Prospects improving further for south-based cement firms

Profitability got a boost in Q4; it might get further uplift as demand and realisations improve

South India-based cement manufacturers reported good performance in the March 2016 quarter (Q4) led by healthy volumes and lower fuel costs. The improved profitability was despite softness in per-bag cement prices, which at Rs 336 were lower than Rs 344 in the December 2015 quarter and Rs 361 in the March 2015 quarter.

While there was also an improvement in profitability, the prospects are improving further, feel experts. After the formation of stable governments in many southern states after elections in Tamil Nadu and Kerala, experts believe the spending on projects will increase in three or four months and, hence, the cement demand should also see a positive rub-off effect. Further, the positive GDP numbers have also encouraged the Street as Assocham president Sunil Kanoria commenting on growth numbers highlighted that Andhra Pradesh (AP) and Telangana are seeing good traction at least in irrigation and infra-led projects. This is good news as cement demand in AP and Telangana had been lagging other south Indian states, pulling down realisations.

According to the latest cement checks by IIFL, prices in AP and Telangana increased by Rs 50-80 per bag in three rounds, with improvement in discipline. Experts believe there will be one more round of price hike. Also, prices in other southern states have gone up moderately, with supplies from AP and Telangana reducing.

In this backdrop, South India-based cement players such as Ramco Cements, India Cements, Dalmia Bharat and Orient Cement are well placed to benefit.

Ramco Cements saw sales volume growth of 11 per cent at 2.08 mt in the March 2016 quarter. Despite nine per cent decline in realisations, it reported earnings per interest, taxes, depreciation and amortisation (Ebitda) per tonne of Rs 1,487 against Rs 1,276 in the year-ago quarter. Analysts at Motilal Oswal Securities (MOSL) say that Ramco is the best southern play and will gain well from superior brand, cost efficiencies and de-leveraging. Ramco current trades at a replacement costs of close to $118, which is reasonable. Given the current market price of Rs 501 and analysts' target prices of Rs 550-560 (MOSL, Prabhudas Lilladher and Reliance Securities), there is upside potential of 10 per cent-plus.

India Cements reported revenue growth of 12 per cent led by substantial demand growth in AP/Telangana (about 40 per cent up year-on-year, according Reliance Securities data) as volumes jumped 18-28 per cent, y-o-y, and sequentially to 2.8 mt. Thus, despite soft realisations, and aided by lower fuel costs, cement Ebitda per tonne jumped to Rs 841 compared to Rs 743 in the previous quarter (Rs 859 in year-ago quarter). Analysts at Edelweiss estimate earnings per share (EPS) to grow at a compounded annual growth rate (CAGR) of 33 per cent over FY16-18 as EPS growth is also driven by benefits of deleveraging. Trading at Rs 95.50 levels, analysts target prices of Rs 115-120 indicate good upside. At Rs 120, it will be trading at replacement costs of $68 a tonne, which analysts at Edelweiss say is reasonable, looking at the historical trading range.

Orient Cement saw 40 per cent y-o-y increase in volumes to 1.39 mt, also helped by expansions. Even as realisations declined 17.5 per cent y-o-y, the company reported Ebitda per tonne of Rs 431 versus general estimates of Rs 262. After the recent commissioning of its Karnataka plant, analysts at Karvy estimate gradual improvement in Ebitda per tonne to Rs 872 by FY18, implying Ebitda CAGR of 80 per cent in FY16-18. For the stock trading at Rs 166.50, one-year analyst target prices stand between Rs 175 and Rs 187. For Dalmia Bharat, with the new plant at Belgaum commissioned and given the imminent pick-up in the southern demand led by AP and Telangana, the stock would be among the prime beneficiaries given it is one of the most cost-efficient cement players, say analysts at Edelweiss. It is current trading at Rs 925 levels.

Others such as JK Cement, too, are well placed with plants in north India as well as south India. Analysts at Reliance Securities believe that given the favourable demand in the northern markets and the expected pick-up in southern demand, JK Cement is in a sweet spot to improve its grey cement profitability in the ensuing period. With an estimated return-on-equity of 18.1 per cent for FY18, Edelweiss gives a target price of Rs 777 (others have target prices ranging from Rs 715 onwards) for the stock trading at Rs 612 levels.

Investors, however, need to note that cement stocks typically tend to consolidate or see some correction during monsoons. So, long-term investors could use such opportunity to accumulate some of these stocks.