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ACC: Valuation is the issue

Jul 20, 2006

Performance summary
Led by more than 25% YoY growth in average realisations in the first half of the calendar year 2006 (December ending fiscal), ACC has reported a 79% YoY rise in operating profit, despite the loss of revenues from the disposal of the refractory division last year. Increased free cash flow allowed the company to repay debt, which resulted in profit before tax growing by 100% YoY in 1HCY06 (despite lower other income). With cement prices remaining firm, the company is expected to post record profitability in CY06.

Consolidated results…
(Rs m) 2QCY05 2QCY06 Change 1HCY05 1HCY06 Change
Net Sales 12,162 14,775 21.5% 24,006 28,331 18.0%
Expenditure 9,653 10,118 4.8% 19,525 20,328 4.1%
Operating Profit (EBDITA) 2,509 4,657 85.6% 4,481 8,003 78.6%
EBITDA margin (%) 20.6% 31.5%   18.7% 28.2%  
Other income 261 160 -38.7% 553 486 -12.2%
Interest 230 152 -33.7% 444 351 -21.0%
Depreciation 550 599 8.8% 1,129 1,212 7.4%
Profit before tax 1,990 4,066 104.4% 3,462 6,926 100.1%
Extraordinary items 88 1,464 1571.1% 208 1,478 610.5%
Share of associate profits 3 4 21.9% 8 7 -8.9%
Tax 563 1,414 151.3% 318 1,975 521.7%
Profit after Tax/(Loss) 1,518 4,120 171.4% 3,360 6,436 91.5%
Minority interest 28 2 -92.3% 48 5 -89.8%
Net income 1,490 4,118 176.5% 3,312 6,431 94.2%
Net profit margin (%) 12.5% 27.9%   14.0% 22.7%  
No. of Shares (m) 178.4 187.2   178.4 187.2  
Diluted earnings per share (Rs)*         55.5  
Price to earnings ratio (x)         14.7  
EV/tonne (US$)         182.0  
(*trailing twelve months earnings)

What is the company's business?
Associated Cement Companies (ACC) is the oldest cement manufacturer in the country. ACC (consolidated) has a total capacity of 18.1 million tonnes (12% of total Indian cement capacity) and is the second largest player in the Indian market after the Grasim-Ultratech combine (31 MT). With 14 units and a 9,000 strong dealer network, ACC is one of the few cement companies to have a pan India presence. The company has continued on its efforts of becoming a focused cement player. It thus continues to divest some of its non-core businesses. Further, it is also aiming at acquiring new cement capacities to augment growth. The acquisition of IDCOL's (Industrial Development Corporation of Orissa) 1 MT plant for a consideration of Rs 1.8 bn was one such move. It had earlier acquired a 75 MW power generation capacity at Wadi from Tata Power for a consideration of Rs 2.4 bn. The company currently meets almost 70% of its power requirements through captive power plants, which is likely to improve further over the next couple of years. Gujarat Ambuja, one of the leading players in the industry, in consortium with Switzerland’s Holcim, has acquired over 34% stake in the company.

What has driven performance in 1HCY06?
It's only prices, prices and prices: For 2QCY06 and 1HCY06, cement volume sales were higher by 4.3% YoY and 7.1% YoY respectively. However, revenues were higher by 18% YoY in 1HCY06, despite the sale of the refractory division last year (this division contributed to 11% of ACC revenues in 1HCY05). Much of the growth was on account of improved performance by the cement division. Based on our estimates, average realisation in 1HCY06 for ACC was Rs 136 per bag as against Rs 109 in the same period last year. While retail prices are much higher (around Rs 150 to Rs 200 per bag depending on the region), we expect net realisations in 2HCY06 to increase marginally (in absolute terms) from the current levels. While ready-mix concrete revenues increased by 44% YoY in 2QCY06, it has to be borne in mind that the company acquired TARMAC last year, which is also reflected in the numbers. Overall, even though the financial performance of the company is not comparable on a YoY basis, the fact that cement prices are expected to remain firm will help margins in the future.

Operating leverage kicks in: While the cement division accounted for around 90% of the topline, almost 96% of PBIT was contributed by this division. The 25% YoY increase in realisations is clearly reflected at the operating profit level. Since cement is a high fixed cost industry (almost 65% to 70% of total cost is fixed in nature), any improvement in prices directly adds to the profitability. ACC's operating margins, at over 31%, are among the highest in the last decade. This is not only a result of prices but also on account of pruning of the employee base, conversion of cement manufacturing process from wet to dry (basically the kilns), disposal of non-core activities and control over overheads. Post the Holcim acquisition, we expect further reduction in overheads and consequently, operating margins are likely to be superior as compared to the last decade.

Segmental margins…
(% sales) 1QFY05 1QFY06 Change* 1HCY05 1HCY06 Change*
Cement 19.3% 30.8% 59.9% 17.9% 27.5% 53.9%
Refractory 17.9% - - 19.4% - -
RMC 8.2% 4.7% -43.2% 9.1% 5.1% -43.8%
Others 18.8% 21.7% 15.4% 12.7% 16.0% 25.8%
(* YoY change in sales)

Net profit - Lower debt, one-time profits: Cash flow of ACC was bolstered in light of a 78% YoY growth in operating profit, enabling the company to retire debt (total debt as of December 2005 stood at Rs 10 bn). Interest cost is also lower on account of the conversion of FCCBs into equity shares (of the total 60,000 bonds issued, 45,525 were converted into equity shares last year itself at a conversion price of Rs 374.4 per share). Apart from this, the company realised profit from the sale of Mancherial Cement Plant to the tune of Rs 162 m in 1HCY06 apart from the profit from the sale of land to the tune of Rs 1.3 bn in the same period.

What to expect?
At Rs 817, the stock is trading at an enterprise value of US$ 182 per tonne. Though valuations look reasonable in terms of price to earnings multiple, investors have to remember that we are in an up-cycle in terms of cement prices. Starting one year from now, we expect supply side to start increasing at a faster pace, which will have a cooling off impact on prices. Overall, we believe that the downside risk is higher than the upside potential and therefore, maintain our 'Sell' view on the stock.

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