SECTOR UPDATE by Sharekhan

Cement dispatches for November 2008 grew by 12% year on year (yoy) to 14.43 million metric tonne (MMT). Cumulative dispatches from April to November 2008 rose by 7.4% to 114.70MMT. The growth for the month under review is mainly on the back of low base effect and end of festive season in October 2008.
The utilisation ratio for the month under review stood at 83.3% as against 90.5% a year ago. The significant drop in utilisation yoy is backed by a 19.3% year-on-year (y-o-y) growth in capacity addition. However, the utilisation ratio also declined on a month-on-month (mom) basis due to capacity addition of 0.11MMT during the month.
Among regions, eastern India emerged as the leading cement-consuming region with a growth rate of 21.7%. Northern and central regions registered an impressive growth of 20.2% and 15.9% respectively. After a long period, the growth rate in southern region has slowed down to 7.9%. However, the western region continued to register a negative growth during the month under review.
Among the companies under our coverage, Shree Cement emerged as a pioneer with a robust volume growth of 33.7% yoy to 0.61MMT during the month, mainly on the back of capacity addition. Ultratech Cement and Orient Paper and Industries Ltd (OPIL) have also registered impressive growth of 16.2% and 14.8% respectively. Dispatches of top three players—ACC, Grasim Industries and Ambuja Cement—have also improved significantly to 8.2%, 5.3% and 8.7% yoy respectively.
Cement prices in November 2008 declined across all major cities (Mumbai, Delhi, Kolkata, Chennai and Hyderabad) compared to those in October 2008. The fall in prices was mainly due to cut in excise duty and slowdown in demand from non-trade segment.
Though macro headwinds remain, in terms of slowdown in key user industries (such as real estate and construction) and overall economy, the recent moderation at cost front and positive impact due to surge in the volumes and savings due to recent cut in central value added tax (cenvat) are likely to improve the estimated profitability of cement companies by 8-15% in FY2010. Additionally, as mentioned in our previous note, the valuations are already attractive with most companies trading at 30-60% discount to their replacement cost. The demand growth is likely to be in the range of around 6.9%, against the earlier expectation of 8-9% growth in FY2009. However, some of the companies like Shree Cement and Ultratech Cement will benefit from relatively early commissioning of their capacities and captive power plants.

Kotak Suspend rating and target price
• Reputation damage difficult to undo
• Concerns on cash utilization still remain—US$430 mn lying in current accounts
baffling
• Potential disruption in the IT services business plausible
• Suspend rating and target price
In a bizarre sequence of events, Satyam proposed and then revoked the proposed
acquisition of its affiliated real estate and infrastructure companies. We believe that the
reputation damage in the minds of all the major stakeholders viz. the non-promoter
shareholders (who hold 90%+ of the company), employees, business partners, and clients
would be difficult to undo. In addition, the negative press that the company would receive
on the event may also negatively impact the cash generating IT services business. We had
previously raised issues about use and deployment of cash especially the increasing
amount of cash balance in current accounts (Rs20 bn at end-2QFY09) (please refer to our
note on Satyam dated Oct 20, 2008) and believe that the market may no longer be
charitable to the company on such issues. We expect a structural de-rating of the stock.
We shall review our estimates and valuation of the company over the next few days in the
light of the event and its potential repercussion on the company’s core business prospects.
In the interim, we suspend rating and target price on the stock.
Reputation damage difficult to undo.
 We expect a structural de-rating in the Satyam
stock on account of yesterday’s sequence of events. Revoking the decision to acquire
affiliated group companies under investor pressure would do little to rebuild the lost
confidence of the market in the company’s corporate governance practices.
Concerns on cash utilization still remain- US$430 mn lying in current accounts
baffling.
 We believe that the markets would not give any benefit of excess cash in books
(Rs53 bn at end Sep-08). We had raised concerns in the past on Satyam’s cash
management (see Exhibit 1). Our subsequent discussions with the management have
failed to yield satisfactory answers. The management yesterday stated that they have
transferred some of the funds from current accounts to deposit accounts.
Potential disruption in the IT services business plausible.
We believe that serious corporate governance doubts and negative press may impact the perception of the
company amongst the stakeholders i.e. employees, business partners and customers. We
believe that these developments can impact the customer base especially in the current
environment where clients are looking to work with fewer vendors (vendor consolidation).
We are also not sure about We are also not sure about the impact of this on middle and senior management team
especially given that they had been incentivized through stock compensation in the past.
Target for hostile takeover?
Satyam is a widely held company with the promoters holding a mere 8.6%. Exhibit 2 gives the last disclosed shareholding pattern of the company. We would not be surprised to see a concerted effort for management change
and reduction in the power of the Board of Directors. We understand that under section
284 of Companies Act, specific director/directors from the Board of a company can be
removed (before the expiry of his period of office). Also under section 169, 10% or more
of the shareholders (in terms of value of underlying equity) can convene an extraordinary
general meeting to remove a director.
So what really happened?
We were baffled by Satyam’s decision to venture into completely unrelated infrastructure development and real estate businesses by acquiring majority stakes in affiliated companies. We found no synergy between the IT services and
real estate/infrastructure businesses. The proposed acquisition would have resulted in
Satyam having a net debt of about US$400 mn (in addition to potential assumed debt of
acquired entities) versus a current cash balance of US$1.1 bn. Effectively, the entire
funding obligation of the infra/ real estate businesses would have been put on Satyam,
while the promoters would have walked away with large portions of cash. We discuss the
proposed acquisitions (subsequently revoked) below.
1. Maytas Properties. Satyam proposed to pay US$1.3 bn to the founders and other
shareholders to acquire 100% stake. The management failed to elaborate on the
valuation methodology employed, shareholding structure and the bankers used for the
deal. Maytas properties has 6,800 acres of land bank, 245 mn sq ft of developable
space and projected revenues of US$90 mn for FY2009.
2. Maytas Infrastructure. Satyam proposed to acquire 51% stake (31% from promoters,
20% mandatory open offer) for a total consideration of US$300 mn. Maytas Infra is a
listed company with a market cap of US$600 mn. Maytas Infra has an order book of
US$2.5 bn and is involved in construction and infrastructure projects.