The Hindu Business Line : Gujarat Ambuja Cements: Hold

There could also be an upward bias once the stock starts to trade on a bonus (one share for every two shares) and stock split (five shares with a face value of Rs 2 each). The stock could undergo a re-rating driven by higher liquidity and enhanced investor interest due to the affordability factor. We remain bullish on the outlook for the cement sector.

It is likely to be the commodity story where downside risks are marginal. We have several buy recommendations outstanding on the stock at prices ranging between Rs 140 and Rs 420 with the latest call in January this year.

We retain our long-held bullish stance on the stock, which trades at valuation levels that provide room for steady upside over a one/two-year period. Our view is, however, tempered by the possibility of pressure on profitability in the near term.

The principal risks to our recommendation are announcements of new capacities in the northern and western markets, and rising energy and transportation costs. In the cement sector, Gujarat Ambuja is placed in a better position to combat these threats and contain the damage to earnings.

It has handled similar risks with a degree of comfort in the past. The higher operating efficiencies and margins are likely to ensure healthy level of earnings even if these risks materialise.

We do not perceive the possibility of a weaker-than-expected monsoon as a major risk for Gujarat Ambuja. Its focus is on the housing market. It also derives a substantial part of revenues from the urban market where cement demand would be less vulnerable to the vagaries of the monsoon.

Gujarat Ambuja's revenues, profitability and earnings growth would remain robust over the next few years. In this backdrop, key triggers that could provide an impetus to valuation are:

The direction that its strategic alliance with Holcim of Switzerland — the largest cement producer in the world — takes would be a critical factor. Gujarat Ambuja is likely to derive benefits from Holcim's expertise in areas such as operating efficiencies, usage of alternative fuels and information technology to manage logistics and production processes.

Announcement of acquisitions that could fortify its position in the northern and western market. The company has indicated that it is likely to pursue acquisitions to enhance its capacity and market share. With cash profits of about Rs 1,500 crore likely over the next two years, Gujarat Ambuja is well-placed to clinch deals quickly and bankroll them comfortably.

Gujarat Ambuja will also have a say in Holcim's acquisition plans, which may be routed through ACC, at least over the next couple of years. This will ensure that the two groups do not end up bidding for the same business and pushing up costs in the process.

The arrangement with Holcim provides an option for Gujarat Ambuja to sell its 33 per cent stake in Ambuja Cement India before 2008. Ambuja Cement India holds a stake of about 35 per cent in ACC.

We believe that Gujarat Ambuja would exit towards the later part of 2007.

This would ensure an attractive return for its holdings, as ACC is likely to command a higher valuation then due to a larger capacity and an improvement in operating efficiency.

The acquisition of shares of ACC from the market and a merger with Ambuja Cement Eastern is also likely to raise Ambuja Cement India's holding in ACC.

By waiting till end-2007, Gujarat Ambuja would have a higher share in ACC's equity compared to the 12 per cent stake that it indirectly owns now. This aspect, too, would improve the value of its stake in Ambuja Cement India.

Despite the financial savvy exhibited over the years, we do not take a favourable view of its investment of about Rs 60 crore in ING Vysya Life Insurance recently.

There is a high degree of uncertainty about the nature of payoffs, if any, from this strategic financial investment.

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