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JK Cement: A value creator? - Views on News from Equitymaster
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  • Jan 2, 2008

    JK Cement: A value creator?

    In our previous articles, we looked at how did the company fare in terms of topline, bottomline and the cost control initiatives taken by the company. In this article, we will take a look at ratios.

    With the upturn in cement cycle and overall improvement in its physical performance, the company was able to report impressive topline and bottomline growth. The rising cement prices coupled with increased capacity utilization and financial restructuring has led to expansion of margins. Being a commodity player, the company enjoys high operating leverage and therefore, any significant improvement in realisations flows directly to the bottomline. This has resulted in huge cash flow generation.

    Fund mobilisation strengthens balance sheet: Post restructuring, (since FY05) the company's performance improved and its debt to equity ratio pared down to 0.7 in FY05 from 1.4 in FY04. Lower D/E ratio reduces interest outgo costs that put pressure on net margins. As cash flow strengthened in light of favorable cement prices, the company was able to improve its overall performance by reducing finance costs and by strengthening its balance sheet. However, the real reason behind improved D/E ratio is increased equity base. The company came up with an IPO during FY06 and raised funds almost worth Rs 3 bn to support its expansion plans. The increased capital base has not only helped the company mobilize funds but has also strengthened the balance sheet of the company.

    Returns to shareholders: On account of its operational efficiencies and optimal utilisation of funds, the company was able to lower its average interest costs by almost 2%. The company has also been able to improve its working capital cycle. The company's inventory days have reduced from 74 in FY05 to 33 in FY07 and debtor days have reduced considerably from 47 in FY05 to 18 days in FY07. Further, in light of the favorable scenario, growth in demand-outstripped supply, and this resulted in improved cash balance by way of improved realisations.

    The sweet fruits of the cost reduction measures and improving financial performance are being reflected in the much-improved returns to share holders, the ultimate motive of being in the business.

    The improved performance and improved realisations enabled the company to increase value as the return on invested capital (ROIC) improved to 26% in FY07 (4% in FY05). Further, the improved return on assets indicate that the current growth is not only led by better realisations but also overall physical performance, which is reflected in improved return on assets and improved sales to asset ratio.

    Glance at ratios
    Particulars FY05 FY06 FY07
    Current Ratio (x) 1.1 2.6 2.2
    Sales/Assets (x) 0.3 0.6 0.8
    AROIC (%) 4.0% 10.9% 26.4%
    AROA (%) 0.5% 2.5% 11.5%
    Avg Interest rate (%) 4.4% 9.2% 6.2%
    Interest Coverage (x) 1.4 2.0 8.8
    Total Debt/Equity (x) 1.4 0.9 0.7
    Fully Diluted EPS (Rs/share) 0.9 4.7 25.5

    The way forward...

    Cost reduction measures such as setting up of a captive power plant, de-risking revenues by venturing into new region accompanied by a favorable price environment are likely to benefit the company immensely. However, one must note that the current growth is more led by improved prices. Realisations in the future may not be as attractive as they have been at the current levels, as new projects are expected to come on stream by the end of 2008 to meet the robust demand growth.

    At the current price of Rs 220, the stock is trading at fair valuation of US$ 120 on the enterprise value per tonne (EV/tonne) basis as per FY07 numbers. Thus, while the near term scenario is favourable, from a medium to long-term standpoint risks outweigh rewards.



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