ACC: Book profits partially and re-enter at lower levels

Recommendation: Book profits partially and re-enter at lower levels

S. Vaidya Nathan

FOR much of the 1990s, ACC was an over-valued stock, trading at price-earnings multiples higher than its industry peers. Over this period, there was a high level of speculative interest in the stock. Now the market appears to be pricing in an improvement in performance that would justify the valuation levels.

What has led to the recent spurt in prices is the interest shown by institutional investors. The flow of liquidity, as the stock finds a place in mutual fund/FII portfolios, has helped lift the stock from the lows of Rs 100 to the recent Rs 160-170.

Much of the recent improvement is linked to the company's showing under the auspices of the Gujarat Ambuja group. Between 1995 and 2000, ACC under-performed the industry trends in terms of volumes.

With a sizeable proportion of old capacities, the operating profit margin was well below the 15 per cent level and, at most times, around 10 per cent. ACC was content watching the other players consolidate and increase capacity.

The last three years Larsen and Toubro, Grasim, India Cements and Gujarat Ambuja Cements have been competing for the top slot in terms of capacities, with ACC which, with around 10.5 million tonnes, has been the industry leader.

In this backdrop, the Tatas decided to exit the company by selling their stake to the Gujarat Ambuja group. The transaction was structured such that it did not deliver value to the non-promoter shareholders of ACC in what was essentially a takeover situation. But the only solace has been the improvement in operational parameters.

A significant improvement

The Gujarat Ambuja group picked up a 14.4 per cent stake in ACC and positioned the arrangement as a strategic alliance. An open offer, under the change of control clause of the Takeover Code, was avoided thanks to a ruling by the Securities and Exchange Board of India (SEBI).

This has made the arrangement cost-effective for the Gujarat Ambuja group. And, quite expectedly, it seems to have pressed on with its agenda of improving ACC's showing on two key parameters -- volume and efficiency, the main success factors from a medium-to-long-term perspective in the industry.

In the first eight months of 2001-02, ACC's volumes grew 12 per cent year-on-year. In the last four months, the volume growth remained above the 15 per cent mark at a time when the industry volumes rose 6 per cent.

To get a perspective on the improvement that has taken place, one has to look at the 1999-2000 performance. In a long time, the industry had a good year with volume growth of 15 per cent. But ACC languished, because of a lackadaisical approach.

The Gujarat Ambuja group appears to have imparted the needed thrust in the area of marketing. The modernisation of capacities at some units and the expansion in Wadi have also paved the way for volume growth. Surely, it is not going to be easy for ACC to sustain the growth it achieved in 2001-02. But recent indications are that the company will not be left behind, even as Grasim, Lafarge, and L&T forge ahead.

Efficiency perks up

On operating efficiency, Gujarat Ambuja Cements is in the forefront. Ever since the so-called `strategic alliance' was forged, some of its emphasis on efficiency seems to have rubbed off on ACC.

This has helped bring about a turnaround in ACC's fortunes, with the company ending the July-September 2001 quarter with profits compared to losses in the corresponding previous period. There appears to be considerable room for further improvement as ACC is nowhere close to operating profit margins in the 25-30 per cent range, which is routine for Gujarat Ambuja Cements.

Even if ACC manages an OPM of 15-20 per cent consistently, its earnings and cash flows would improve. But the improved performance and the liquidity rush have led to interest in the stock.

Beneficiary of consolidation

The recent deal between Grasim and Reliance Industries, under which the former has picked up a 10.4 per cent stake in L&T, has dramatically altered the situation in the cement industry. Now the Grasim-L&T and the Gujarat Ambuja-ACC combines together control close to 42 per cent of the industry capacity and more than 50 per cent of sales by cement majors.

This consolidation has ensured that once the demand-supply gap narrows, Grasim and Gujarat Ambuja would have considerable control over the price levels. They are also well-placed to squeeze market share out of other smaller players.

The change in the situation is evident from the fact that five companies controlled around 55 per cent of the capacity before the two strategic partnerships happened. This is a far cry from the time when ACC, accounting for 10-14 per cent of industry capacity, was the leading player.

The Grasim-L&T deal has also made it difficult for any MNC to gain the kind of volumes that the two groups command. But this deal has also brought about an interesting dimension to ACC's ownership.

Target for hostile bid?

Given the difficult business environment, international cement majors such as Lafarge, Cemex and Holderbank, may go slow on building a position in the Indian market. But very likely ACC will be a target, should they decide to expand into India.

Only ACC and India Cements can give the MNCs the kind of volumes needed to match the industry majors. But will a hostile bid benefit ACC shareholders?

A lot would depend on how domestic institutional investors act in such a situation. But this is more in the realm of expectations. The expiry of the three-year period which would allow the Gujarat Ambuja group to declare itself a promoter and raise its stakes without an open offer may also happen in the next 24 months. Any hostile bid would have to come before the Gujarat Ambuja group gets this status.

Looking ahead

While the hostile bid is a possibility, the positive for shareholders would be further improvements in efficiency and volumes. Efficiency improvement is vital for ACC as the prices may not sustain at the ramped up levels seen in 2000 and early 2001.

This could continue to offer a firm peg for sustaining ACC's premium valuation vis-a-vis its peers. The gradual exit from the non-core businesses should free cash flows and cut debt levels. The acquisition of complete control over Eternit Everest may offer ACC a synergistic opportunity in the building materials business.

One uncertainty, however, looms large: What would be the status of ACC under the auspices of the Gujarat Ambuja group? Now, the holdings are vested in Ambuja Cement India. If the Gujarat Ambuja group gets the status of promoter under the Takeover Code and an opportunity to raise its stake, would it merge ACC with itself?

This may not happen as there would be a notable difference in the performance parameters of the two. Gujarat Ambuja may not want to drag its profitability levels down.

The flip side is that a continuation of both as separate entities could raise concerns of conflict of interest which may come to the fore once ACC's performance parameters improve further. But for the present, these may be on the backburner as the focus rivets on ACC's performance.

Shareholders can wait for an uptrend in the Rs 160-170 range to pare exposure and book profits. But re-entry can be contemplated as the stock could make gains over a two-year time-frame. However, a buy-and-hold strategy would not be appropriate and investors would have to capitalise on profit opportunities from time to time.