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Sustaining higher cement prices is vital

* Q3 results beat our estimates on higher-than-expected volumes (down 10.3% yoy vs. estimate of 12% decline) and lower opex. EBITDA came in at Rs2.15bn vs. our estimate of Rs2.05bn and OPM stood at 18.5% vs. estimated 18.1%.

* Key positives: 1) Rs26/ton qoq decline in variable cost despite increase in petcoke/fuel price; 2) lower-than-estimated sales volume drop; 3) lower fixed costs - Rs1.5bn vs. Rs1.95bn in Q3FY20. Key negatives: 1) Realization decline of 4.8% qoq vs. estimated 3.5% drop; 2) Higher freight costs due to increased sales in the East region.

* Management highlighted their efforts to improve profitability - sustainable reduction in fixed costs, improve contribution through better pricing and higher volumes in the East region with an aim to improve utilization. Expansion plan in the Central region will be delayed by few quarters as the focus is on debt reduction.

* We raise EBITDA assumptions for FY21-23 by 1-2% on higher cement prices. Cement prices went up in the South region due to low capacity utilization and may not be sustained. Valuations at 8.6x FY23E EV/EBITDA do not look attractive, considering net debt/EBITDA of 2.8x and RoCE of 7.2% in FY22E. We maintain Sell.

Higher realization helps profits:

Cement prices in the South region remain high compared to last year even after some moderation seen in Q2/Q3FY21. Our channel checks indicated that cement prices in the South region were up 12% yoy (down 3.3% qoq) in Q3FY21. ICEM reported 7.5% yoy improvement in realization (down 4.8% qoq). Higher-than-estimated decline in realization was due to increased sales in the East region (0.3mt sales in Q3, including clinker sales of 0.12mt). Higher sales in the East region also led to an increase in lead distance and in turn, higher freight costs (up 5.6% yoy/7.9% qoq).

Sales volume was down 10.3% yoy as demand remained under pressure in the South region. Variable cost has declined Rs26/ton as the company has low cost fuel inventory and expects coal cost to rise only in Mar-Apr’21. Fixed cost fell to Rs1.5bn/quarter from Rs1.95bn in Q3FY20. Absolute employee expense was down 8.9% yoy. Other expense declined 17.2% yoy/15.3% qoq. Lower costs led to 1.3% yoy/1% qoq decline in opex/ton. EBITDA increased 67.3% yoy with 7.8pp improvement in OPM led by higher realization. Interest expense was down 15% yoy/2.8% qoq on lower debt and borrowing costs. Profit stood at Rs620mn vs. a loss of Rs54mn in Q3FY20.

Maintain Sell on expensive valuations:

We raise EBITDA estimates by 1-2% for FY21-23 as we increase realization assumptions marginally. Cement prices in the South region have been volatile historically and sustainability needs to be seen for building in aggressive assumptions. In FY21 so far, prices have sustained at higher level despite a steep fall in demand. The company’s inability to reduce debts in absence of capex has been a concern for the last few years (Rs7.2bn increase in gross debt during FY17-FY20).

Though gross debt has declined by Rs3bn in 9MFY21, net debt/EBITDA is likely to be remain at 3.9x/3.5x/2.8x in FY21/22/23E. Management indicated that capacity expansion in the Central region will be undertaken after few quarters, which may delay debt reduction. Valuations at 8.6x FY23E EV/EBITDA appear rich, considering higher debt, lower return ratios (RoE/RoCE at 4.7%/7.7% in FY23E) and volatility in cement prices. We maintain Sell with a revised TP of Rs120 (7x FY23E EV/EBITDA) vs. Rs115 earlier. The key upside risk is the sustenance of higher prices in the South region and a steep recovery in demand.

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