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ACC: Expensive? - Views on News from Equitymaster
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ACC: Expensive?
Jul 18, 2005

Performance Summary
ACC announced its 1QFY06 results last week wherein it posted a strong topline and bottomline growth. Growth in topline during the quarter was on the back of strong volume sales. However, surge in some miscellaneous cost items led to the contraction in operating margins. A large other income component, however, led to the strong growth in net profits.

(Rs m) 1QFY05 1QFY06 Change
Net Sales 9,479 11,283 19.0%
Expenditure 7,605 9,150 20.3%
Operating Profit (EBDITA) 1,875 2,133 13.8%
EBITDA margin (%) 19.8% 18.9%  
Other income (111) 415  
Interest 209 219 5.0%
Depreciation 439 480 9.3%
Profit before tax 1,116 1,849 65.7%
Tax 306 456 48.7%
Profit after Tax/(Loss) 810 1,394 72.1%
Net profit margin (%) 8.5% 12.4%  
No. of Shares (m) 178 179  
Diluted earnings per share* 13.6 23.3  
Price to earnings ratio (x)   18.4  
* For the three quarters ending December 2005

What is the company’s business?
Associated Cement Companies (ACC) is the oldest and the second largest cement manufacturer in the country. The company has a total consolidated capacity of 17.6 MT (million tonnes) and has a near 12% industry capacity share. With 14 plants and a 9,000 strong dealer network, ACC is one of the few companies to have a pan Indian presence. It is particularly strong in the northern and eastern regions with approximately 18% and 19% of the market share respectively.

What has driven performance in 1QFY06?
Strengthening topline: Riding on the strong housing construction boom being witnessed in the country and the infrastructure activities taking shape, ACC reported a strong topline growth of 19% YoY for the quarter ended June 2005. This growth came on the back of a 13% YoY increase in volume sales. Around 2% to 3% improvement in realisations further helped improve the sales of the cement division (85% of total sales) of the company, which grew by 16% YoY.

Revenues: Segmental breakup…
(Rs m) 1QFY05 Share 1QFY06 Share Change
Cement 8,446 87.7% 9,814 85.7% 16.2%
Refractory 491 5.1% 738 6.4% 50.2%
RMC 431 4.5% 547 4.8% 26.9%
Others 265 2.8% 358 3.1% 35.0%
  9,634 100.0% 11,457 100.0%  

However, it would be unfair to ignore the strong growth witnessed in the other business segments of the company, which made their bit of contribution in the overall scheme of things. Just to put things in perspective, ACC’s refractory business (6% of 1QFY06 sales) and ready mix concrete business (RMC) (5% of 1QFY06 sales) grew by 50% and 27% respectively during the quarter.

Cost break-up (% of net sales)
  1QFY05 1QFY06
Inc/Dec in stock in trade -4.9% -2.6%
Raw material consumed 15.5% 15.2%
Staff costs 5.5% 4.8%
Power & Fuel 22.0% 18.3%
Freight & Forwarding 13.4% 15.4%
Excise (net of recovered) 0.7% 1.9%
Purchase of cement 5.8% 8.1%
Other expenditure 22.2% 20.1%
Total expenses 80.2% 81.1%

Margin contraction: Operating margins came under pressure during the quarter as they declined by 90 basis points to under 19%. While the company seemed to have reined in most of the operating costs well, high freight costs and increased purchase of cement negated the improvements achieved under various other operating heads i.e. raw materials, staff costs and power and fuel (see table above).

Other income boosts bottomline: ACC reported a strong 72% YoY profit growth for the quarter. This surge has come about despite operating margins registering a fall, interest expenses growing by 5% YoY and depreciation charges increasing by over 9% during the quarter. Both these expenses grew mainly on account of the acquisition of Wadi Captive Power Plant (CPP) and commissioning of the Chaibasa CPP and Gagal Unit I expansion. The bottomline growth was mainly a factor of the strong other income component, which was at Rs 415 m compared to an expense of Rs 111 m in the corresponding quarter of the previous year. Higher dividend income and income from the sale of land at Thane aided the strong rise in other income. This was reflected in the bottomline as net profit margins expanded by 390 basis points.

What to expect?
At the current price of Rs 430, the stock is trading at a price to earnings multiple of 18.4 times its FY06 (December 2005) earnings (over US$ 100 on the EV/ton basis). While the company has managed to outperform our estimates by a small margin, we do not feel the need to revise our full year numbers, as we believe that the current quarter numbers (considering this being the monsoon season) would bring these in line with our full year estimates.

Going forward, we remain optimistic on the cement sector as a whole, which is in the midst of surging demand led by the booming housing industry and growth in infrastructure related activities. Coupled with the lack of any significant greenfield cement capacity addition in the medium-term, we expect the pricing environment to remain favourable for cement manufacturers. We also reckon ACC to be a big beneficiary of this and continue to report strong numbers over the next couple of years.

However, while every aspect favours a strong performance by the company in the medium-term, we believe that at the current price, the stock is appropriately valued as it trades at over US$ 100 on the EV/ton basis and leaves little room for upside. Thus, we maintain our SELL recommendation on the stock. Investors must note here that Gujarat Ambuja remains our preferred play in the sector, wherein we have set a price target of Rs 72 in the medium-term.

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