Macquarie lowers Ambuja Cements' target price to Rs 137/sh

Rakesh Arora, Head of Research, Macquarie Capital Securities sees Ambuja Cements' sliding post the deal with Holcim India. Macquarie has now awarded Ambuja a target price of Rs 137 per share after factoring in earnings downgrade and a potential CCI penalty.

Also read: Holcim announces merger with Ambuja Cements Below is the verbatim transcript of his interview on CNBC-TV18 Q: Since you track Ambuja Cements closely what did you make of the development and what kind of punishment is warranted? A: Ambuja becomes a holding company. The other example we have from the cement space is Grasim Industries which owns 60 percent in UltraTech Cement and trades at a substantial discount. It is like 30-40 percent holding company discount is built in Grasim stock price. So while I don't think we will go to that extreme in Ambuja but the target is much lower than where the stock is trading at the moment. Our target is Rs 137 so still a long distance to go before it settles. Q: This target of Rs 137 is premised on fundamentals or just according it a holding company discount after yesterdays deal? A: It is not giving a holding company discount; it is just based on the fundamentals. We think that there has been earnings downgrades in the last six months in the cement sector and probably another 10-15 percent is due post the results which came out yesterday and  also on how Q3 is shaping up right now, which is looking extremely weak. Earnings downgrade will continue in cement sector and based just on that our target price is Rs 137. We had a little bit of discount for potential penalty by Cabinet Committee on Investment (CCI) so that is also built in our target price. Q: What is interesting is that the market has also chosen to trade ACC down, that stock is down almost 3 percent today. Is that a reflection of the kind of earnings people expect to see as you were talking about or are people just a bit peeved at how the management has gone about its business in India with regards to its cement assets? A: Some of the investors are telling me that if the main shareholder doesn’t really want to keep that asset, why minority shareholders would stick to it. So that is the counter to why ACC is trading down. Generally, I would think that ACC is in much better position as compared to Ambuja primarily because Ambuja is committed to buy a rather 10 percent stake over the next two years via creeping acquisition. So, that will support the valuations of ACC. Moreover, it remains a pure cement play and there is no holding company structure so probably it starts to trade little better. Having said that the overriding factor is that industry is going through lot of pain and earnings downgrades will continue. So, don't expect ACC to jump up, probably stabilise at these levels or slightly up and down. Q: Your notes over the last few weeks have indicated that you guys are tilting on the optimistic side. Are you still feeling that way going into August, do you expect to see the market move higher rather than lower? A: Most of the negatives are well known. The last one was phasing-out of Quantitative Easing (QE) which is to some extent built into our market. So what I would say is that the chances are that QE may not be phased-out early. Probably it may not happen till December. Already some talks about raising of debt ceiling in US is gaining ground and people are starting to worry whether that will have a negative impact on the US economy and probably Federal Reserve might be promoted to extend. Therefore, I think negatives are largely built in and risk reward ratio is favourable and as monsoon is panning out pretty well, rural demand should be up in the next six months and we are also hopeful that government spending will pick up pre-election. These two things tells me that probably there will be some buoyancy in the economy going into the second half of FY14 and probably the QE phasing out may not happen as soon. So, things might settle out and we might see a slightly better market in the second half. Q: What have you made of the beating in stocks like Yes Bank and IndusInd Bank over the last few days, do you think it is warranted? A: It is an overreaction. I would say that you have RBI governor changing in September and if the economy starts to look slightly better, and quantitative easing (QE) doesn’t phase out so fast, things stabilise and these restrictions will go by August or September. We would be buyers into this dip, in all these quality private sector banks. Q: Just looking at the top ten picks in your model portfolio though, you guys don’t have a single fast moving consumer goods (FMCG) name featuring there, are you done with how the valuations are for that space, what do you feel about some of these FMCG stocks and where they are trading at? A: Valuations in FMCG stocks are extremely rich and it is difficult to justify holding any of these names at these valuations. While we are not telling investors to dump them and get out as yet, they can continue to hold on till the time there is some more uncertainty. However, there are better plays and better values, which are emerging. So eventually we will have to take a call and shift to some of those private sector banks or a high dividend yield public sector undertaking (PSU) stocks, which we think can give better return over the next six months. _PAGEBREAK_ Q: Is there any recourse in Ambuja that minority shareholders have to corporate action like this and they will just have to grin and bear this kind of exercise of taking out cash and this destruction in their marketcap? A: Obviously the merger would entail shareholder approval and court approvals, so there is recourse available for the shareholders. However the first tranche of the transaction is actually sale of 24 percent stake in Holcim India that is just a pure investment and doesn’t really acquire shareholder approval. So the big damage is already done in the first tranche. For the second tranche you need shareholder approval and court approval. So let us wait and see how things pan out. I think there will be some resistance from the shareholders. Q: You were talking about FMCG, how are you approaching IT as a space now because there the large cap valuation has expanded and of late some of the midcaps have started to catch up names like Hexaware Technologies? A: Midcap IT still look reasonably valued; HCL Technologies is trading at 12-13 P/E, Tech Mahindra is around 10-11 P/E. These stocks are playing the catch up game after Tata Consultancy Services (TCS’s) run up and Infosys also jumping to 14-15 P/E. We are market weight on IT sector and not going overboard and buying these names. There would be lot of pullbacks here and there to give is opportunity to go overweight in this space. So may be they can buy HCL Tech which is our favourite pick in IT space but wait for pullback in companies like Infosys etc. One quarter is good but probably they might surprise on the downside in the next one-two quarters. Q: What do you guys hear about fund flows and what kind of flows one can expect going into the month of August, do you expect activity to pickup in a market like India or are people still a bit disinterested in this one? A: If the rupee stabilizes around the current levels and the volatility reduces fund flows will improve and it would also depend on how the Indian economy is shaping. Therefore, I would tend to think is liquidity is abound in the global market and some of it will find way into India if things start to look better. Already the outflows have started to moderate quite a bit and probably by August September we will see little bit of inflows trickling in back. Our assumption is that slow and steady inflows till December should happen. Q: Can any regulatory authority take some action on its own accord because of the contours of this Ambuja Cement, ACC Holcim deal or you think they are clean on that front as well? A: Since they are particularly saying that the marketing division, etc remain separate and they remain as two separate companies, and having their own distribution channels, and retail network. So I don't think CCI would have any objection to this deal. Probably it is for the Foreign Investment Promotion Board (FIPB) to see whether almost USD 600 million would be taken out and whether those kind of approvals are obtained or not? Q: Jaiprakash Associates has come down to Rs 45 now of course because of balance sheet concerns. Would you buy it here? A: No actually the company is into deeper problem with huge amount of debt and the interest coverage ratio is hardly 1.3-1.4 times. That doesn’t really auger well, and if the downturn in the industry continues for some more time they would have to do either equity raising or some asset sale. They have been trying to do some asset sale but they have not been successful. So, risks are highly loaded against JP Associates at the moment. Therefore, one needs to refrain from doing any kind of bottom fishing in that name. Q: The other big collapse which has happened in the last few weeks is Wockhardt now down to Rs 600. Is there a case for buying it or would you still stay away? A: We recommend staying away  because their two other facilities are going in for FDA inspection in August. It is difficult to predict what will be the outcome given the warning letter and import alert in their third facility. So, it is better to stay away and wait for clarity on those two facilities because the impact is going to be much sharper, almost 30-40 percent of earnings. Therefore stay away till we have more clarity on inspection of FDA from those assets. Q: Are you getting worried about what might happen at individual corporate levels because that was more or less robust through the course of this year, stock level action, corporate action, deals getting done, money coming in - because of how business is struggling do you think companies will start facing a tougher task for road on that count as well? A: That is the reason public sector banks are going down under because these large corporates probably would be coming for restructuring and that would be the sign of bottom. We have not really hit the bottom in terms of restructuring in non-performing assets (NPAs) and in the next three-four months if things continue at this sluggish pace you will see lot of these large companies come up for restructuring.