Shree Cement: Foray into new geographies holds key

High valuations and potential impact of entry into new regions on margins has led certain analysts lower their ratings

Shree Cement's stellar fourth quarter and FY14 (year ends in June) performance and the news of the company planning to acquire a grinding unit of Jaypee Group at reasonable valuations add to its positives. Capacity expansion in Rajasthan will consolidate its existing geographical strength, while those in Bihar and Chhattisgarh will also lead to Shree Cement becoming an all-India player having exposure to all regions except south. But, given the expansion in newer geographies and high valuations, certain analysts have become sceptical on further upside for the stock. They say that sustaining the margins at high levels is crucial as the company expands into new geographies, which in turn will reflect on valuations.

Power offsets Cement's strong show in Q4

The June quarter performance was driven by cement segments' strong volume growth and better realisations. Cement sales at Rs 1,490 crore grew almost 30 per cent year-on-year as per tonne realisations grew 12 per cent annually (3.8 per cent sequentially). Sales volumes at 3.72 million tonnes (mt) were much higher than 3.17 mt in the year-ago quarter. The cement division also saw profitability jump - Ebit margin stood at 14.4 per cent versus 8.2 per cent last year, aided by the company's ability to control fuel costs on the back of higher pet coke usage and lower coal prices.

Overall Ebitda (earnings before interest, tax, depreciation and amortisation) grew by 14.1 per cent year-on-year to Rs 434 crore (slightly ahead of estimates) and, could have been better thanks to the surge in freight costs (up 35.7 per cent year-on-year). Lower other income, higher depreciation and taxes led to profits at Rs 277 crore coming slightly lower than Rs 284 crore in the year-ago quarter, though higher than Rs 222 crore in the March quarter. The power segment, however, was a drag on the overall performance, as per unit realisations at Rs 3.4 a unit were lower than Rs 3.9 a unit in the year ago quarter. Volumes in the power business also fell almost 16 per cent year-on-year.

Expansions & acquisition
The company plans acquiring a 1.5 mt per annum (mtpa) Panipat-based grinding unit of JP Associates for about Rs 360 crore. Analysts believe the unit acquired at attractive valuations is also positive as post commissioning of two-mt clinker units in Rajasthan, Shree Cement would have faced capacity constraints and setting up a new unit would have taken about two years. Shree Cement's two mtpa grinding unit in Bihar and two mtpa cement integrated unit in Chattisgarh will take its total capacity to 21 mtpa in FY15. While 17 mtpa capacities in North India will keep the company's medium-term prospects firm, expansions in the east will help geographical diversification and partly de-risk its business model. However, these expansions into new markets coupled with stretched valuations aggravate concerns of some analysts while certain others remain bullish.

Analysts at HSBC feel company's foray into traditionally unknown markets could keep per tonne Ebitda under check. They feel that that after 81 per cent year-to-date run up on the bourses, the stock now trades at an enterprise value (EV) of $174 a tonne based on fully expanded capacity, which while lower than peers, is much higher than replacement cost. Hence, they have downgraded the stock.

Sanjeev Kumar Singh at Centrum Broking, too, observes that though Shree Cement's earnings is expected to improve significantly on the back of volume growth due to recent capacity additions, the sharp increase in the stock price (up 67 per cent in the past six months) factors in the improved outlook. But there are some others who remain bullish. Analysts at Karvy say that timely expansions in the north and eastern regions and the acquisition of JP Associates' 1.5-mt grinding unit should lead to 15 per cent volume CAGR in FY14-17 period. And hence, they raise their target price to Rs 9,300.

Of the 11 analysts polled on Bloomberg after the results that came on Monday post market hours, five each have a 'Buy' and 'Hold/Accumulate' and one 'Underperform' rating. Their average target price of Rs 7,951 for the stock trading at Rs 7,915 levels suggests limited gains.