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A comparative study - Views on News from Equitymaster
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  • Apr 14, 2001

    A comparative study

    Picking a winner in the cement sector should not be very difficult. Ofcourse there are many critical factors such as anticipated growth in volumes and location of plants, but control on costs is arguably the most critical. This is so because in such businesses producers are not price setters, they are price takers.

    GACM tops the list
    Stock Price Rs 132.8 170.8 288.0 225.5
    Operating Profit Margin % 11.7% 34.5% 15.6% 11.3%
    Cement Capacity MMT 13.0 7.0 10.5 14.0
    Market Cap per tonne Rs 1,745.8 3,591.7 NM NM
    P/e x 384.7 12.5 6.5 21.6
    Price/sales x 0.9 1.9 0.4 0.8
    Sales per employee Rs 000 2,549.7 5,525.0 1,918.3 2,967.8
    All data for FY01E; Net profit excludes Extraordinary Items
    Expected capacity as in March'01
    * Number of employees as on 31st March 2000

    The company that tops the list is Gujarat Ambuja Cements Limited (GACM). The company earns an operating margin in excess of 34 percent. One of the primary reasons for the company’s dominance on this front is its management, which is considered to be the best in the industry. What’s the reason for the company’s leadership?

    First, GACM’s plants are very efficient. Over the last three years the company’s plants operated at well above capacity levels. Second, GACM has opted for the unconventional but very cost efficient way of transporting cement via sea to its key markets. Captive ports enable the company to export its surplus output and at the same time import high quality coal. Third, GACM has focused on key western markets, which are also among the richer states in India. Fourth, its plants are well located to maximize tax benefits. Fifth, the acquisition of a 14.4 percent stake in ACC will benefit GACM as together the companies would have more pricing power. Finally, GACM has developed a high level of expertise in building cement plants at low capital costs (Rs 3 billion for a million tonne as against the industry average of Rs 4 billion). A low capital cost effectively lowers the cost of production, thus improving net margins.

    Associated Cement Companies (ACC), on the other hand, can now look forward to a much brighter future. The company, which had posted a net profit of Rs 769 m in FY97, incurred a loss of Rs 589 m in FY00. Things have started to look up with efforts to contain costs yielding results. Indeed, the recent rise in price of cement has enabled the company to turn the corner. Operating margins have improved from 7.1 percent in FY00 to 11.1 percent in the third quarter of the current financial year. As the company takes measures to further improve its profitability and divest its unrelated investments, valuations could improve further. This seems likely as ACC now has as its primary promoter GACM, which earns operating margins in excess of 34 percent as compared to ACC’s 11 percent.

    L&T, which derives a third of its revenues from cement, has probably been the worst hit by the slowdown in cement demand. As per a company presentation, operating margins for the cement division were put at a low 15.1 percent in FY00. Moreover, the company’s EPC business has been hit by a slowdown in the allocation of new projects. Among the other factors that have pulled down the company’s profitability is the sharp rise in interest expenditure (up 12.2 percent in the first nine months of FY01). Going forward, the stock price would look for triggers such as a successful hive off of the cement business and a pick up of growth in the EPC business.

    In Grasim, too, the cement business accounts for a third of the sales. Its other businesses cushioned the impact of a decline in profitability of the cement division. What is striking about Grasim is its low valuation as compared to its peers. This could be attributed to its having a presence in several unrelated commodity businesses.

    The fall in the market capitalisation of cement companies has been substantial. The biggest losers, surprisingly, are also the industry leaders. To sustainably drive stock prices higher, the counters will need triggers; be they growth in consumption, rise in cement prices or higher profitability due to cost cutting. ZUntil then, it’s all about sentiment.



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