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.