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Madras Cements: Regional disparity takes toll

Mar 8, 2005

Performance summary
Madras Cements continued to disappoint on the results front with a poor show in 3QFY05. The companyís bottomline has declined significantly during the quarter despite some growth witnessed in its topline. Significant cost pressures adversely impacted the operating margins, which was reflected in the poor performance.

(Rs m) 3QFY04 3QFY05 Change 9mFY04 9mFY05 Change
Net Sales 1,500 1,608 7.2% 5,031 5,318 5.7%
Expenditure 1,166 1,368 17.4% 3,810 4,188 9.9%
Operating Profit (EBDITA) 334 240 -28.4% 1,221 1,130 -7.5%
EBITDA margin (%) 22.3% 14.9%   24.3% 21.2%  
Other income 12 14 20.7% 40 38 -6.5%
Interest 95 84 -11.6% 372 251 -32.5%
Depreciation 161 139 -13.5% 482 478 -0.8%
Profit before tax 90 31 -66.0% 407 438 7.8%
Tax 49 3 -94.3% 176 108 -38.7%
Profit/(Loss) after Tax 41 28 -32.3% 230 330 43.4%
Net profit margin (%) 2.7% 1.7%   4.6% 6.2%  
No. of Shares (m) 12.1 12.1   12.1 12.1  
Diluted earnings per share* 13.6 9.2   25.4 36.4  
Price to earnings ratio (x)   121.2     30.7  
(* annualised)            

Background
Madras Cements would rank as one of India's most cost competitive cement companies. The company has a total capacity of nearly 6 MT (million tonnes) and caters exclusively to the southern markets with Kerala and Tamil Nadu acting as principal markets. It controls 14% of the total cement capacity in the southern region. 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 3QFY05?
Realisations remain weak:  Despite the strong performance of the cement industry at the national level, the performance of the company was weak during the quarter. This could be attributed to the fact that the company is located in South India, where the industry demand-supply mismatch is stark. It must be noted that infrastructure and housing are the key demand drivers for the commodity. Though demand growth in the southern market is estimated to be on the lower side as compared to the overall market, cement prices in the southern part of the country have remained under pressure in light of adverse supply conditions. This has affected cement realisations, which is reflected in a mere 7% rise in the topline during 3QFY05.

Cost pressures hit margins:  Apart from lower realisations, pressure on costs front also had an adverse impact on the companyís profitability during the quarter. Key inputs required in the manufacturing process of cement like coal and furnace oil have become more expensive. It must be noted that as a percentage of sales, while raw materials increased by 100 basis points, power & fuel expenses witnessed a rise of over 600 basis points in 3QFY05. Transportation and handling costs also increased by 100 basis points seemingly on the back of higher diesel prices in the same period. Thus, overall, the operating margins feel by 740 basis points during the quarter.

Bottomline succumbs to pressure:  The impact of all of the above i.e. lower realisations and cost pressures, was reflected in the over 32% YoY fall in the bottomline of the company. Fall in interest rates and a significantly reduced tax provisioning (down 94% YoY) saved the grace for the company. Nonetheless, the performance during the quarter was poor.

What to expect?

At the current price of Rs 1,120, the stock trades at a price to earnings multiple of 30.7 times its annualised 9mFY05 earnings. While the company is acknowledged for its cost efficient cement manufacturing and its conservative approach, we believe that the growth prospects are challenging. This is because, though the company has high operating margins, itís sole dependence on a market (South India), which has the highest demand-supply mismatch in the country remains a concern. And to that extent, on a relative basis, valuations have to be adjusted (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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