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Grasim: Cement to take charge... - Views on News from Equitymaster
 
 
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  • Jan 7, 2004

    Grasim: Cement to take charge...

    Although 2003 was a rather lacklustre year for the Indian cement industry, Grasim, India's largest cement producer did little to disappoint investors. Riding on the back of CemCo (L&T Cement) acquisition, which has put the company into the elite league of the world's largest cement producers, the stock price of the company has almost tripled in 2003.

    In this article let us try to dwell upon the reasons behind the deal and how does Grasim stand to benefit from the same.

    The Global league…
    Producer Rank Capacity
    Lafarge 1 135.5
    Holcim 2 121.2
    Heidelberg 3 81.8
    Cemex 4 79.5
    Italcementi 5 56.9
    Taheiyo 6 37.7
    Grasim+CemCo 7 31.0
    *Source: Company data

    Besides cement, Grasim has interests in VSF, Sponge Iron and textiles. Before the acquisition of L&T's cement division, Grasim's main growth propellant used to be the VSF division. The company is the largest producer of VSF in the world and on account of the large economies of scale that it enjoys, it has also emerged as the lowest cost producer globally. As a result of this, the division generates strong cash flows. Just to put things in perspective, while the division accounted for 35% of Grasim's revenues in FY03, the PBIDT contribution from the division stood at 53% of the total PBIDT of the company. However, the demand for VSF has reached a stage of maturity and is not expected to grow at a rapid pace in the future, thus obviating the need for large investments.

    On the other hand, cement demand has grown at a CAGR of 8%-9% in the last decade and considering the huge demand for dwelling units as well as infrastructure needs of the country, the cement industry is expected to maintain the current levels of growth in demand. This was an opportune time for the company to consolidate its presence in the cement industry and bring into good use, the large amount of cash generated by the VSF division.

    Thus, after hectic round of negotiations, the company finally acquired L&T's cement division and the company's net investments for the same are expected to be in the region of Rs 22.2 bn. Following is the summary of the company's total investments in CemCo.

    Transaction structure Rs m
    Total existing investment in L&T 10,280
    Grasim to acquire 8.5% of CemCo from L&T 3,620
    Grasim to make offer for 30% of CemCo 12,780
    Total outflow for 38.5% (8.5%+30%) 16,400
    Inflow on a/c of sale of L&T(Engco) shares to Foundation/Trust (4,460)
    Net investment for 51.1% stake 22,220

    The cement capacities of the two companies are complementary from the regional point of view and hence the deal would not only give the company a strong national presence but leadership position in 8 states which control 42% of the industry volume. It is also estimated that the synergies that would result in the form of economies of scale and improved logistics is likely to result into gains of Rs 500 m each for the two companies. Besides, on account of low capacity utilisation, CemCo also has considerable scope for upside in operating margins. Thus, on account of all these reasons, we believe that the CemCo deal is a deal well struck.

    Grasim is currently trading at Rs 1,010, implying a P/E of 14x of its annualised 1HFY04 earnings. With CemCo in the bag, the company has undergone a transition whereby the mantle of growth will now be donned by the cement division rather than the VSF division. Therefore, from the point of view of a cement company, the valuation of the company seems to be a little stretched from a short term perspective. However, from a long- term perspective, they look attractive.

     

     

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