| Summary of Contents
| SECTOR UPDATE Cement On concrete footing Key points -
Cement dispatches for February 2012 continued to be impressive: As per the data released by the Cement Manufacturers of India (CMA), the all-India cement dispatches for February 2012 increased by 9.8% on a year-on-year (Y-o-Y) basis to 16.25 million tonne. The cement demand in the domestic industry has revived since November 2011 primarily on account of increased cement consumption in the rural house building activity. On a year-till-date (YTD) basis (April-February 2012), the cement dispatches grew by 6.1% and for FY2012 we believe the all-India cement dispatches would grow at over 6.5% (as compared with the earlier growth of 4.5-5.0% expected by the Street). Going ahead, the cement demand for FY2013 would grow at about 8.0-8.5% and support the revenue growth of the cement companies. -
Positive impact of budget: In the Union Budget 2012-13, though the excise duty rate has increased from 10 to 12% (as anticipated by the Street), the net impact of the move has been neutral as the finance minister has allowed 30% abatement. Further, the exemption in the import duty on coal has benefited the companies that have higher dependency on imported coal, like India Cements, Madras Cement, Dalmia Cement and UltraTech Cement. Hence the changes announced in the budget have had a positive impact on the sector as against the neutral to negative impact anticipated by the Street. -
Railway freight hike results in cost increase of Rs8-9/bag: Recently the railways have effected major changes in the freight slabs which would result in a 20-25% rate increase over the same distance. For cement, there has been a hike of around 20%. The new railway freight scheme will increase the cost of freight by around Rs3-4 per bag of 50kg. Cement companies also transport domestic coal via the railways which would have an additional cost burden of around Rs4 per bag of cement. Hence the overall impact of the changes in freight slabs is an increase in the production cost of cement by around Rs8-9 per bag. However, we believe the incremental cost burden will be passed on to the end user. -
Price hike more than the incremental cost burden, hence EBITDA/tonne in Q4 likely to be better sequentially: In order to pass on the incremental cost burden in terms of the increase in the railway freight the cement manufacturers have increased the prices by around Rs15-20 per bag across major cities of the country. As per our analysis, the cost burden on account of the railway freight is around Rs8-9 per bag. Hence the price hike is much higher than the cost burden which will improve the EBITDA per tonne of the cement players in Q4FY2012 on a sequential basis. Outlook
With the recovery in the cement consumption by the rural housing segment the all-India cement volume for FY2012 is likely to grow by over 6.5%. However, the failure to adhere to the supply discipline could be a key risk to the cement prices. Another cause for concern remains the cost pressure in terms of higher coal prices and freight cost. Hence, we maintain our neutral stand on the sector. However, selectively we are positive and our top pick in the sector is Grasim Industries in the large-cap space and in the mid-cap space we prefer Orient Paper & Industries. Change in price target and recommendation -
On account of the revival in the cement demand in the past couple of months and the higher than expected price hike implemented by the cement players we believe few cement companies under our coverage could see earnings upgrades for FY2013. -
Further, looking at the sluggish volume growth in H1FY2012 we had downgraded the valuation multiple to arrive at the price target. However an improvement in the demand outlook and the benefit allowed in the budget have led us to revise our valuation multiple. Hence, we are upgrading our price target for India Cements to Rs125, for Madras Cement to Rs160 and for Shree Cement to Rs3,100. -
Looking at the reasonable upside from its current market price we are also upgrading our recommendation on India Cements from Hold to Buy. However, we are keeping our recommendation on Madras Cement and Shree Cement unchanged at Hold on account of the limited upside in their stock prices from the current levels.
VIEWPOINT Bharat Forge Robust business; wait for better entry point Key points -
Stand-alone revenue growth likely to moderate: Bharat Forge Ltd (BFL)'s stand-alone revenues are expected to grow by 13.5% compounded annual growth rate (CAGR) between FY2012 and FY2014 as against the growth of 40% CAGR achieved in FY2010-12. The automotive segment, which contributes roughly 62% to the stand-alone revenues, is expected to grow by 9.5% and 12.6% in FY2013 and FY2014 respectively against the 33.4% CAGR recorded between FY2010 and FY2012. Similarly, the non-automotive revenue growth is expected to moderate to 18% CAGR between FY2012 and FY2014 as against the 56.8% CAGR achieved in FY2010-12. The share of the non-automotive business in the stand-alone revenues has gone up from 30% in FY2010 to 35% in M9FY2012. BFL aims to equate the non-automotive revenues with the automotive revenues over the next ten years. -
Non automotive business-the game changer: The company charted a major diversification path after the slump in its automotive business in FY2009. While the non-automotive business is primarily focused on forgings, the company is targeting to increase the proportion of machining components from 30% currently to 100%. The company receives 47% contribution from exports in the non-automotive business and the rest from the domestic markets. -
Capital allocation critical to boost valuation in long run: The company has allocated over Rs900 crore or 25% of its balance sheet into various investments and joint ventures (JVs) to enhance the growth but has met with limited success. While the subsidiaries on a consolidated basis are expected to report a 25% revenue growth in FY2012, they are still operating at less than 1% profit before tax (PBT) margin. -
Other business will take time to take off and add substantially to valuations: The BFL-Alstom JV is executing as per plan. Recently, the court ruling has gone in favour of NTPC. The JV is expected to receive the order worth Rs3,300 crore from NTPC being the lowest bidder (L1). The execution time is of four years starting from FY2014. The other JVs with NTPC and KPIT are also in investment phase. Valuations
For FY2013, we are factoring in a lower than consensus revenue growth of 12.1% for the stand-alone operations due to the reduced guidance for non-automotive growth as well as the reduced guidance for India. We estimate the standalone earnings per share (EPS) would grow by 19% CAGR, higher than the revenue growth of 13.5% CAGR between FY2012 and FY2014. The company is expected to boost its earnings in FY2014 as new investments/capital expenditure (capex) start contributing to revenues. We also expect a reduction in debt during FY2014 as the capital expenditure reaches its tail end. The company can trade at 13x FY2014 earnings and the valuations can also incorporate the book value of its investments in subsidiaries and JVs. In spite of having the positive long-term view, the sharp run-up in the stock has now got limited upside in store.
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