CCI imposes penalty on cement companies: Angel Broking

In a first-of-its kind order, Competition Commission of India (CCI) has imposed cumulative penalty of `6,307cr on 11 cement makers for forming cartels. Cement companies upon whom the penalty has been imposed include top cement players such as ACC, Ambuja Cements, UltraTech Cements and JP Associates. The penalty has been imposed for violating the provisions of the Competition Act 2002, which deals with anticompetitive agreements including cartels. CCI has passed the order after it was convinced of the existence of parallel and coordinated behavior amongst cement makers with respect to price, dispatch and supplies in the market. Penalty, which has been computed by applying 0.5x on FY2010 and FY2011 profits of these companies, is much higher than the earlier expectations of 8% on the average of past three years’ revenue.

What the order says: CCI has considered action of the cement manufacturers during May 20, 2009, and March 31, 2011. It has concluded that cement makers have controlled supply through under utilization of capacity. Further, CCI in its order has said that cement players have maintained similar and parallel behavior in production and dispatch to maintain high prices in the market. It has also mentioned that the act of controlling supplies in the market and determining prices through anti-competitive agreement is detrimental to both the consumer’s cause and to the whole economy.

Our take on the order: Cement companies have managed to post reasonably healthy return ratios over the past two years, despite the declining demand and excess capacity in the industry. The RoE of 15-17% reported by the industry during this down cycle is much higher than the RoE of 7-9% during the last down cycle witnessed during FY2001-03. To a large extent, this was possible due to the strong production discipline adopted by them. We believe this ruling of CCI is a significant negative for cement makers, as it would curtail their pricing power in the near to medium term and would have a significant effect on their profitability.

Outlook and valuation: In our view, the cement sector’s valuations in terms of EV/sales and EV/tonne are ahead of the cycle when compared to utilization levels and are almost 36% more expensive than historical valuations during periods of similar utilization levels. Hence, we maintain our Neutral view on the sector. That said, we maintain our Buy recommendation on JK Lakshmi Cement due to its attractive valuations, as it is trading at EV/tonne of US$43 on FY2014E capacity.

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