CCI imposes hefty penalties on cement companies: Emkay

CCI imposes hefty penalty on cement cos50% of FY10 & FY11 net profits: The Competition Commission of India (CCI) has imposed penalty on cement companies finding them guilty of cartelization under section 3 of the competition act. The penalty is imposed @ 50% of net profit for FY10 & FY11 and is 1.7-2X of what we had expected it to be. Penalty works out to an average ~13% of last 3 years average turnover, which is sharply higher in comparison to other recently levied penalties by CCI which were in the range of 5-8% of last 3 years average turnover. The penalty worth Rs63 bn is imposed on 11 cement producers which include our coverage companies like ACC, Ambuja Cements, Ultratech, Grasim, India Cements, Madras Cements, Jaiprakash Associate. 

Penalties harsh on ACC & Ambuja & JPA financials: Though the final outcome of the event could a time consuming affair given the gravity of penalties, the respective companies on the instance of auditors might have to provide for these penalties. And hence the impact of penalty imposed by CCI could bee particularly harsh on financials of some companies. For e.g. Penalties could erode 15% of CY12 estimated Networth of ACC and 13% for Ambuja. Similarly it could impact JPA FY13E consolidated networth by 9%.

Our View - CCI could act as a watchdog - Industry could see some near term loss of pricing power: We believe that the circumstantial evidence provided by CCI are strong in some instances but the same statistical evidence provided could be considered weak given very specific time period analysis. Though the financial impact on 100% provision/payment of penalties are significant, we see a much larger implication of the CCI order as the industry could now have CCI as its full time watchdog. We notice that the commission in its order has indicated that it will monitor the activities of the industry and if the activities are further found to violate the ‘cease and desist’ order it can impose further penalties. This could mean that in the near term industry could see some loss of pricing power. In FY12 the industry was able to maintain its pricing power as all India cement prices increased 8.9% yoy. The price increase helped the industry pass on the sharp increase in energy and freight cost and maintains its EBIDTA margins of ~21-22%. However in the near term we see that industry could see some loss of pricing power as hiking cement prices in the event it is fighting the case of cartelization might weaken industry chances of a favorable judgment. 

Maintain REDUCE on Ambuja & Ultratech keep ACC as relative preferred pick- Positive on Shree lowest cost producer and Grasim- improving VSF performance to protect consolidated margins: We remain cautious on the sector as we find very little comfort with rich valuation of cement stocks. We maintain our negative on the stance on Ambuja & Ultratech. Maintain ACC as relative preferred pick. We remain positive on Shree cements as it is the lowest cost producer in its region of operation (North) which means even in the event of a big blow to pricing power, margins for Shree will remain protected. We also would prefer Grasim Industries as gradually improvement in VSF segment performance coupled with capacity expansion kicking in from Q4FY13 is expected to cushion any adverse impact on the cement business.

Public holding more than 90% in Indian cos

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