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Madras Cements: Riding the sector boom - Views on News from Equitymaster
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Madras Cements: Riding the sector boom
Feb 3, 2006

Performance Summary
Madras Cements reported enthusing December quarter results earlier this week wherein it reported a 244% YoY rise in bottomline on the back of a strong topline, which grew by 51% YoY. The smart increase in profits was owing to the considerable improvement in operating margins, which even took care of the rise in financial charges. The company declared an interim dividend of 50% i.e. Rs 5 per share (dividend yield of 0.3%).

(Rs m) 3QFY05 3QFY06 Change 9mFY05 9mFY06 Change
Net Sales 1,608 2,427 50.9% 5,318 7,086 33.2%
Expenditure 1,368 2,010 46.9% 4,188 5,652 34.9%
Operating Profit (EBDITA) 240 416 73.7% 1,130 1,434 26.9%
EBITDA margin (%) 14.9% 17.1%   21.2% 20.2%  
Other income 14 13 -5.0% 38 33 -12.5%
Interest 84 112 34.0% 251 253 0.6%
Depreciation 139 173 24.5% 478 504 5.4%
Profit before tax 31 144 369.1% 438 710 62.2%
Tax 3 48 1617.9% 108 246 127.4%
Profit/(Loss) after Tax 28 96 243.7% 330 465 40.8%
Net profit margin (%) 1.7% 4.0%   6.2% 6.6%  
No. of Shares (m) 12.1 12.1   12.1 12.1  
Diluted earnings per share*       109.3 58.9  
Price to earnings ratio (x)         31.0  
(* trailing 12-month earnings)            

Background
Madras Cements has a total capacity of 6 MT (million tonnes) and caters exclusively to the southern markets, with Kerala and Tamil Nadu being its principal markets. It controls 14% of the total cement capacity in the southern region and is amongst the largest. While the company's management has constantly created value for its shareholders, it has not looked beyond the southern markets to diversify geographically, which is a useful strategy for a commodity business like cement.

What has driven performance in 3QFY06?
Strong topline growth continues: Continuing with the trend witnessed over the last couple of quarters, the company reported a robust topline growth for 3QFY06 as well, with net sales rising by 51% YoY. This was on the back of the continued strong demand for cement witnessed during the quarter in the southern region, which has worked to the company’s advantage. It must be noted that cement consumption in the region has registered an impressive 10% to 11% YoY growth in 3QFY06 (17% to 18% in 9mFY06) and Madras Cements being a key player in the southern states of India has benefited from the same. However, since the company does not provide its volume sales numbers, it would be difficult for us to comment on the same. Nonetheless, considering the strong topline growth during the quarter, volume sales would have definitely been very strong.

Cost break-up (% of net sales)
  3QFY05 3QFY06 9mFY05 9mFY06
Inc/Dec in stock in trade -6.6% 1.5% -2.1% 0.3%
Raw material consumed 17.3% 14.6% 16.3% 14.5%
Staff costs 6.8% 5.2% 5.8% 4.9%
Power & Fuel 34.9% 24.6% 29.0% 26.3%
Transportation & handling 13.4% 18.0% 11.7% 16.4%
Other expenditure 19.3% 19.0% 18.0% 17.4%
Total expenses 85.1% 82.9% 78.8% 79.8%

Margin pressure eases: On a YoY basis, operating margins have registered an improvement of 220 basis points, which could primarily be attributed to significant savings on the power and fuel costs front, which, as a percentage of net sales, have declined sharply from 35% in 3QFY05 to 25% in the quarter under consideration. Seemingly, this is the result of the benefits starting to trickle in from the company’s 36 MW thermal power plant that has been commissioned. There were some savings on the raw materials front also. However, transportation costs continue to edge higher, owing to higher petro product prices during the quarter.

Bottomline leapfrogs: Despite a 34% YoY rise in interest costs, a 25% YoY increase in depreciation charges and tax provisioning having risen from Rs 3 m in 3QFY05 (9% of PBT) to Rs 48 m in 3QFY06 (33% of PBT), the company reported a 244% jump in net profits for the quarter, albeit on a small base. This increase was largely possible owing to the strong operating performance of the company.

Performance over the last few quarters…
  3QFY05 4QFY05 1QFY06 2QFY06 3QFY06
Net sales growth (YoY, %) 7.2% 8.7% 25.6% 25.5% 50.9%
Net profit growth (YoY, %) -32.3% 138.0% 5.4% 43.8% 243.7%
Operating profit margin (%) 14.9% 20.3% 22.9% 20.9% 17.1%

What to expect?
At Rs 1,825, the stock is trading at 31 times its trailing 12-month earnings per share (approx. US$ 103 on the basis of EV/ton), which is rather rich. At the current price, the stock is trading at 15.5 times our FY08 estimates and at US$ 92 EV/ton, which is still expensive. While the company is acknowledged for its cost efficient cement manufacturing, the growth had been hard to come by until recently, considering its regional focus. It must be noted that the supply has been outpacing demand in this region for some time now.

However, with no significant new capacity coming up in this region over the next couple of years, and the consumption having shown an improving trend, the demand-supply gap has started to improve. This has augured well for cement prices in the region. Thus, going forward, though the company is expected to register strong profit growth over the next couple of years, we believe at the current juncture, much of this has already been priced into the stock. Further, considering that the company is concentrated on the southern region, valuations should be on the lower side compared to peer players, which either have a presence in a market with favourable demand-supply dynamics or have a pan-India presence.

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