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.