India Cements - Earnings deterioration continues; maintain Sell - Centrum

Rating: Sell; Target Price: Rs39; CMP: Rs52; Downside: 25%

Earnings deterioration continues; maintain Sell

We maintain Sell rating on India Cements with a price target of Rs39 (earlier: Rs38) as we believe challenges will continue for the company in future due to its concentration in the South region, where price volatility has increased in the last few quarters due to continued oversupply. At the same time political issues like demand for the separation of Telangana state will hamper volume growth for the players in the South region. RoE of the company is expected till FY16E. Clarity on cost savings from Indonesian coal is yet to emerge despite several quarters of delay as excavation cost is higher than the market price of coal there and hence, the company prefers to buy coal from open markets. In the quarter, EBITDA was slightly ahead of estimates mainly due to lower other expense.

- Decline in sales volume and higher opex impact profits: Revenue (adjusted for Rs49.3mn related to sales tax incentives for earlier years) of the company declined 4.7% YoY to Rs10.3bn led by 5% YoY drop in sales volume to 2.29mt. Realization was up 0.8% YoY to Rs4,407/tonne. Led by decline in sales volume and higher opex (up 5.6% YoY on per tonne basis due to increase in employee cost, energy cost and other expenses), adjusted operating profit declined by 27.6% YoY to Rs1,394mn.

EBITDA/tonne declines Rs223/tonne YoY: Led by lower sales volume and higher operating costs (cement segment's operating cost increased 7.2% YoY), OPM of the company declined 4.3pp YoY to 13.5%. Operating profit/tonne of cement declined Rs223/tonne YoY to Rs579/tonne. On a sequential basis, 7% QoQ increase in realization negated the impact of 6% OoQ drop in sales volume and helped the cement segment post Rs144/tonne QoQ improvement in operating profit.

Concentration in the South region continues to hurt: We believe that the effective utilization rate for cement companies in the South region will remain at 60-64% till FY16E due to demand-supply mismatch. Political uncertainty related to the separation of Telangana region will also continue to hamper growth in Andhra Pardesh, which accounts for 55-60% of the company's production in the South region. Lower utilization rate may continue to impact the pricing power of manufacturers in the region resulting in increased volatility in earnings.

Valuation & Risks: At the CMP, the stock trades at 11.5x FY15E EPS, 5.2x EV/EBITDA and EV/tonne of US$54. We believe that the oversupply in the South region will continue to put pressure on the earnings of the company and return ratios will be subdued till FY16E. We maintain Sell on the company with a possible downside of 25% from the CMP. Key upside risks to our estimates are a) higher than expected sales volume, b) sharp increase in cement realization and c) significant savings in energy cost due to coal procurement from Indonesian mines in the future.

Source : Equity Bulls

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