Executive Summary

Executive Summary

Short term play: Tight demand-supply to facilitate price and EBITDA growth till Q1FY08E

Cement prices have risen sharply on an average by nearly 19% or INR 32/bag to INR 195/bag (average
cement price across four metros) during the H1CY06 period from H2CY05 price levels. We expect
prices on an average to increase further by about INR 20-25/bag driven by tight demand-supply
scenario in the next three quarters (October 2006 to June 2007) with utilisation levels crossing 94%.
The price increase during this period will, however, not be as sharp as it was in the H1CY06 period, due
to the absence of a sharp cost trigger like the implementation of the truck overloading ban in February
2006. Accordingly, we expect EBITDA/tonne to increase by about 19-20% by Q1FY08E from Q1FY07
levels.

Limited earnings upside thereafter from cement prices; growth dependent on efficiency
and volume gains

We expect prices and EBITDA to peak by Q1FY08E as supplies are expected to accrue from H2FY08E
and correspondingly utilisation levels are likely to decline to 91% by FY08E. Further, nearly 70.6 mtpa
of capacity additions by FY09E will lead to a cycle reversal with excess capacities arising in the North
and South. Our demand-supply forecasts factor in a strong 10% demand growth scenario, incremental
supplies arising from blending, and fresh capacity additions. Moreover, exports are likely to decline in
the Middle East from 2007 onwards. Hence, we expect prices to soften a bit by the last quarter of
FY08E and believe that earnings upside post Q1FY08E is likely to be limited, except for players
lowering costs or adding capacities.

Short term upside in valuations; no gains in the long term

We believe that there is a close linkage between valuations, capacity utilisation levels, and EBITDA
levels. (1) Valuations (EV/tonne) closely map capacity utilisation levels historically. We expect utilisa-
tion levels to rise over 100% levels in Q4FY07E and remain above 90% levels in Q1FY08E. This
suggests a short term upside in valuations as well. (2) Valuations (EV/tonne) typically peak ahead of
EBITDA profits peaking historically, implying that valuations factor in price/profitability increases in
advance. We expect cement price gains to accrue in the successive quarters and therefore, expect
valuations would also closely follow suit.

Post Q4FY07E/Q1FY08E, however, price upside is limited and we expect prices to decline from
Q4FY08E onwards. We expect valuations to correct ahead of EBITDA peaking in Q1FY08E and prior
to the onset of the cycle reversal (we are more than two years into the current cycle upturn).

Select picks

In the short term (upto Q1FY08E), we like UltraTech (UTCL), Madras Cements (MCL) and India
Cements (ICL) whose one year forward EV/EBITDA valuations at 8.2-9.4x are attractive relative to
12.4x and 11.9x (CY06E ending) for Gujarat Ambuja (GACL) and ACC respectively, and attractive
relative to the past cycle peak (i.e. six months prior to the operating peak in April 1996). Post Q1FY08E,
the operating peak, we believe that there is limited upside in valuations for the cement sector due to
70.6 mtpa capacity additions by FY09E, with a likely overcapacity scenario in South. We expect
valuations to correct ahead of the cycle reversal. Hence, we initiate coverage on these companies
with an ‘ACCUMULATE’. We believe that valuations for GACL and ACC are expensive as their
enterprise valuation and one year forward EV/EBITDA valuations trade at a premium far higher than
pan India presence for ACC or cost efficient play for GACL can command. Hence, we initiate cover-
age for these companies with a ‘REDUCE’
‘REDUCE’.