India Cements: Buy

Investors with a long-term perspective can buy the stock of India Cements. Trading at a price-to-earnings ratio of 10 times its estimated earnings for 2011-12 against the industry average of 12-15 times, the stock is a value buy in the cement space. From Rs 123 at which we recommended ‘book-profits' on the stock, the stock has declined to Rs 68 now. Downside for the stock hereon appears limited, given that India Cements appears well-placed to benefit from falling raw material costs and maintain its price line, given the pricing discipline of players in the market of southern India.

The stock trades at an enterprise value of Rs 3,200/tonne now, which is one-fourth the value that prevailed in December-2007, and is cheaper than cement manufacturers of comparable size.

Despite a 12 per cent drop in despatches in the recent June quarter, India Cements reported a sales growth of 20 per cent and PAT growth of over 300 per cent.

Profits were driven by higher realisation — cement price in South India has moved up to 275-280/bag in the June quarter from Rs 245/bag in the same period last year. .

Realisation strength

Decelerating demand triggered sharp profit margin erosion for India Cements and other players in the southern cement market in 2010.

From Rs 250/bag in September-09, prices dropped to Rs 170-200/bag by September 2010 in this market.

Concerted efforts to curtail output, however, helped lift prices to Rs 250-255/bag levels in October last year, from where there has been a steady improvement. The wholesale market price of cement is around Rs 290/bag in Chennai now.

Contrary to expectations of many, players in the South have managed to hold on to good prices for a long time now. Pricing discipline in the market has not been disturbed despite the entry of many new players.

The southern cement manufacturers can be expected to reap the benefit of current high prices for two more quarters till the low base effect wanes.

Post-monsoon, as the State governments plan their spends for the current fiscal, cement demand may see some boost. While the Tamil Nadu and Kerala region posted flat despatches in the recent June quarter, there was a 21 per cent dip in demand year-on-year in the Andhra Pradesh region.

However, with several infrastructure projects being rolled out in Tamil Nadu, demand in the region may revive.

While the players in the South are currently running at 65 per cent capacity utilisation, according to an industry estimate, India Cements' current capacity utilisation is around 71 per cent.

The company has a capacity of 14.05 million tonnes (including the 1.5 million tonne capacity in Rajasthan) now. With addition of 11 lakh tonne to its capacity in the last two years, India Cements is all set to tap the opportunity whenever it comes.

Further, the company is also adding up its captive power capacity (by 100 MW) and will, by end-December this year, be ready to start mining in its coal mine in Indonesia.

Watching on cost

Despite coal prices having gone up to $120/tonne now from $99/tonne last year, India Cements' power costs were 22.5 per cent of sales, down from a higher 31 per cent last year. The company imports 55 per cent of its coal requirement.

A sequential improvement in the company's margins appears likely as thermal coal prices have come down from the peak of $130/tonne in January to $120 now. A further drop from the current levels may offer respite to the company.

In the June quarter, the company's operating margins (post-depreciation) were 17 per cent, almost 10 percentage points higher than what was reported in the same period last year.

The company has outlined capex of Rs 600 crore to set up two captive power plants, one each in Andhra Pradesh and Tamil Nadu. These units, as they are commissioned, will help in additional savings. The company's coal mine in Indonesia is all set to begin activity by end-December. Despite recent regulatory changes in the Indonesian mining laws, India Cements expects a price advantage of $8-10 a tonne on this venture.

The company had a debt of around Rs 2,456 crore as of end-March 2011. This keeps the company's debt-to-equity ratio at 0.6.

Should you bet on IPL revenues?

With India Cements-owned Chennai Super Kings (CSK) winning the title in India Premier League for two years in a row, brand visibility for India Cements has received a boost in the non-Southern markets.

The company claims to have leveraged on the Chennai Super Kings brand to expand into the markets of Gujarat and Rajasthan over the last one year. However, franchise revenues from this foray aren't yet significant.

The franchise income reported by the company on CSK playing in IPL was Rs 85 crore for the June quarter. Income, net of expenses, however, was at a relatively small Rs 7 crore; just 2.8 per cent of the June quarter operating profit of Rs 243 crore.