Institutional

Update

Eq 24 March 2011
India

Mid-cap cement stocks
Steep valuation gap makes them long-term value bets
Even while we have been cautious on the cement sector given the likelihood of demand-supply imbalance over FY11-13 (see our initiating coverage dated 2 December 2010: Valuations defy fundamentals: Sell into H2 strength), the frontline cement stocks (ACC and Ambuja) have moderately outperformed Nifty over the past one year, while stocks in the mid-cap and small-cap space have underperformed Nifty by 6-42% and the BSE Mid-Cap Index by 0-36%. The outperformance of cement stocks in the large-cap space has been driven by flow of news about cement price hikes over the past five months and implementation of production and price discipline amongst the companies. While the mid-cap cement space is an equal beneficiary of the prevailing price discipline, the underperformance of stocks in this space has made them available at steep discount to the frontline stocks. The disconnect between price curves in the two spaces makes some of the mid-cap stocks long-term value buys with a high margin of safety. In particular, a model company we would like is one whose stocks are available at steep discount to the replacement cost (US$100-125 per tonne) provided it has recently concluded expansion and is fairly leveraged. The companies that become interesting bets in this context are: J.K. Cement (not rated), India Cements (Outperform, TP `140), OCL India (not rated), and Orient Paper and Industries (Outperform, TP `80). We like Birla Corpn too on account of its undervaluation even though it is not a leveraged company. No rationale for price curve disconnect between large-caps and mid-caps
We believe the disconnect in price performance between large-caps (modest outperformance to Nifty) and mid-caps (steep underperformance to Nifty and BSE Mid-Cap Index) in the cement sector is unjustified given that smaller companies are equally exposed to industry dynamics – such as benefits of price and production discipline, impact of government-induced cost push, and excise duty rejig.

Cement
Recommendation summary Company ACC Ambuja Ultratech Grasim India Cem Shree Cem Orient Paper Birla Corp J K Cement OCL Reco UP UP UP OP OP N OP NR NR NR TP (`) 833 118 915 2,670 140 1,725 80 ---Upside (%) -19.6 -10.6 -10.1 9.0 65.7 -8.0 70.0 ----

Source: Indiabulls research. Performance (%) 1m ACC Ambuja Ultratech Grasim India Cem Shree Cem Orient Paper Birla Corp J K Cement J K Lakshmi Madras Cem Mangalam Cem Heidelberg Cem OCL Prism Cem Nifty Sensex BSE Mid-Cap BSE Small-Cap Source: Bloomberg. 2.2 6.7 5.4 8.1 -1.0 9.5 -7.6 -0.5 0.2 -5.6 -2.3 -3.9 10.1 3.1 -3.3 0.8 0.2 0.7 -2.1 3m -3.4 -3.9 -3.1 6.1 -11.6 -6.0 -17.2 -15.8 -11.5 -18.2 -8.6 -17.9 -9.0 -5.5 2.9 -8.4 -8.9 -13.2 -15.6 1yr 8.3 13.0 -8.1 15.6 -30.4 -15.3 -3.6 -17.6 -27.1 -37.3 -19.1 -37.0 -24.2 -9.6 -1.0 4.9 4.3 -1.5 -6.9

Mid-caps available at steep discounts to replacement cost
Post recent underperformance, many mid-cap cement stocks are available at almost 50% discount to replacement cost and P/BV of less than 1x against the 30-75% premium to replacement cost and P/BV range of 2.7-3.1 x commanded by frontline companies.

Leveraged players with volume growth seem good long-term value plays
In particular, a model company we would like is one whose stocks are available at steep discount to the replacement cost (US$100-125 per tonne), if it has recently concluded expansion and is fairly leveraged. The companies that become interesting bets in this context are: J.K. Cement (not rated), India Cements (Outperform, TP `140), OCL India (not rated), and Orient Paper and Industries (Outperform, TP `80).We like Birla Corpn too on account of its undervaluation even though it is not a leveraged company.

Rajan Kumar

rajan.kumar@indiabulls.com +91 22 3045 8074

Divyah Ahooja

divyah.ahooja@indiabulls.com +91 22 3045 8056

Indiabulls research is also available on Bloomberg (IBULLS <GO>), Thomson Reuters, and FactSet.

6 1.0 1.8 0.1 1.0 10.4 2.1 1.6 0.& Mid-caps India Cements Shree Cements Orient Paper Birla Corp JK Cement J K Lakshmi Madras Cements Prism Cement Hiedelberg Mangalam Cement OCL Source: Company.0 47.0 -10.8 3.0 311.036.8 2.875.0 -50.7 6.0 52.0 7.4 52.0 2.2 103.0 106.7 0.0 -30.2 40.0 15.1 2.8 45.450.8 135 175 131 NA 68 106 42 56 58 46 94 96 45 32 50 183 201 164 NA 103 116 49 65 87 56 177 185 42.0 -10.0 52.0 -20. P/BV 3.4 2.4 1.5 4.7 29.7 1.8 42.0 97. Source: Bloomberg.7 131.0 2.0 7.2 0.2 1.0 5.1 Exhibit 2: Relative performance vs Nifty 70. 24 March 2011 Indiabulls Research 2 .3 1.0 132.6 5.018.0 78.8 12.0 92.Sales Large-caps ACC Ambuja UltraTech Grasim Small.0 50.Mid-cap cement stocks Exhibit 1: Select mid-cap cement stocks at steep discount to large caps CMP Capacity EV/tonne EV/tonne Company (`) (mn tonnes) (US$) (US$) .0 10.5 11.0 -40.2 0. Indiabulls research.0 0.0 ACC AMBUJA ULTRATECH Grasim INDIA SHREE Orient Paper Birla Corp J K Cement J K Lakshmi Madras Cement Mangalam Cement Heidelberg Cement OCL Prism Cement Exhibit 3: Relative performance vs BSE Mid-Cap Index 20.4 23.0 -30.0 SHREE INDIA Orient Paper Birla Corp J K Cement OCL Madras Cement Mangalam Cement Heidelberg Cement Prism Cement J K Lakshmi Source: Bloomberg.0 30.

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