The Hindu Business Line : ACC: Buy

ACC is poised to emerge as the largest cement play and Holcim's window to India. This stock is likely to be the preferred large-cap play in cement. Buy, especially on weakness, with a two/three-year perspective.

ACC's operations may be scaled up to Holcim's global benchmarks: Mr Anil Singhvi, MD (right), Gujarat Ambuja Cement with Mr Paul Hugentobler, Member of the Executive Committee of Holcim - Paul Noronha.

ACC has, for decades, been the flagship of the cement industry. It has been through the vicissitudes of the industry as it moved from a stringent regulatory framework to a largely market-oriented set up.

The company has been through it all and bears the scars too as it is still in the process of investing to make its facilities contemporary. Its efficiency levels, despite an improvement over the past five years, still trail the likes of Madras Cements, Shree Cement, and Gujarat Ambuja Cements (its likely merger partner).

Merger imminent

ACC's merger with Gujarat Ambuja Cements — the poster boy of the free-market era in cement — is imminent to create Holcim's listed outfit in India. Holcim of Switzerland is set to become the largest cement player in the world with its high profile acquisitions in India over the past 15 months. After ACC last year, Holcim picked up a key stake in Gujarat Ambuja Cements this January.

Holcim's move to buy a stake in Gujarat Ambuja has, as expected, had a positive effect on ACC. Cement stocks across-the-board have posted gains over the past three months. ACC has been at the forefront with a 40 per cent gain since Holcim acquired a foothold in Gujarat Ambuja. This has enhanced ACC's enterprise value per tonne of capacity to a level that is close to the attractive price at which the stake in Gujarat Ambuja was sold to Holcim.

Efficiency gains

Despite the stock uptrend, we remain positive on ACC. We have several buys outstanding on the stock, the latest being in May 2005 at Rs 390. The price gains have come in anticipation of the merger, which will deliver benefits of synergy and fast-track the pay back for Holcim for its investments in excess of $2 billion in India. It will also push the profitability of the Indian operations closer to tHolcim's global benchmarks. ACC has also completed the process of exiting non-core businesses and is all set for the merger. There is no reason for Holcim to maintain ACC and Gujarat Ambuja as two separate entities. The subsequent induction of Mr Anil Singhvi, CEO of Gujarat Ambuja, on the board of ACC only strengthens our view of an imminent merger.

A merger will also enable Holcim pursue further acquisition opportunities in India using the robust cash flows of the ACC-Gujarat Ambuja combine and enhance its edge over MNC peers and Grasim.

Once the open offer by Holcim for Gujarat Ambuja is completed, a month from now, the merger process is likely to be set in motion. As investor response is likely to be muted and Holcim may end up with a stake of less than 25 per cent, in the best-case scenario (assuming the Sekhsaria group sells its residual stake), in Gujarat Ambuja, a merger will improve its clout. This process may be completed over the next year.

Upside potential

We believe that a substantial part of the merger-possibility linked gains is factored into the price of the two stocks. In the homestretch, a stock split to make the face-value even with that of Gujarat Ambuja could perk up ACC.

If you buy with a two/three-year perspective, there could be room for gains linked to fundamentals and acquisition initiatives. Only over such a period would the cost-benefit of the merger percolate to the earnings stream.

The industry picture — the tightening demand-supply gap in most markets across India, the greater pricing power in the hands of producers, the higher average cement price levels and the flow-through benefits from the focus on infrastructure and housing — is also a major positive for the merged entity. Such a macro-picture could lead to cash profits of at least Rs 3,000 crore over the next couple of years. This should be more than adequate to wind down debt even if acquisitions are pursued.

ACC's operating margins have improved since it came under the Gujarat Ambuja fold. Holcim's expertise in the use of alternative fuels and waste materials and superior technology could also expand by a few percentage points over the long term. This process will be earnings accretive and is also likely to support a higher valuation for the stock vis-à-vis its peers.

Risks

The principal risks to our recommendation are a delay in the merger process and an unexpected slowdown in cement demand, which could have a bearing on prices. In two-three years, these risks, even if they materialise, could be overcome. Stock price gains are unlikely to be of the magnitude enjoyed by investors over the past three years. They could, however, be attractive for a large-cap stock.

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