Shree Cement

The sharp de-rating of cement stocks, due to concerns about limited pricing power, has trimmed valuations for producers such as Shree Cement.

Investors who bought the stock on our earlier recommendation should hold on, given the prospect of upside linked to better valuations. The stock can be accumulated by investors willing to hold on for a 3-year time frame.

At the current market price of Rs 576, the stock trades at eight times its trailing earnings and about five times its expected FY-09 earnings. While this is at a discount to peers, it appears cheap on a replacement cost basis. Shree Cements’ enterprise value now stands at about Rs.3137/tonne, attractive when compared to the average enterprise value of leading players in the North, at Rs 5,550/tonne.

Shree Cement’s ability to tackle supply-side pressures and increases in input costs has helped the company hold its profit margins at levels superior to the industry average in recent times.

An operating profit margin of 35 per cent during a period (June quarter), strained by cost pressures, shows the company’s resilience to pressures in the business.

Timely commissioning of expanded capacities, healthy cash flows and forays overseas to tackle a situation of surplus in the domestic market are other key advantages.

Surfacing as a major player

Shree Cement is exploring the overseas markets(Libya, Israel and Sudan) to expand its reach and offload excesses at times of surplus in the domestic market. It also plans to cater to the rural markets of Punjab, Rajasthan and Haryana on a larger scale to improve volumes and retain profit margins. The path embarked does appear promising. Establishing links in the rural markets may not be difficult, given its established brand and strong network. Poor infrastructure in ports could pose a challenge for exports.

On the volume front, the company is adding another one-million tonne to its 9.1 million tonne capacity through an investment of Rs 550 crore this fiscal. Shree Cement has in the past, managed to tap opportunities created by the commodity cycle through timely capacity enhancement.

With robust operating cash flows of Rs 663 crore (March ’08), the company may be partly funding its capex through internal accruals and rest through debt. The company’s high credit rating helps it to secure funds at relatively lower costs.
Cost efficiency

The company’s initiatives on cost-cutting through captive power plants, effective logistics management and waste heat recovery system make it a cost-efficient player.

Shree Cement is also using chemical gypsum and resorting to higher blended cement production through use of fly ash. To fight currency-related risks, it has swapped its floating rate ECBs for fixed coupon borrowings. Shree Cement’s high debt rating fetches it funds through MIBOR linked instruments for working-capital requirement at reduced cost.

Shree Cement’s sizeable capacities and efficient operations also render it an attractive consolidation play in the cement sector. The business is now valued at about Rs 3,187/tonne (enterprise value). This is considerably lower than the price at which some of the smaller acquisitions in the cement space have recently been made.

For instance, CRH paid Rs 5,692/tonne for My Home Industries while Vicat paid Rs 4,214/tonne for acquisition of stake in Sagar Cements. At the macro level, the price and demand scenario does not appear dire. Part of the slowdown in cement offtake in the northern markets is linked to the monsoon, suggesting a possible pickup in the coming months.

The removal of the curb on selling prices of cement by the Government may also provide leeway for cement manufacturers to raise prices, once demand starts picking up on increased activity in the real estate and infrastructure sectors, post-monsoon