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Madras Cements: On the recovery path? - Views on News from Equitymaster
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Madras Cements: On the recovery path?
Jun 23, 2005

Performance Summary
Madras Cements reported its 4QFY05 and FY05 results just a short while ago. The company has reported less than expected set of numbers wherein while the topline grew by 9% YoY, the profit before tax grew by 29% YoY. The more-than-doubling of the bottomline has to be viewed in the context of a tax write back, which propped up the net profits. Operating margins have continued to remain under pressure.

(Rs m) 4QFY04 4QFY05 Change FY04 FY05 Change
Net Sales 1,915 2,081 8.7% 6,946 7,400 6.5%
Expenditure 1,518 1,658 9.2% 5,328 5,847 9.7%
Operating Profit (EBDITA) 397 423 6.6% 1,618 1,553 -4.0%
EBITDA margin (%) 20.7% 20.3%   23.3% 21.0%  
Other income 12 14 16.1% 52 51 -1.3%
Interest 124 108 -12.9% 496 359 -27.6%
Depreciation 150 155 3.2% 633 633 0.1%
Profit before tax 135 174 29.0% 541 612 13.1%
Tax 31 (73)   207 35 -83.1%
Profit/(Loss) after Tax 104 247 138.0% 334 577 72.8%
Net profit margin (%) 5.4% 11.9%   4.8% 7.8%  
No. of Shares (m) 12.1 12.1   12.1 12.1  
Diluted earnings per share* 34.4 81.8   27.6 47.8  
Price to earnings ratio (x)   12.8     21.9  
(* annualised)            

Background
Madras Cements 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 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 FY05?
Lagging its peers: The company ended 4QFY05 with a mere 9% topline growth. This when compared to peers like Gujarat Ambuja and ACC during the same quarter, is rather poor. To put things in perspective, while Gujarat Ambuja had more than 30% YoY growth during the March quarter, ACC’s growth during the quarter was at 16% YoY. This under performance by Madras Cements could be attributed to the fact that the company has a presence largely in the southern region, where the demand-supply scenario continues to remain relatively unfavourable for cement producers in the region. This was reflected in the cement price increase in the region, which was about 5% to 6% compared to around 8% to 9% at the national level. It must be noted that since the company does not provide its volume sales numbers, it would be difficult for us to comment on the same. However, considering the improved prices and the company’s topline, the volume sales growth wouldn’t be much.

Cost break-up (% of net sales)
  4QFY04 4QFY05 FY04 FY05
Inc/Dec in stock in trade 7.8% -0.7% 1.5% -1.7%
Raw material consumed 14.4% 15.0% 15.2% 15.9%
Staff costs 4.7% 4.7% 5.3% 5.5%
Power & Fuel 22.3% 28.2% 25.5% 28.8%
Transportation & handling 12.0% 13.6% 11.1% 12.2%
Other expenditure 17.9% 19.0% 18.0% 18.3%
Total expenses 79.3% 79.7% 76.7% 79.0%

Margin pressure: Margins have remained under pressure with the YoY margins down by 30 basis points. For the full year also, the operating margins took a hit of 230 basis points. As can be seen in the table above, the biggest hit is owing to the rise in power and fuel costs, which have increased from 22% of operating sales in 4QFY04 to 28% in 4QFY05. For the full year, the increase in these terms has been about 330 basis points. Apart from this, transportation and handling charges also contributed to the margin pressure.

Tax write-back prop up: The company’s bottomline grew by 138% YoY during the quarter and about 73% for the full year. However, this should be considered in the backdrop of the fact that the company has written back some deferred tax provision in the March quarter amounting to Rs 70 m. This is seemingly in wake of the fact that from the current fiscal, Madras Cements (akin to other corporates) would have reduced tax liabilities considering the reduction made in corporate tax rates in the budget this year. Fall in interest expenses (down 13% YoY in 4QFY05) also contributed to the bottomline growth.

What to expect?

At Rs 1,045, the stock is trading at 21.9 times its FY05 earnings per share (approx. US$ 67 on the basis of EV/ton), which is way above our valuation band. While the company is acknowledged for its cost efficient cement manufacturing, the growth has been hard to come by, considering the 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 is likely to improve. This augurs well for cement prices in the region. Further, considering that the company is adding a coal based power plant, which is expected to bring down its power costs, pressure on margins would be reduced.

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 are 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. To conclude, we continue to remain apprehensive on the stock.

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