India Cements presents an opportunity for long-term investors

Chennai-based India Cements seems to have missed out the current rally on the Dalal Street. It gained just 27.5% since the beginning of March
’09, compared with a nearly 101% jump in the Sensex during this period. The ET Cement Index had also gained 74.2% during this period.
India Cements is now one of the cheapest stocks under various valuation metrics — be it price-to-book value, price-to-earnings multiple. For instance, India Cements trades at just 1.2 times its book value. In contrast, Shree Cements with a focus on northern markets, trades at 4.6 times its book value, while UltraTech cement, which also has a presence in the south, trades at 2.85 times its book value. Also, the dividend yield of India Cements at 1.6%, is higher than that of Shree Cement and UltraTech cement.

The Street has been concerned that south-based players like India Cements could grapple with weakening price realisations in future. That’s because the cement capacity in the region is expected to rise from 78 million tonnes in FY 09 to nearly 120 million tonnes in FY 12, and demand growth is expected to be much slower. During the monsoon season there was strong price correction in some southern markets.

However, India Cements has been attempting to diversify its presence beyond the southern markets, and in April 09, it had brought on stream a one million tonne cement grinding unit capacity in Maharashtra. The company is expected to add nearly Rs 350 crore to its net sales in FY 10 from this plant. Long- term investors have recognised this shift in the strategy and there has been a steady increase in delivery trades.

CAPACITY& CAPEXPLANS:

India Cements’ installed capacity at the end of FY 09 was 12.95 million tonnes compared with 8.81 million tonnes a year earlier. As part of this expansion during FY 08, a grinding unit with a capacity of one million tonnes at Chennai was completed in August 2008.

In last two years, the company had invested nearly Rs 1,960 crore in capacity expansion. This expansion has been funded largely through internal accruals. India Cements is expected to end FY10 with a capacity of 14.3 million tones. In the first quarter, it commissioned additional grinding capacity at its Malkapur facility and is working on the upgradation of its kiln at Chilamakur, Andhra Pradesh. And despite this capex programme, its debt to equity ratio was at 0.68 at the end of FY 09, compared with 0.96 a year earlier. It had cash flows of Rs 706 crore in FY 09 and Rs 1,017 crore in FY 08. The company is also building two captive power plants of 50 MW each, at its facilities in Tamil Nadu and Andhra Pradesh, at a cost of nearly Rs 500 crore.

Recently, the company along with its wholly-owned subsidiary, ICL Financial Services, had launched an open offer for Indo Zinc, a loss-making zinc producer. Indo Zinc was implementing a project for setting up a cement plant in Rajasthan with a capacity of 1.5 million tonnes, but this project will now be implemented by India Cements. The cost of setting up this plant in the north along with captive power facilities, is estimated at Rs 600 crore. India Cements had recently raised Rs 592.5 crore via a QIP for its expansion plans. India Cements also owns an IPL team and has a presence in the shipping industry, with small vessels operating in the dry bulk segment. However, the contribution of the non–cement business was very small to its total net sales.

FINANCIALS:

During the June 09 quarter, India Cements operating profit margin declined 500 basis points y-o-y to 30.5% and that’s despite a 9.6% y-o-y growth in its net sales to Rs 960.25 crore. Pressure on its operating profit margins was due to its power & fuel costs that rose nearly 21.4 % y-o-y to Rs 1,011 per tonne, and it offset the 7.8 % growth in cement realisations on per tonne basis.

VALUATIONS:

At Rs 123.7, India Cements trades at a P/E of 7.6 and investors could take a position in this stock with a long-term outlook. Other south-based players like Madras Cement trades at a P /E of 7, while for UltraTech cement it is at 9.1 times.

Cement stocks offer investors a good shorting opportunity

The cement industry is expected to add installed capacity increasing surplus capacity further which is going to dramatically change the profitability of cement firms.

Cement stocks have been rather subdued since August, falling at an average rate of about 7%, at a time when the markets have extended the year’s gains by 6%.

This is in response to the correction in cement prices, especially in south India and some parts of north India. According to an analyst, prices have corrected by 9-10% in south India and eastern Uttar Pradesh.

Overall, cement demand has been steady across the country and has even grown strongly in some pockets. In August, for instance, cement demand rose by around 17%, higher than the 10% growth in July and the 14% in June.

The decent growth in demand has in a way delayed the correction in cement prices. The industry is expected to add 114 million tonnes in installed capacity in the four-year period between April 2007 and March 2011, according to Citigroup research.

Graphics: Ahmed Raza Khan / Mint.

About half of this has already come on stream in the past two fiscal years, taking the installed capacity up by 33% since April 2007 to 221 million tonnes. This resulted in a fair amount of over-capacity since demand last year stood at 178 million tonnes. With demand growing in double-digit rates this year, propped up by strong government spending, price cuts by cement manufacturers had been delayed to some extent.

But capacity continues to come on stream and the proportion of surplus capacity is expected to be much higher by the end of this year and increase further in fiscal year 2010-11. This would dramatically change the profitability of cement firms, which have been enjoying the benefits of high prices and low costs.

The current round of cement price cuts may just be the beginning of a broad correction in prices. Analysts at Ambit Research point out in a recent note, “In our view the cement cycle has peaked with an anticipated capacity increase by 23% in FY09-11 relative to increase in demand of 10% compound annual growth rate during the same period. This is expected to put pressure on cement prices, which in turn, is expected to lead to a decline in earnings.” Citigroup reiterated in a report dated 27 July that it sees the current fiscal year as a peak in terms of earnings for cement firms and that it expects a sharp fall in the next fiscal year.

Cement stocks don’t reflect all this and investors seem to be waiting for the above prognosis to get reflected in these companies’ reported numbers. As a result, some cement stocks offer a good opportunity to go short on the market.