Market saw two major decisions on consolidation,Vaibhav Agarwal of PhillipCapital (India) Pvt. Ltd. captures.
As expected, February 2016 has seen few major and historic consolidation moves. While, Birla Corp called off its proposed transaction with Lafarge India and entered into an agreement with Reliance Cement to buy-out whole of their capacity, UltraTech Cement announced an historical deal by agreeing to buy-out 22.4mn tn capacity of Jaypee Cement. In our opinion, these moves should be seen as more of a structural evolvement of the cement industry rather than just consolidation. We also believe the valuations of these deals may not be a benchmark for any future deals, especially the UltraTech-Jaypee deal, as these deals were entered more by compulsion and not by choice of the sellers. The same is true for buyers as well but UltraTech made up for the same by a good bargain on the valuation. This consolidation will mean erosion of 6% of competition from Indian cement markets and will definitely give an edge to the price stability and pricing power of cement manufacturers in the longer term. Now the only large capacity which is up for sale is the whole of assets of Lafarge India (~11mn tn capacity) and we understand CRH and JSW Cement are the two leading contenders here. Interestingly, the buy-out strategies of both these contenders appear distinct. While CRH is known to buy assets at a premium valuation, JSW Cement is unlikely to buy any asset at a premium. We need to wait and watch whether the buyers of these assets understand the urgency of Lafarge India to sell these assets and make the most of the deal, as UltraTech Cement did with Jaypee Cement. This may be probably the last leg of consolidation move in the Indian cement industry and we expect the deal flow to slow down for the next 2-3 years within the sector. Notably, these recent deals may risk Birla Corp?s long term financial viability as they may be worried of UltraTech?s central India acquisition of Jaypee Cement. Given the competition intensity in the region, post consolidation, UltraTech may turn pretty aggressive in these markets which may harm Birla Corp?s financial strength in the longer term. Barring these possibilities, the only larger transaction which may happen in the long run is consolidation of Century Textile?s Cement division with AV Birla Group / UltraTech Cement and this will again be in favor of the industry. But in our opinion, this is away for at least 2-3 years from now.
As far as Q3FY16 earnings are concerned, consolidated volumes for our coverage universe grew by 10%/7% yoy/qoq. No disappointment on volumes is the best part of Q3 and probably indicates the green-shoots of demand. Shree Cement continued its outperformance on volume growth with maximum 23%/12% yoy/qoq growth. Volume growth for large caps was muted and we understand this was mainly to protect pricing. Amongst multi-region large-caps, UltraTech outperformed peers and the maximum alignment was seen in case of Ambuja, which returned to its earlier strategy of volume calibration to ensure better pricing. Blended realisations for the sector remained down 1%/3% yoy/qoq and we did not observe any material disappointment. Ambuja Cements and Dalmia Bharat outperformed the realisation trend with flattish qoq. Maximum disappointment came from JK Cement at -6% qoq; despite this, it beat consensus? expectations. This probably also means that JK Cement has the competitive advantage to generate earnings growth higher than peers with bounce back in realisations.
Operating costs for the sector were the biggest saviours in Q3 earnings. Costs declined by 3% yoy/qoq. Power & fuel costs were the biggest contributors GCo down 18%/11% yoy/qoq. Mangalam Cement showed maximum improvement in cost structure yoy (-10%) driven by stock adjustments and high base, while JK Cement showed maximum improvement qoq (-8%) driven by savings from its Mangrol expansion. Amongst large-caps, UltraTech outperformed peers on opex by delivering 3%/6% yoy/qoq declines in opex. The opex trigger is yet to materialise in Ambuja as pet coke usage remained flattish at ~50%. Had cost savings been delivered at Ambuja, its operating results would have been the best. Ambuja could deliver on opex saving from Q1CY16.
Despite no disappointment in volumes and cost savings, EBITDA trend for the sector looks flattish qoq. Sectoral EBITDA/tonne was at Rs 705, -1%/+14% qoq/yoy. Yoy jump is largely on cost savings. EBITDA improvement is now realisation dependent.