct-05

Apr-05

Oct-04

Apr-04

Oct-03

Apr-03

Oct-02

Apr-02

0

ICICI Securities

Shree Cement, April 21, 2008

Summary financials Table 4: Profit and Loss Statement

Table 6: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31) FY07 14,055

Operating Income (Sales) of which Domestic 14,055 Operating Expenses 8,133 EBITDA 5,922 % margin 4,214 Depreciation & Amortisation 4,331 Gross Interest 104 Other Income 212 Recurring PBT 1,700 Add: Extraordinaries 195 Less: Taxes 124 - Current tax 852 - Deferred tax (727) Less: Minority Interest 1 Net Income (Reported) 1,770 Recurring Net Income 1,575 Source: Company data, I-Sec Research

FY08E 19,575

FY09E 27,490

FY10E 33,353

19,575 11,539 8,036 4,105 4,607 406 752 3,775 11 906 906 2 2,880 2,869

27,490 16,389 11,101 4,038 3,254 623 908 8,132 2,033 2,033 3 6,099 6,099

33,353 20,113 13,241 3,970 3,041 719 1,453 10,934 2,733 2,733 4 8,200 8,200

Table 5: Balance Sheet (Rs mn, year ending March 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Capital Work-in-Progress Total Assets

FY07

FY08E

FY09E

FY10E

7,741 3,533

12,662 7,631

18,755 12,974

26,673 20,758

2,846 4,895 500 500 5,482

3,479 9,183 500 500 7,875

4,553 14,202 500 500 6,592

4,468 22,205 500 500 7,751

3,438 13,822

471 17,483

1,200 21,946

595 30,503

10,375 (37) 348 10 11,753 11,609 21,946

11,986 (37) 1 348 10 18,699 18,555 30,503

Liabilities Borrowings 9,314 10,966 Deferred Tax Liability (37) (37) Minority Interest Equity Share Capital 348 348 Face value per share (Rs) 10 10 Reserves & Surplus* 4,689 6,698 Less: Misc. Exp # Net Worth 4,545 6,555 Total Liabilities 13,822 17,483 Source: Company data, I-Sec Research *excluding revaluation reserves; # = not written off

FY07 FY08E Operating Cash flow 5,718 6,718 Working Capital changes (1,573) (184) Capital Commitments (6,553) (4,034) Net Operating FCF (2,408) 2,500 Investing Activities 212 752 Issue of Share Capital Buyback of shares Inc(Dec) in Borrowings 5,586 1,652 Dividend paid (230) (871) Extraordinary Items 42 (0) Chg. in Cash & Bank 3,342 4,098 Source: Company data, I-Sec Research

FY10E 9,998 (430) (3,595) 5,974 1,453 1,611 (1,254) 0 7,784

Table 7: Key Ratios (Year ending March 31) FY07

FY08E

FY09E

FY10E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

50.8 45.2 169.5 6.6 116.3

82.7 82.4 214.6 25.0 174.0

175.1 175.1 268.5 30.0 319.1

235.4 235.4 322.7 36.0 518.5

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

102.3 167.1 297 297 1.9

39.3 35.7 82 82 0.3

40.4 38.1 113 113 0.3

21.3 19.3 34 34 0.2

Valuation ratio (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

23.8 6.4 9.3 7.3 3.1 10.4

13.1 5.0 6.2 5.1 2.1 6.3

6.2 4.0 3.4 3.1 1.3 4.0

4.6 3.3 2.1 2.2 0.9 3.0

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (days) Receivables (days) Payable (days) D/E Ratio (x)

11.5 4.9 12.5 6.5 9.9 7.0 5.0 56.0 2.0

10.3 4.6 19.9 23.9 8.9 6.2 6.3 60.1 1.7

12.1 4.4 11.2 25.0 5.6 5.6 7.4 60.9 0.9

12.0 4.3 13.3 25.0 4.7 6.2 7.9 54.8 0.6

14.1 26.7 51.7 30.4

21.5 44.4 67.2 17.1

23.6 44.4 54.4 15.3

Profitability Ratios (%) Rec. Net Income Margins 11.0 RoCE 17.0 RoNW 42.0 Dividend Payout 14.6 Source: Company data, I-Sec Research

96

FY09E 8,620 148 (2,700) 6,069 908 (591) (1,045) 5,342

Shree Cement, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Capacity additions.................................................................................................88 Table 2: Key markets and market share.............................................................................89 Table 3: Performance trend and forecast assumptions ......................................................92 Table 4: Profit and Loss Statement ....................................................................................96 Table 5: Balance Sheet.......................................................................................................96 Table 6: Cash Flow Statement............................................................................................96 Table 7: Key Ratios.............................................................................................................96

Charts Chart 1: Key market share trends .......................................................................................89 Chart 2: Power & fuel costs trend .......................................................................................90 Chart 3: Key cost trend .......................................................................................................91 Chart 4: Sales, EBITDA and EBITDA margin movement ...................................................92 Chart 5: EBITDA/te ............................................................................................................93 Chart 6: Strong FCF over next couple of years ..................................................................93 Chart 7: RoCE and RoE trends...........................................................................................94 Chart 8: P/E bands..............................................................................................................95 Chart 9: EV/EBITDA bands.................................................................................................95

Shree Cement, April 21, 2008

ICICI Securities

This page has been intentionally left blank

98

Equity Research April 21, 2008 BSE Sensex: 16481

INDIA

UltraTech Cement

BUY

Stalwart of success

Cement

Rs784

Reason for report: Initiating coverage Shareholding pattern Promoters Institutional investors MFs and UTI Insurance Cos. FIIs Others Source: CMIE

Sept '07 53.7

Dec '07 54.1

Mar '08 54.4

17.3 1.9 5.9 9.5 29.0

16.7 1.8 6.9 8.0 29.2

15.5 1.9 7.0 6.7 30.1

f Volumes to boost topline. While UTCL has already commissioned its 3.3mnte clinkerisation unit in Andhra Pradesh end-March ’08, its grinding unit is likely to be operational in the next couple of months. As a result, an additional 4.9mnte would help strong revenue growth going forward vis-à-vis the company facing capacity constraints in the past couple of years. Further, UTCL is implementing two grinding units in Gujarat along with port terminals, the benefits from which are likely to accrue largely in FY11E.

Price chart 1,200

f Captive power to aid margin expansion. UTCL would commission a 92MW lignite-based plant at Gujarat from April ’08 in a phased manner. Additionally, the company is expected to commission a 50MW thermal power plant (TPP) at Chhattisgarh and another 50MW TPP along with the Tadipatri expansion. Savings resulting from these two plants would help offset impact of rising international coal prices, thereby leading to margin expansion.

1,100 (Rs)

UltraTech Cement (UTCL), having witnessed capacity constraints in the past, is likely to benefit from commissioning of a 4.9mnte plant in Tadipatri, Andhra Pradesh. Besides volume growth, UTCL would see cost savings from commissioning of 190MW captive power in FY09E. The company’s impressive earnings of 21% over FY08-10E would be aided by improvement in both topline and margins. We believe that current valuations are inexpensive and initiate coverage with BUY recommendation, targeting a price of Rs1,105/share over the next 12-18 months.

1,000 900 800 Jan-08

Apr-08

Nov-07

Jun-07

Sep-07

Apr-07

700

f Earnings growth to impress. We expect UTCL to post earnings CAGR of 21% over the next two years, backed by both volume growth and cost savings. While the company’s FY09E free cash flow (FCF) should turn negative, an estimated free cash generation of Rs12bn in FY10E would ensure D/E falling to 0.4x. f Attractive valuations. UTCL is currently trading at attractive valuations of FY09E and FY10E EV/E of 5.4x and 4.4x respectively and EV/te of US$141. Although the company is comparable with ACC in terms of size and width of market presence at present, it is likely to achieve operating margins higher than ACC’s. We estimate a fair value of Rs1,105share (FY09E EV/E of 7.1x), which is a 41% upside from current levels. We initiate coverage with BUY recommendation. Market Cap Reuters/Bloomberg

Rs97.6bn/US$2.4bn ULTC.BO/UTCEM IN

Shares Outstanding (mn) 52-week Range (Rs) Free Float (%)

45.6

FII (%)

Novonil Guha [email protected] +91 22 6637 7385

124 1165/707 6.7

Year to March

FY07

FY08E

FY09E

FY10E

49,108

55,692

67,544

78,683

7,823

10,373

13,109

15,226

62.8

83.3

105.3

122.3

240.3

32.6

26.4

16.1

P/E (x)

12.5

9.4

7.4

6.41

Revenue (Rs mn) Net Income (Rs mn) EPS (Rs) % Chg YoY

Daily Volume (US$'000)

2,120

CEPS (Rs)

81.0

101.9

129.4

153.3

Absolute Return 3m (%)

(10.7)

EV/E (x)

8.3

6.8

5.4

4.4

Absolute Return 12m (%)

(22.6)

Dividend Yield

1.3

1.7

2.1

2.5

Sensex Return 3m (%)

(13.3)

RoCE (%)

36.0

37.0

37.4

36.0

Sensex Return 12m (%)

(18.8)

RoE (%)

55.8

47.4

41.6

35.3

Please refer to important disclosures at the end of this report

ICICI Securities

UltraTech Cement, April 21, 2008

New plant operations to boost growth Post Grasim’s acquisition of UTCL in ’03, UTCL was initially focusing on improving overall efficiencies, maximising existing volume potential through debottlenecking and improving its balance sheet. Thereafter, helped by higher cement prices, consequent cash generation and improvement in operational efficiency levels, the company embarked on a 4.9mnte brownfield capacity expansion along with a 50WM captive TPP in Tadipatri, Andhra Pradesh in mid ’06. A clinkerisation unit of 3.3mnte has just been commissioned while the grinding unit is expected to be operational in Q1FY09. UTCL’s volume growth has been muted in the past, primarily due to capacity constraints; however, with commissioning of new capacity, we expect impressive growth as the company gets full benefit of the robust demand.

Market leader in key markets Table 1: Key markets and market share Market share (%)

% of total despatches

8-year consumption CAGR (%)

Share of total consumption (%)

West Gujarat Maharashtra

29.6 21.9

16.6 27.9

4.5 7.2

6.8 12.2

South Tamil Nadu Karnataka Kerala Andhra Pradesh

7.2 12.0 4.6 7.1

6.9 10.0 2.4 6.5

7.4 11.2 6.8 8.5

8.6 7.5 4.7 8.2

East West Bengal Bihar & Jharkhand Orissa Assam

18.0 6.4 20.3 17.3

9.3 3.4 6.7 1.3

6.7 10.1 10.9 7.4

4.6 4.8 3.0 0.7

9.3

7.3

9.6

7.0

Total 9.7 98.3 Source: Cement Manufacturers Association (CMA), I-Sec Research

8.1

100

Central Madhya Pradesh and Chhattisgarh

UTCL’s key market is the western region, where the company is the market leader in Maharashtra and Gujarat. Maharashtra also happens to be the largest cement consuming state in India. UTCL and Grasim together hold ~35% market share in Maharashtra and ~39% market share in Gujarat. Further, UTCL is also a significant player in the South and East. UTCL, along with Grasim, is the market leader in Orissa (26%), Madhya Pradesh (22%), Chhattisgarh (33%) and Karnataka (30%). With significant presence in key markets coupled with synergy gains, especially in logistics and freight, we expect the company to post strong performance going forward. Further, commissioning of the second unit at Tadipatri would boost market share in Andhra Pradesh, Karnataka and Kerala. However, UTCL has negligible presence in the northern markets, which is primarily catered to by Grasim.

100

ICICI Securities

UltraTech Cement, April 21, 2008 Chart 1: Key market-share movement 35

Gujarat WB

Maharashtra Orissa

Karnataka

30

(%)

25 20 15 10 FY04

FY05

FY06

FY07

Source: CMA, I-Sec Research

101

ICICI Securities

UltraTech Cement, April 21, 2008

Captive power to moderate rising costs UTCL imports ~30% of total coal requirements at present and, hence, is exposed to sharp rise in prices of international coal and bulk freight rates. While the company is expected to see higher impact of fuel costs as against peers using domestic coal, commissioning of captive power plants would help partly neutralise the impact.

Investment in efficiency improvements to bear fruit UTCL has consistently focused on higher efficiencies and modernisation. Initial investments were aimed at achieving rated capacity (historically, UTCL has operated at very low utilisation due to production bottlenecks). High cost of power was also a concern for the management, thereby prompting it to set up captive power plants; UTCL is implementing three captive power plants totalling 175MW (excluding the 50MW brownfield expansion at Tadipatri). Of these plants, a 92MW lignite-based plant at Pipavav (Gujarat) is expected to be commissioned from Q1FY08 in a phased manner while a 50MW coal-based TPP at Hirmi (Chhattisgarh) is likely to be commissioned by September ’08. The lignite-based TPP will replace the current naphtha-based plant, which has become operationally unviable due to restrictive cost of naphtha. The company uses grid power at Gujarat at present and the lignite-based TPP would save over Rs2/unit of power. The TPP at Hirmi would be based on coal middlings (leftovers from coal washery), which are lower on calorific value and even lower on cost. The plant uses grid power at present and switching to captive power would result in ~Re1/unit savings in power costs. Overall, we expect ~Rs1bn savings for UTCL over the next couple of years. Chart 2: Power & fuel costs and average unit cost of power Pow er & Fuel

900

5

Average per unit cost of pow er (RHS)

800 4

600 3

500 400

2

300 200

1

100 0

0 FY06

Source: I-Sec Research

102

FY07

FY08E

FY09E

FY10E

(Rs/kWh)

(Rs/te)

700

ICICI Securities

UltraTech Cement, April 21, 2008 Chart 3: Key cost and EBITDA/te 1,400

Pow er & Fuel

Freight

EBITDA/tonne

1,200

(Rs/te)

1,000 800 600 400 200 0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Grinding units to have logistic and freight benefits Amongst other capex plans, UTCL is implementing two grinding units at Gujarat as well as port terminals along coastal Gujarat and Maharashtra. Consequently, the company would meet its western Maharashtra cement demand from Gujarat itself using the cheaper transportation mode of sea freight, resulting in significant savings in freight from transporting cement from its Chandrapur plant in eastern Maharashtra. However, these benefits are likely to accrue only in FY11E.

103

ICICI Securities

UltraTech Cement, April 21, 2008

Estimate 21% earnings CAGR over FY08-10E Table 2: Performance trend and forecast assumptions FY07 17,000 14,635 86 17,669 13.6 3,318 32.0

Capacity (’000 te) Production (’000 te) Capacity utilisation (%) Sales (mnte) Growth (%) Realisation (Rs/te) Growth (%) Source: I-Sec Research

FY08E 17,000 15,436 91 17,436 (1.3) 3,923 18.3

FY09E 21,900 18,615 85 19,615 12.5 4,080 4.0

FY10E 23,900 22,227 93 22,477 14.6 4,080 -

Tadipatri expansion to drive topline. UTCL’s volumes that were constrained by installed capacity would witness a boost, primarily from its 4.9mnte Tadipatri brownfield expansion. We expect volumes to grow 12.5% and 14.6% for FY09E and FY10E respectively. Further, we expect share of clinker as part of total sales to dip over the next two years. Assuming 4% and 0% realisations growth over FY09E and FY10E respectively, we expect the company’s topline to post CAGR of 19% over the next two years. Chart 4: Sales, EBITDA and EBITDA margin movement 90,000

Net sales

EBITDA

EBITDA Margin (RHS)

80,000

35

70,000

30

60,000

25

50,000 20 40,000

(%)

(Rs m)

40

15

30,000 20,000

10

10,000

5

0

0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company data, I-Sec Research

Margin improvement from captive power. While UTCL is expected to face the brunt of steep rise in prices of imported coal along with international freight rates, the impact is expected to be partly neutralised by the commissioning of ~140MW of captive power. This coupled with the expected 4% growth in prices in FY09E is likely to result in ~250bps rise in operating margins for the year. However, for FY10E, EBITDA margin is expected to decline 55bps due to lack of any significant pricing upside.

104

ICICI Securities

UltraTech Cement, April 21, 2008 Chart 5: EBITDA/te 1,400 1,200

(Rs/te)

1,000 800 600 400 200 0 FY06

FY07

FY08E

FY09E

FY10E

Source: Company, I-Sec Research

UTCL’s interest depreciation is expected to rise in FY09E with commissioning of the 4.9mnte Tadipatri plant. UTCL’s effective tax rate is likely to remain high at ~33% for the next couple of years. Aided by robust topline growth and cost savings, the company is expected to post earnings CAGR of 21% over the next two years. The recent export ban is likely to impact Gujarat based companies to some extent. However, the impact is expected to be marginal as export quantities are expected to be absorbed by the western markets given the acute supply shortage expected in FY09E. While the export ban is not likely to be a long term measure, should it be effective for the entire year, and we expect about 3-4% earnings impact for UTCL. Chart 6: FCF and D/E 14,000

Free cashflow

2.5

D/E (RHS)

12,000 2.0

10,000

1.5

6,000

(x)

(Rs mn)

8,000

4,000

1.0

2,000 0

0.5

(2,000) (4,000)

0.0 FY06

FY07

FY08E

FY09E

FY10E

Source: I-Sec Research

UTCL’s FCF is expected to turn negative in FY09E, mainly due to capex for the Tadipatri expansion. However, the company is expected to generate FCF of ~Rs12bn in FY10. UTCL’s D/E is also likely to see substantial reduction to ~0.4x in FY10E.

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ICICI Securities

UltraTech Cement, April 21, 2008 Chart 7: RoCE trend 60

RoCE

RoE

50

(%)

40 30 20 10 0 FY04

FY05

FY06

FY07

FY08E

FY09E

FY10E

Source: I-Sec Research

UTCL’s return ratios saw substantial improvement in FY07, primarily helped by rising cement prices. However, we expect RoCE to stabilise at ~36% in FY10E while RoE is likely to decline to 35% in FY10 from ~47% in FY08.

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UltraTech Cement, April 21, 2008

Attractive valuations At the current market price, the stock is trading at FY09E and FY10E P/E of 7.4x and 6.4x and EV/E of 5.4x and 4.4x respectively. On EV/te, the company is valued at US$141. UTCL is the closest to ACC in terms of size and market spread. However, despite its operating efficiencies being better than ACC’s, UTCL is valued at a significant 32% discount to ACC in P/E terms. We believe that UTCL should get a marginal premium to ACC, given higher earnings growth and operational efficiencies. On the basis of FY09E EV/E of 7.1x, we target a price of Rs1,105/share, which is a 41% upside from current levels. We initiate coverage with a BUY recommendation. Chart 8: P/E bands 1,800 1,600 15x

1,400

(Rs)

1,200 11x

1,000 800

8x

600 400 200 Mar-08

Jan-08

Nov-07

Jul-07

Sep-07

May-07

Feb-07 Apr-07

Oct-06

Dec-06

Jun-06

Aug-06

May-06

Jan-06

Mar-06

Nov-05

Jul-05 Sep-05

May-05

Apr-05

Feb-05

Oct-04

Dec-04

Aug-04

0

Source: Bloomberg, I-Sec Research

Chart 9: EV/EBITDA bands 250,000 200,000 (Rs mn)

9x 150,000 7x 100,000 5x 50,000

Apr-08

Jan-08

Oct-07

Jul-07

Apr-07

Jan-07

Oct-06

Jul-06

Apr-06

Jan-06

Oct-05

Jul-05

Apr-05

0

Source: Bloomberg, I-Sec Research

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UltraTech Cement, April 21, 2008

Summary financials Table 3: Profit and Loss Statement

Table 5: Cash Flow Statement

(Rs mn, year ending March 31)

(Rs mn, year ending March 31) FY07 49,108

Operating Income (Sales) of which Exports 6,928 Domestic 42,180 Operating Expenses 34,930 EBITDA 14,178 % margin 29 Depreciation & Amortisation 2,263 Gross Interest 868 Other Income 615 Recurring PBT 11,662 Add: Extraordinaries Less: Taxes 3,839 - Current tax 4,006 - Deferred tax (167) Less: Minority Interest 3 Net Income (Reported) 7,823 Recurring Net Income 7,823 Source: Company data, I-Sec Research

FY08E 55,692

FY09E 67,544

FY10E 78,683

5,527 50,165 38,224 17,467 31 2,308 748 957 15,367 4,994 4,764 231 4 10,373 10,373

3,938 63,606 44,670 22,874 34 2,998 1,388 1,078 19,565 6,457 6,163 293 5 13,109 13,109

2,463 76,220 52,465 26,218 33 3,855 896 1,259 22,725 7,499 7,158 341 6 15,226 15,226

Table 4: Balance Sheet (Rs mn, year ending March 31) Assets Total Current Assets of which Cash & cash equivalents Current Liab. & Prov. Net Current Assets Investments of which Strategic/Group Marketable Net Fixed Assets* of which Intangibles Capital Work-in-Progress Goodwill Total Assets

FY10E 18,561 (1,228) (5,411) 11,922 (4) (9,064) (2,741) 113

Table 6: Key Ratios (Year ending March 31) FY07

FY08E

FY09E

FY10E

Per Share Data (Rs) EPS(Basic) Diluted Recurring EPS Diluted Recurring CEPS Dividend per share Book Value

62.8 62.8 81.0 9.9 141.7

83.3 83.3 101.9 13.2 210.0

105.3 105.3 129.4 16.6 296.4

122.3 122.3 153.3 19.3 396.6

Growth Ratios (% YoY) Operating Income EBITDA Recurring Net Income Diluted Recurring EPS Diluted Recurring CEPS

48.8 1.6 240.5 240.3 1.3

13.4 0.2 32.6 32.6 0.3

21.3 0.3 26.4 26.4 0.3

16.5 0.1 16.1 16.1 0.2

12.5 9.7 5.5 8.3 2.4 12.5

9.4 7.7 3.7 6.8 2.1 9.8

7.4 6.1 2.6 5.4 1.8 8.1

6.4 5.1 2.0 4.4 1.5 6.6

8.6 2.6 5.3 32.9 0.0 5.8 11.8 40.9 1.2

8.6 3.4 6.2 32.5 0.0 5.2 11.7 45.3 0.8

9.7 2.9 5.5 33.0 0.0 5.1 11.9 43.9 0.7

9.4 2.6 5.5 33.0 0.0 4.9 12.0 44.4 0.4

18.3 37.0 47.4 15.8

19.1 37.4 41.6 15.8

19.0 36.0 35.3 15.8

FY07

FY08E

FY09E

FY10E

9,602 896

11,116 985

13,120 1,133

15,537 1,247

7,552 2,050 4,835 242 4,592 25,173

9,073 2,043 5,983 242 5,740 24,364

10,744 2,376 6,557 242 6,314 50,259

12,218 3,319 7,819 242 7,577 53,974

6,970 39,027

15,813 48,202

4,610 63,802

2,451 67,564

Valuation Ratios (x) P/E P/CEPS P/BV EV / EBITDA EV / Operating Income EV / Operating FCF

20,783 6,127 1 1,245 10 35,648 36,893 63,802

11,718 6,467 2 1,245 10 48,133 49,378 67,564

Operating Ratios (%) Raw Material / Sales SG&A / Sales Other Income / PBT Effective Tax Rate NWC / Total Assets Inventory (x) Receivables (days) Payable (days) D/E Ratio (x)

Liabilities Borrowings 15,786 16,226 Deferred Tax Liability 5,603 5,833 Minority Interest Equity Share Capital 1,245 1,245 Face value per share (Rs) 10 10 Reserves & Surplus* 16,393 24,899 Less: Misc. Exp # Net Worth 17,638 26,144 Total Liabilities 39,027 48,202 Source: Company data, I-Sec Research *excluding revaluation reserves; # = not written off

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FY07 FY08E FY09E Operating Cash flow 8,826 13,793 15,831 Working Capital changes 602 (1,741) (693) Capital Commitments (7,352) (10,343) (17,691) Net Operating FCF 2,076 1,709 (2,553) Investing Activities (2,496) (191) 504 Issue of Share Capital 1 Buyback of shares Inc(Dec) in Borrowings 1,268 439 4,557 Dividend paid (1,408) (1,867) (2,360) Extraordinary Items Chg. in Cash & Bank 280 90 148 Source: Company data, I-Sec Research

Profitability Ratios (%) Rec. Net Income Margins 15.7 RoCE 36.0 RoNW 55.8 Dividend Payout 15.8 Source: Company data, I-Sec Research

UltraTech Cement, April 21, 2008

ICICI Securities

Index of Tables and Charts Tables Table 1: Key markets and market share...........................................................................100 Table 2: Performance trend and forecast assumptions ....................................................104 Table 3: Profit and Loss Statement ..................................................................................108 Table 4: Balance Sheet.....................................................................................................108 Table 5: Cash Flow Statement..........................................................................................108 Table 6: Key Ratios...........................................................................................................108

Charts Chart 1: Key market-share movement..............................................................................101 Chart 2: Power & fuel costs and average unit cost of power............................................102 Chart 3: Key cost and EBITDA/te .....................................................................................103 Chart 4: Sales, EBITDA and EBITDA margin movement .................................................104 Chart 5: EBITDA/te ...........................................................................................................105 Chart 6: FCF and D/E .......................................................................................................105 Chart 7: RoCE trend .........................................................................................................106 Chart 8: P/E bands............................................................................................................107 Chart 9: EV/EBITDA bands...............................................................................................107

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UltraTech Cement, April 21, 2008

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UltraTech Cement, April 21, 2008

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