Since our recommendation in November 2016, the stock of cement player JK Lakshmi Cement (JKLC) is down 6 per cent. While demonetisation and GST delayed economic recovery and impacted cement despatches, the rise in petcoke and diesel prices affected margins in the last year.

However, at the current market price of ₹439, the stock’s valuation looks attractive with an enterprise value of $89 per tonne, which is much lower than the replacement value of $125-$150. The price-to-earnings multiple, based on trailing 12-month earnings, is 60 times, slightly above its three-year average of 57 times. Going forward, the company’s profits are expected to improve substantially as a result of its cost-saving initiatives and valuations will moderate sharply.

Policy boost

After the ramp-up in the company’s operations, volumes are expected to grow at higher-than industry rates, aided by government policies towards road construction and affordable housing. Investors can buy the stock; at these levels, it is among the cheapest cement stocks in the country.

JKLC has a consolidated production capacity of 12.5 million tonnes (mt) with a large footprint in the north (Rajasthan and Haryana), west (Gujarat) and east. About 78 per cent of its capacity is from the north and west markets, while the eastern market contributes the rest. JKLC targeted the lucrative eastern market about three years back with the commissioning of a cement plant in Chhattisgarh. Currently, the company has a sales market share of 6-7 per cent in the northern market and about 10 per cent in the western market.

Strong volumes

JKLC has been posting better-than-industry volume growth consistently. In FY-17, it was 8.2 per cent, against 21.7 per cent and 7.1 per cent in the previous two years.

During the September 2017 quarter, volumes were up 10 per cent. The company benefited from the commissioning of a new plant (Durg) in the East, while improving market share in the western and the northern regions, where a vacuum was created by disruptions at Binani Cement. The latter is facing bankruptcy proceedings from its lenders.

Increased eastern region operations are expected to drive volume growth over the next two years. The management plans to add another grinding unit of 0.6 mt at Odisha. Its consolidated capacity will move to about 13 million tonnes by FY-19.

The company’s capacity utilisation ratio is now 69 per cent, against 63 per cent about a year back. The management plans to improve the capacity utilisation of its Udaipur (Rajasthan) plant to 80 per cent by the end of FY-18 from current levels of 50 per cent. Moreover, with demand remaining strong in the East, the company is expected to ramp up overall capacity utilisation to 80 per cent or more over the next two years.

Cement demand is expected to pick up with economic recovery. The Centre’s initiatives to construct 2.2 crore affordable homes under the Pradhan Mantri Awas Yojna over the next two to three years, and lay 83,000 km of roads over the next five years will act as triggers. With elections on the cards, construction activity is expected to pick up.

Cost savings

The company’s northern operations are largely self-sufficient in power, with about 80 per cent of its requirement coming from captive plants. However, in the east, its plants source power from the grid at a high cost. Commissioning of the captive plant at Durg is expected to cut power costs.

The management expects to save about ₹200 per tonne from its various cost-saving initiatives. The Durg plant will get 20 MW of captive power, leading to a saving of ₹120-150 per tonne.

This is expected to happen by the end of FY-19. JK Lakshmi Cement is set to commission a 7 MW waste heat recovery system at Durg, which will lead to an estimated saving of ₹40-50 per tonne. The conveyor belt being installed at Durg for transporting limestone could save ₹35-40 per tonne.

During the September 2017 quarter, the company’s EBITDA per tonne was ₹505. After its cost-saving initiatives, improved EBITDA per tonne could boost operating margins.

Improving financials

JKLC’s consolidated sales were up by 11.1 per cent to ₹2,910 crore during FY-17 over the previous year. During the six months ended September 2017, the company’s standalone sales grew 17.1 per cent y-o-y. Operating margin went up in FY-17 to 17.1 per cent from 12.8 per cent the previous year. This was largely led by improvement in ‘other income’. Operating margin was down to 14.5 per cent in the first half of 2017-18 compared to 16.7 per cent in the year-ago period. This was due to a 50 per cent hike in power and fuel costs as well as a 23 per cent rise in freight costs.

The rise in petcoke and diesel prices pushed up costs, especially in the Northern plants, which accounted for about 80 per cent of the company’s total petcoke usage. However, with the commissioning of captive power plants, power and fuel costs are expected to come down.

JKLC currently has gross debt of ₹2,150 crore and a debt-to-equity ratio of 1.5 times. The company is in a deleveraging phase and is repaying debt to the tune of ₹200 crore every year.

The company witnessed a sharp turnaround in operations in FY-17, when it reported net profit of ₹86 crore compared with ₹1 crore the previous year. However, for the six months ended September 2017, net profit was down 22 per cent due to falling margins and higher depreciation cost with the addition of the new Surat plant capacity.

Challenges

The company is facing policy-related challenges — be it the ‘price gap’ issue in Chhattisgarh or ban of petcoke. But things may be getting better. Recent reports say the temporary ban by the Supreme Court on petcoke use by cement manufacturers has been revoked.

Moreover, the company is negotiating with the Chhattisgarh government on the ‘price gap’ issue that limits its ability to increase cement prices in the State. As an alternative, the management is exploring options to sell outside the State.

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