Volume, profitability gains ahead for Shree Cement

Strong efficiencies in cement, power; expansions, reasonable valuations to help sustain outperformance

While most cement stocks have underperformed the Sensex and seen corrections from their 52-week highs in October 2012, Shree Cement’s stands out from the rest of the pack. Although its stock is down marginally by seven per cent in the past two-three weeks, it is still up 83 per cent in the past year. It is up 18.5 per cent since mid-October 2012, when ACC, Ambuja Cements and UltraTech had seen their 52-week highs before seeing a correction.

Shree Cement’s outperformance can be attributed to the company’s strong operational performance. According to Elara Capital analyst Ravi Sodah, Shree Cement’s operational efficiency makes it the lowest-cost cement producer in India, making the company a ‘defensive’ play within the cement space during times of downturn such as the current one.

Notably, Shree Cement’s stock is also trading at a discount to its peers on a cost of replacement basis. For instance, UltraTech trades at an enterprise value (EV) per tonne of $159, while ACC and Ambuja are trading at $123 and $170, respectively, according to FY14 estimates. Comparatively, Shree Cement is trading at $144.

While Teena Virmani at Kotak Securities has a target price of Rs 5,023 for Shree Cement, others such as analysts at Edelweiss and Religare Securities had given target price of Rs 5,313 and Rs 5,500, respectively. Given the stock’s closing price of Rs 4,851 on Monday, the target prices indicate an upside of 4-14 per cent. While the stock is expected to sustain its outperformance, investors may consider corrections to buy it from a medium-term perspective.

Cement demand and realisations have been under pressure since October 2012. Initially, this was being attributed to the long festival season during the December 2012 quarter. However, later on, the extended spell of cold in the North also had its impact during March 2013 quarter. States such as Maharashtra and Karnataka, which had seen a lack of water availability since September 2012 quarter due to weak monsoon last year, have also seen slowdown in construction activities.

Shree Cement, which is predominantly a North Indian player, has also gained from the relatively-lesser volatility in North India. Analysts such as Sodah see better outlook for demand versus supply in the North, compared to other parts of India.

In terms of profitability, the company has been using larger proportion of pet coke to fulfil its fuel requirements. Lower pet coke prices have helped the firm report better profitability.

During the March quarter, while the company’s cement realisations declined 2.3 per cent sequentially, power and fuel cost, too, declined 16 per cent sequentially on the back of lower pet coke prices. This pushed up its earnings before interest, depreciation, taxes, and amortisation (Ebidta) per tonne to Rs 1,088, compared to Rs 1,017 in the December 2012 quarter.

Its power division, which contributes around 20 per cent of sales, has also been growing well. Merchant power sales have almost doubled from 390 and 307 million units (MUs) in June and September quarters of FY13 to 786 and 722 MUs in December 2012 and March 2013 quarters, respectively. Notably, its Ebidta per unit has also improved to Rs 0.90 in past three quarters, compared to Rs 0.60 till June 2012 quarter. Sudhir Kumar Singh at Centrum Broking expects the Ebidta per unit to remain stable at Rs 0.90 during the current quarter as well.

Moving forward, the company will see its cement capacities grow from 13.5 million tonnes (mt) to 20 mt in FY14. This will improve volumes at a time when demand is seen growing. Analysts see a pickup in demand in the second half of FY14 on the back of increased government spending thanks to the general elections. Profitability is also expected to remain healthy. Sodah sees softening of pet coke and coal prices, helping improve profitability of the companies in the cement sector.

While in the near-term, the pickup in monsoon activity across the country may impact cement sales, demand for the sector, and therefore the stock prices, post-monsoon is expected to see an improvement.

Among key risks are an adverse monsoon or delay in government spending, both of which could impact demand as well as realisations.