India Cements - Value in the gloom

We have a negative view on the cement sector's earnings and pricing outlook, but we believe ICEM at its current valuation has priced in all the gloom. The stock is trading at 0.7x FY10F P/B and US$50 EV/mt (half replacement cost), which we see as cheap. We cut our earnings by 20-28% and our target price to Rs103.93. Buy. 

ICEM is exposed to the best cement market in India 
Demand growth ytd is 6.5% on an all-India basis, but 12% in the south. This has meant better pricing for ICEM, which achieved an EBITDA/mt of Rs1,227 in 1HFY09, vs Rs902 for Associated Cement. While capacity additions of 32mmt in the south through FY11F will outstrip our incremental demand forecast of 18mmt and cause pricing pressure, we expect the south to remain one of India's better markets. 

ICEM's expansions are fully funded 
In 2007, ICEM began investing Rs8.4bn to raise capacity in the south from 9.1mmt to 14.2mmt, a move now near completion. This was funded in part by a Rs3.2bn FCCB (May 2011 redemption). The company also began spending Rs14.5bn on two greenfield cement plants in the north, which would raise overall capacity to 18mmt. In December, it raised Rs5.9bn via an equity raising to fund this programme. ICEM has since put one of the greenfield plants (costing Rs6.5bn) on hold, so we believe it should be able to meet all its planned capex to raise capacity now to 16mmt without incremental leverage. We forecast its current debt/equity ratio of 70% will fall to 27% by FY11. 

We see an industry surplus for the next two years 
We downgrade our demand expectation to 6.5% for FY09 and 8% for the FY10-11, due to the slowdown we have already seen on the back of the global credit crisis and reduced activity levels in real estate and construction. While the commissioning of a few cement plants has been delayed, we reckon more than 90% of the announced projects will still be commissioned causing a surplus for the next two years at least. 

We cut our earnings sharply, but maintain Buy 
We lower our FY09-10F volumes by a total of 1.5mmt to 10mmt and 11.5mmt and cut our FY09-10F EPS 20-28% to account for lower cement and coal prices. We value ICEM at a 10% discount to the end-2009 EV/EBITDA valuations of ACC and Ambuja Cement given its focus on the south and higher leverage, giving us a fair value and target price of Rs103.9. Even so, we see ICEM as cheap at current valuations. Buy. 

Associated Cement - A long winter ahead?

ACC seems financially well placed with moderate expansion plans, but we believe its earnings outlook has weakened, given the industry is likely to see excess supply for at least two years, which would lower cement prices. We cut our EPS estimates and downgrade to Sell. 

We see higher earnings risk for the next two years 
FY09F cement demand growth ytd (6.6%) is below our expectations, due, we believe, to the stress in credit markets and delays in capex in many sectors. Hence, we lower our demand estimate for FY10 and FY11 by 200bp each to 8%, which exposes the industry much longer to larger surplus supply. The commissioning of a few cement projects has been delayed, but, with rapid progress at most projects, we expect capacity addition of around 89mmt until FY11, with incremental demand in this period being just 46.3mmt. We believe this will put pressure on prices. 

We expect the current cement downcycle to be shorter than the last 
In the 10 years after ACC's earnings peak in FY96, there were eight difficult years and two good ones. We expect the current earnings downcycle to last until FY11, given better consolidation in the sector (the top five groups now control more than 60% of the market), a large share of capacity is being added by existing players and that we see scope for more consolidation. 

ACC seems financially better positioned to handle this downturn 
Restructuring over the last five years has seen ACC exit many non-core businesses (refractory). The company, which had high gearing in the last business cycle (1997-2003), now seems in a much stronger financial position. We estimate it would have a debt-equity ratio of just 7% even after financing its entire planned capex of Rs37bn over the next three years. This capex would raise it capacity by 9.6%, just slightly ahead of the expected demand growth. 

We cut earnings sharply, and downgrade Sell 
We lower our FY09-11F cement volumes due to macro factors, and also adjust EBITDA to factor in lower cement and coal prices. We cut our EPS estimate by 11-12%, and lower our DCF-based target price to Rs369.9. ACC looks cheap, trading at a cement EV/mmt of US$61 (vs replacement cost of US$110), but we see more downside to earnings, given the overhang of excess supply. 

For all Warren Buffet Fans

A version of this article appeared in print on October 17, 2008, on page A33 of the New York edition.

Buy American. I Am By Warren E. Buffett

The financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be
scary.

So ... I've been buying American stocks. This is my personal account I'm talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation's many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can't predict the short-term movements of the stock market. I haven't the faintest idea as to whether stocks will be higher or lower a month - or a year - from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932 . Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor's best friend. It lets you buy a slice of America's future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky's advice: "I skate to where the puck is going to be, not to where it has been."

I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I'll follow the lead of a restaurant that opened in an empty bank building and then advertised: "Put your mouth where your money was."

Today my money and my mouth both say equities.

Grasim Industries - Earnings outlook deteriorates

Grasim's ongoing capex should raise its cement capacity by 59%, but the underlying demand outlook has weakened. We expect just 75-80% utilisation in both its VSF and cement businesses, as well as margin pressure. We cut our FY09-11F earnings by 6-37%, and downgrade to Sell.

Grasim to capitalise Rs110bn of assets in the next few months
Grasim says it plans to raise its cement capacity by 18.1mmt to 48.8mmt in the next few months by commissioning capacity in three greenfield locations. However, this comes as the outlook for industry demand growth has weakened due to the ongoing global financial crisis and consequent capex slowdown in many sectors. The slowing of textile exports has weakened the volume outlook even at Grasim's viscose staple fibre (VSF) business, where the company recently raised capacity to 334,000mt per year (from 270,000mt). We expect Grasim's capital-related costs to rise, straining profits.

We see cement oversupply persisting for more than two years
We have lowered our FY09-10 demand growth expectation from 9-10% to 7-8%. FY09 trends, so far, indicate growth of just 6.5%. We expect incremental cement capacity addition of 89mmt till FY11 vs incremental demand growth of just 46.3mmt, which, we believe, will put pressure on prices in FY10 and FY11.

VSF earnings could stabilise after the sharp fall in FY09F
The VSF business, which competes with polyester staple fibre and cotton, has faced slowing volumes due to weak global textile demand. Prices of sulphur, a key raw material, have fallen from US$850 in June 2008 to US$85 currently, reducing overall VSF costs by 12%. However, the recent weakness in both cotton and PSF prices will force Grasim to reduce VSF prices as well. We expect VSF EBITDA to fall 49% in FY09, although they should recover gradually from there on.

We cut earnings sharply, downgrade to Sell
We have reduced our FY09-11 cement volume forecast due to macro factors, and adjusted EBITDA to factor in lower cement and coal prices. We have cut our FY09-11F EPS by 6-37% and lowered our DCF-based target price to Rs919. Trading at 0.8x FY09F book and at an EV/mmt of US$66 (vs replacement cost of US$110) on cement, Grasim looks cheap, but we see more downside risk to earnings in next two years, given the large capacity creations.

Jyoti Structures Limited - 2QFY09 update

JSL’s 2QFY09 numbers were inline with our estimates. Top line grew by 32% yoy to Rs4.2bn & bottom line growth of 18.5% yoy to Rs201mn. EBITDA margin stood at 11.9% down 61bps yoy. The recent correction in the stock price has brought the stock in to value zone where it trades at less then 4.4x its FY10F consolidated EPS. We are revising our target price downward by cutting the target PE multiple from 12x to 7x on account of challenging macroeconomic environment. We maintain BUY.

.. JSL’s 1QFY09 sales were in line with expectation, Sales at Rs4.21bn up 32.3% yoy (expected Rs4.26bn). EBITDA margins stood at 11.9% down by 61bps yoy (11.8%) on account of raw material cost up 40% yoy at 67% vs 63.3% in 2QFY08 & staff cost up 39.6% yoy at 3% vs 2.8% in 2QFY08. However other expense was up only by 12.1% yoy at 18.1% vs 21.3% in 2QFY08. Interest expense stood at Rs174.3mn up 64% yoy (Rs160.6mn). However PAT was marginally above our expectation at Rs201.1mn up 18.5% yoy (Rs197.8mn) due to lower tax provisioning at 35.6% (39.1%).

.. Order book stood at Rs36bn. The order book consists of 60% from transmission line, 20% from substation & remaining 20% from rural electrification. Domestic orders were worth 85% of the total order book while the remaining 15% consist of exports & deemed exports. Management expects ~Rs58bn (Rs30bn in transmission line, Rs6bn in rural electrification & another Rs21bn in substation) domestic jobs to be put for tendering in next couple of months. They also indicated to bid for Rs7-8bn worth of international orders.

.. We keep our forecast intact however revise downward our target price on account of challenging macroeconomic environment. We cut our target PE multiple from 12x to 7x. Planned expenditure on T&D in the 11th five year plan & current order book provides visibility on account of revenue going forward. We retain our positive outlook on the company & maintain BUY. At CMP of Rs63, JSL is trading at 5.5x FY09F consolidated EPS of Rs11.3 & 4.4x FY10E consolidated EPS of Rs14.1. Higher order winning could likely see a re-rating in the stock. The key risk for the stock would be further margin pressure due to higher raw material price, higher interest cost and high institutional holding.

Maruti Suzuki India - Small car for the long haul

Maruti looks well placed to recover from its weak Sep 08 quarter results with the help of product launches amid easing commodity and fuel prices. We trim our EPS estimates, factoring in a gradual recovery in the demand, but maintain our Buy rating.

September 2008 results: EBITDA margins hit a new low
Maruti's Sep 2008 results disappointed us, with EBITDA margin 8% lower than we expected due to higher manufacturing and other expenses. Still, an improving product mix extended the sharp rise in realisation per vehicle. The discrepancies between our expectations and the results include the impact of currency fluctuations on imports and higher power and promotion expenses.

New product launches to limit the impact of weak demand
Maruti's new product launches in the coming quarters should help limit the impact of weak demand. We expect any recovery in car demand to be gradual, especially in an environment of job insecurity, pay cuts in the private sector and limited vehicle finance availability. Maruti's focused efforts to convert government employees' sixth-pay-commission benefits into car purchases should offer some relief. We trim our domestic sales volume estimates 3-6% for FY09-10F to reflect a 7% CAGR in domestic volume. We maintain our export targets, however.

Easing commodity prices to boost profitability in the coming quarters
We expect EBITDA margins to bottom near Sep 2008 levels as new product launches in the compact segment help reduce promotion expenses, and easing commodity prices support profitability. However, factoring in our concerns about domestic volumes, we trim EPS 5% for FY09-11F. We expect a higher yield on the company's Rs52bn investment book to help limit the impact of margin pressure.

We maintain our Buy rating
Maruti looks well placed to weather these turbulent times given its cash-rich balance sheet, and new expanded capacity to support new products and engine series for both the domestic and export markets. We expect competition from international car majors to ease, especially in capacity build and new product launches. On our revised EPS estimates, Maruti trades at the low end of its historical forward PE band, at 10.5x FY09F. We lower our target price to Rs750 to reflect our EPS changes. It remains our top pick in the Indian auto sector.

Dabur India

A diversified product portfolio with known brands will keep it on steady growth path

Dabur India is the fourth largest fast moving consumer goods (FMCG) company in India, with presence in health care, personal care and food products in various categories such as hair oils, shampoos, toothpaste, health supplements (glucose, chyawanprash), baby and skin care, insect repellants, fruit juices, and ayurvedic tonics. It has powerful brands like Dabur Amla, Dabur Chyawanprash, Dabur Honey, Vatika, Hajmola and Real. Manufacturing locations are across India and abroad. The company also has an international business division.

Consolidated net sales grew 16% to Rs 2361.07 crore in the year ended March 2008 (FY 2008) compared with Rs 2043.14 crore in FY 2007. In the haircare category, hair oils sales rose 13%, led by Dabur Amla, which grew 18% in FY 2008. The shampoo category, too, continued its strong performance, with sales increasing 25%. Dabur has now expanded its haircare offering with the introduction of a new Vatika Black Shine shampoo variant besides entering the conditioner market with two variants under the Vatika brand.

Dabur’s toothpaste sales, led by Babool, Dabur Red and Meswak, spurted 27% in FY 2008 and FY 2007 — much ahead of the industry growth of 14%. The company has also expanded its oralcare portfolio with the introduction of the Babool Neem variant in the fiscal.

Revenue of the health supplement business moved up, while the foods business grew 19% in FY 2008. Dabur India has revamped and relaunched 60% of the consumercare division product portfolio, laying the foundation for a stronger future growth. The consumerhealth division also marked a turnaround, with sales spurting 12% in the second half of FY 2008 and 5% in the entire financial year.

Overseas sales also recorded significant gains, surging 26% in FY 2008, with strong performances across most focus markets. Sales in the Gulf Co-operation Council (GCC) region increased 33%, led by new product launches, while Dabur Egypt’s sales soared a robust 49%.

Operating profit margin (OPM) increased 20 basis points (bps) to 17.3%. Strong growth in key categories coupled with stringent cost-saving initiatives helped Dabur India to mitigate the impact of escalating costs. Operating profit grew 17% to Rs 409.33 crore, profit before tax 20% to Rs 384.44 crore, and net profit after minority interest 18% to Rs 332.94 crore.

Dabur India is seeing high growth in the fruit-drink segment in addition to the fruit-juice segment as consumers are shifting from aerated waters to fruit drinks. The company plans to emphasise fruit drinks, going forward, after giving its current product Twist a new identity. The integration of foods into the consumercare division will help in the next big emphasis on fruit drinks.

Besides rolling out the Gulabari skin-care range across India and launching ayurvedskin care, Dabur India will unveil juice variants at different price points, and re-launch Meswak.

The other key development in FY 2008 will be Dabur India’s foray into retail through its subsidiary company H&B Stores. The subsidiary plans to grow rapidly and mark its presence across India by opening around 30 new stores by end FY 2009. Initially, the business will be in an investment phase, but will start generating returns as it attains a certain size and increases its footprint. Investments in retail resulted in a minor negative impact on consolidated net profit in FY 2008, and will continue to have such an impact over the next couple of years.

We expect Dabur India to register consolidated sales and net profit after minority interest of Rs 2720.29 crore and Rs 380.48 crore, respectively, in FY 2009. On an equity of Rs 86.50 crore and face value of Re 1 per share, EPS works out to Rs 4.5. The share price trades at Rs 72. P/E is 16.

Wyeth

Continues to expand in line with the steady growth in the domestic pharmaceutical industry

Wyeth is a 51.12% subsidiary of the US$ 22.4-billion Wyeth, US, a leading player in the pharmaceutical, consumer healthcare and animal health products. Three companies — Wyeth Laboratories, John Wyeth (India) and Wyeth (India) Pvt Ltd — were amalgamated with Cyanamid India and the combined entity was named Wyeth Lederle on 1 January 1998. Effective 1 April 2003, Geoffrey Manners & Company was merged with Wyeth Lederle and the name of the company was changed to Wyeth.

In India, Wyeth is a market leader in oral contraceptives, folic acid and depilatory cream. The company has many established brand names in the formulations segments of anti-infectives, gynaecologicals, corticosteroids and tranquilisers. Some of the prominent brand names include Wymox (antibiotic), Wysolone (corticosteroid), Ultragin (analgesic) and Ovaral (contraceptive).

Pioneering several new therapies in India, Wyeth was the first to launch hormone therapy and vaccines against HIB and invasive pneumococcal disease. Enbrel, a breakthrough treatment for rheumatoid arthritis; Rapamune, an immuno suppressant for prevention of rejection after renal transplant; Prevenar, a pneumococcal conjugate vaccine; and Tygacil, the world’s first glycilcycline antibiotic, are among the internationally known products launched by Wyeth in India.

One new product has been unveiled every year since FY 2007 and plans are on to launch one new product in the financial year ended March 2009 (FY 2009), too. Tygacil, a hospital injectable antibiotic for life threatening infections such as complicated intra-abdominal infections and complicated skin and skin structure infections, was launched in 2008. The products launched in the last couple of years have achieved good growth. Enbrel, a breakthrough treatment for rheumatoid arthritis and psoriasis, grew 65% FY 2008. Revenue from Prevenar, a vaccine for invasive pneumococcal disease, rose 222% in FY 2008.

Wyeth’s consumer healthcare division recently introduced an extension of its product Anne French in the form of 25-gm tube pack. This initiative has been well received by consumers and the trade. To enhance the brand image of Anne French, leading film star Kareena Kapoor has been signed on as brand ambassador.

As with demands made on many other pharmaceutical companies, the government of India asked from Wyeth Rs 59.08 crore (inclusive of total interest of Rs 42.06 crore) up to 31 March, 2008 under the Drugs Prices Control Order (DPCO), 1979. The company feels the ultimate liability would not exceed the amount already provided in the accounts.

Wyeth’s sales grew 15% to Rs 331.32 crore in FY 2008 in line with market growth of 14.84%. The Indian retail pharmaceutical market, valued at Rs 32095.75 crore, expanded 14.84% in FY 2008 (source: IMS MAT, March, 2008), and is expected to advance 12%-14% in the coming years on growth in rural areas and health insurance.

Sales grew 21% to Rs 105.83 crore in the quarter ended September 2008. Operating profit margin (OPM) was steady at 41.1% as against 41.6% in the quarter ended September 2007, taking the operating profit (OP) up 20% to Rs 43.46 crore. Profit before tax (PBT) spurted 20% to Rs 46.69 crore, and net profit 25% to Rs 33.83 crore.

Sales were up 15% to Rs 200.843 crore in the six months ended September 2008 over the same period of the previous year. OPM jumped 39.4% (39%), pushing up OP 17% to Rs 79.12 crore. PBT increased 14% to Rs 85.29 crore, and net profit 17% to Rs 60.38 crore.

Wyeth continues to invest in all the key brands to increase sales and also takes initiatives to reduce cost to improve profitability. Currently, its top 10 products contribute 50%-55% of the total revenue. Around 8% of the products come under the DPCO.

In the last few years, Wyeth’s growth was hurt as it rationalised major products and discontinued some that did not have a future. The company has no major pending discontinuation now.

We expect Wyeth to register sales and net profit of Rs 386.48 crore and Rs 94.99 crore, respectively, in FY 2009. EPS works out to Rs 41.8. The company has paid dividend of Rs 30 per share since the last two years. The share price trades at Rs 370. P/E works out to just 8.8 and dividend yield an attractive 8.2%