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Concrete cost saving

SPECIAL REPORT

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Venkatesh Rangan Mumbai
Better cost-efficiencies and the additional capacity expected to come on stream this year should save the day for India Cements.
 
To talk about a cement company in such uncertain times is probably nothing short of suicide. As an analyst puts it, "In such times a negative outlook for the entire sector can well overshadow sentiments about the company."
 
By all measures, India Cements' Q4 performance was above expectations. In the March quarter 2007, while net sales rose nearly 35 per cent to Rs 673 crore, net profit showed a whopping increase of over 4.17 times to Rs 139.8 crore.
 
For FY07, too, while the topline grew about 29.6 per cent to Rs 2372.9 crore, operating profit margins improved 1400 basis points to 27.9 per cent. But analysts aren't too enthused. While many have a "sell" recommendation, some optimistic ones prefer a "hold" on the stock.
 
"Well, while firm prices have helped revenue growth, the rise in profits was also due to the negligible provisioning of taxes due to the merger of Vishaka," says Ajit Motwani, research analyst Emkay Shares and Stock brokers.
 
The company has said that it would consider the provision for deferred taxation in its audited annual accounts only after the sanction of the merger of Vishaka Cements with it, which is expected to be completed by July.
 
While analysts aren't too excited, the bourses haven't been lucky for India Cements either.
 
Although most cement stocks have bled since the beginning of this year, India Cements (-22.2 per cent) has fallen far more than its peers "� Shree Cements (-10 per cent), Madras Cements (-5.2 per cent), JK Cements (-15.8 per cent). And yet a closer perusal would reveal a few fundamental positives which would stand the company in good stead.
 
The cost advantage
With a consolidated capacity of about eight million tonnes (including Vishaka Cements), India Cements expects to have a capacity addition of about three million tonnes per annum, including two million tonnes on a standalone basis. The additional capacity will kick in by March 2008.
 
In fact, much of the capacity would be kick started this year itself thus enabling the company to reap the benefits of the strong demand scenario in the south before the widely expected supply overhang in 2009.
 
Besides, India Cements seems to be expanding quite efficiently too. "For example, while it takes Rs 400 crore for a greenfield capacity of one million tonne, India Cements is spending about Rs 350 crore for two million tonnes," says Nakul Dharmat, research analyst, Pioneer Intermediaries.
 
This translates into India Cements' capex cost of around Rs 1435 per tonne as compared to the industry average of around Rs 3690-3700 per tonne.
 
"One of the significant reasons for this saving of costs is because nearly one million tonnes of this expansion is coming in due to de-bottlenecking and brownfield expansion," says an analyst.
 
Meanwhile, India Cements' overall cost efficiency is also likely to improve. Currently, the company's overall cost of production is marginally higher than the industry average and higher than some other regional peers. One of the main reasons for this is the lower proportion of PPC in its product mix.
 
PPC (portland pozzolona cement) or blended cement involves clinker mixed with some other materials like fly ash, etc. While one tonne of clinker could yield 1.05 million tonnes of ordinary portland cement, the same amount would result in about 1.3 to 1.35 million tonnes of PPC.
 
Consequently, the cost of production of PPC is Rs 100-125 / mt less than OPC. As a senior executive from the company says, "PPC, which presently constitutes about 60 per cent of our product mix, is expected to grow to nearly 75 per cent by FY08."
 
This increase in the proportion of blending should not only release excess capacity but also make operating costs more manageable.
 
Demand dynamics
Though southern markets have traditionally had lower prices than other regions at around Rs 210 -235 depending on the region, the demand prospects are the brightest here.
 
Most analysts estimate demand growth in the south to be the fastest among all regions. For example, while demand is estimated to increase by about 12 per cent annually in the next three years, that in the north is estimated to increase by 9 per cent while the eastern region is expected to increase by 11 per cent.
 
India Cements being the market leader in the south with an over 17 per cent market share (excluding Vishaka) is sure to be a beneficiary of this buoyant demand.
 
Moreover, the merger of Vishaka Cements should also help expand its operations in the lucrative Maharashtra state, where cement prices at around Rs 230-240 per 50 kg bag remain significantly higher than in the southern region.
 
The Vishaka acquisition could give other benefits too as it enjoys higher margins and lower operating costs than India Cements. 
 
FINANCIALS
Rs croreFY07FY08FY09
Net Sales2373.002784.003090.00
Operating profit661.60819.00885.00
Operating profit margin (%)28.0029.4028.60
EPS (Rs)21.3022.1020.70
Source: Analysts estimates
 
Why the pessimism?
The key reason for the pessimism surrounding the stock is that chances of further rise in cement prices looks slim considering the lack of pricing power thanks to the government's determination to curb price rise.
 
Overall, the supply additions, though it will happen in stages, will keep prices under check. Thus, both topline and bottomline growth would be intrinsically linked to volumes and cost-savings.
 
Though the company, operating at over 100 per cent capacity, is counting on the additional one-third capacity coming on stream this year to fuel growth, analysts see limited upside.
 
On the cost side, too, the company's high reliance on imported coal for upto 60 per cent of its requirements could put some pressures on costs given that international coal prices have been firming up in the past few months.
 
Though the reliance on low cost power sources, which comprise about 45-50 per cent of total power cost at present, has significantly contributed to cost efficiencies, the company's proposals for further addition of captive power plants are as yet either preliminary or uncertain.
 
On the upside, India Cements' balance sheet looks better than ever before. After suffering accumulated losses of Rs 1400 crore between FY02-04, it has steadied itself and reduced its gearing from 5.4 times in FY04 to 1.7 in FY06 to about 1.1 at present.
 
"And given an FCCB conversion this could further reduce to about 0.5 by FY08", says Pioneer's Dharmat.
 
On the valuations front, at 7.8 times estimated FY08 earnings, the scrip stands at the middle on the mid-cap universe with its peers trading in the 6.5-8.6 range. Despite the favourable demand-supply scenario in the next 15-16 months, analysts are divided in their recommendation.
 
"If an investor wants to invest in cement stocks, then on relative terms, it would be advisable to look at a Ultra Tech or a Mysore Cement where, I feel there is some scope for improvement in margins," says Hitesh Agrawal,senior research analyst, Angel Broking.
 
But Dharmat opines, "Given the market leadership position in the South as also the increasing cost efficiency, I am positive on the stock."
 
Overall, while India Cements may not stand out in the crowd, its attractive valuations and prospects of greater cost-efficiencies appears to make it prudent to hold on to for the moment.

 

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First Published: Apr 30 2007 | 12:00 AM IST

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