Ambuja Cement - Realization growth assists margin expansion despite disappointing growth in volumes - Finquest

Maintain 'Sell' on Ambuja Cement with revised price target of Rs 178

Despite flat cement volumes growth during Q3CY12, Holcim group Ambuja Cement managed to post excellent set of numbers driven primarily by Y-o-Y improvement in realization. The performance on Q-o-Q understandably was disappointing due to seasonality factor. The cement volumes fell 16% Q-o-Q (flat Y-o-Y) to 4.7 mn, while the realization improved 20% Y-o-Y to Rs 4613 per tonne. Consequently net sales improved 20% to Rs 21.68 bn. There was sharp Y-o-Y fall in raw material cost as the company's new clinker unit stabilized. Earlier the company resorted to purchase of clinker from other manufacturer to feed its grinding units, thus the raw material cost was on the higher side. As a result of sharp fall in raw material cost, the company managed to improve its margins despite sharp increase in freight expenses. The EBIDTA margins improved 730 bps Y-o-Y (450 lower Q-o-Q) to 24%. EBIDTA margins contracted Q-o-Q following sharp increase in freight expenses; otherwise the realization on Q-o-Q basis has remained at the same levels. Rather such sharp Y-o-Y increase in margins was primarily assisted by firm realization. The cost per tonne in Q3CY12 rose 8.8% Y-o-Y (6.4% Q-o-Q) to Rs 3517. The EBIDTA per tonne rose by 72% Y-o-Y (lower by 16% Q-o-Q) to Rs 1110. The net profit after tax for the company in Q3CY12 came in at Rs 3.04 bn, which was 77% higher Y-o-Y, 35% lower Q-o-Q. Adjusted EPS for the quarter came in at Rs 1.97.

As there is no doubt about the demand improvement, it remains to be seen whether the company can sustain the current realization levels. To our mind this would be a huge challenge and as the cost matrix deteriorates due to fuel price increase the margins would come under pressure. We estimate CY12 revenue and EPS to come in at Rs 97.42 bn (+14.4%) and Rs 10.6 (+300%).

The demand growth for the cement industry has remained weak during the past several quarters and that has kept the capacity utilization of various plants in the country at very low levels as the industry witnessed significant capacity addition during that period. Although the macro situation has improved during the past few weeks since the government announced slew of reform measures to pump up the economy, the pricing situation continues to remain weak while the input cost scenario is also expected to worsen, thus impacting the margins. We do not see the company; or, for that matter the industry holding on to the current price levels, neither do we see margin improvement since the costs are expected to increase further due to volatile fuel prices. Two major worries for the company at this point in time are the Competition Commission of India (CCI) penalty and the Royalty payment that the company may have to make to its parent (Holcim).

Maintain our 'Sell' rating on the stock with revised target price of Rs 178

Although we see demand picking up going ahead the realization growth would be muted or even negative. Added to these would be the cost pressure due to higher fuel and transportation cost which would impact the margins. We believe that Ambuja Cement's current stock price is not supporting the valuations as it is not factoring in the limited pricing power, the cost pressure and the CCI penalty. The market is also ignoring the implementation challenges of the recent reform measures of the government, and so the trickle down impact of these on cement demand would not be as high as expected. Thus we maintain our 'Sell' rating on the stock with a revised target price of Rs 178 (Enterprise Value (EV) tonne of USD 164 - 50% discount to the average EV per tonne of the previous five years, PE of 19x and EV/EBIDTA of 9.2x CY12E earnings). EV per tonne of Ambuja Cement is higher than the current replacement cost of around USD 140 per tonne.(Ambuja Cement has always traded at premium to its other peers due to its significant presence in the Western markets where the demand and prices have remained relatively firm as compared to other regions.) We cite imminent margin pressure due to high fuel prices, higher freight expenses, penalty by CCI, probable royalty payment to be made to Holcim and limited pricing power for the industry from these levels. At the current market price of Rs 204 the stock is trading at PE of 22x and EV/EBIDTA of 10.9x CY12 earnings.

Source : Equity Bulls

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