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Gujarat Ambuja: All's good but price

Jul 21, 2006

Performance summary
Gujarat Ambuja, the country's most profitable cement manufacturer, announced its fourth quarter and twelve months results (the company's fiscal year will stand changed from June ending to December ending in line with Holcim, which acquired the management control). Led by higher volume sales and remunerative prices, at the consolidated level, net profit has risen by 75% YoY for the first twelve months of the fiscal. Growth would have been higher but for exchange losses due to adverse foreign exchange market.

Consolidated performance snapshot…
(Rs m) 4QFY05 4QFY06 Change 12mFY05 12mFY06** Change
Net sales 7,395 11,546 56.1% 30,796 35,676 15.8%
Expenditure 5,177 7,114 37.4% 22,644 24,256 7.1%
Operating profit (EBDITA) 2,218 4,432 99.8% 8,152 11,420 40.1%
EBITDA margin (%) 30.0% 38.4%   26.5% 32.0%  
Other income 135 84 -38.1% 622 338 -45.6%
Interest 230 120 -47.6% 902 648 -28.2%
Depreciation 415 498 20.0% 2,195 2,012 -8.3%
Profit before tax 1,708 3,897 128.2% 5,677 9,098 60.3%
Extraordinary items 49 (185) - 325 (51) -
Tax 219 676 208.3% 831 1,458 75.3%
Share of profits of associates 175 565 222.7% 179 1,467 718.9%
Profit after tax before minority interest 1,713 3,601 110.2% 5,350 9,057 69.3%
Minority interest 1 - - 169 4 -
Net income 1,712 3,601 110.3% 5,181 9,053 74.7%
Net profit margin (%) 23.1% 31.2%   16.8% 25.4%  
No. of shares (m) 179 1,359   179 1,359  
Diluted earnings per share*         6.7  
Price to earnings ratio (x)         14.9  
(* trailing 12-months, ** twelve months ended because of a 18 month fiscal year)

What is the company's business?
Gujarat Ambuja, with a total consolidated capacity of 13.9 million tonnes (MT), is the third largest cement producer in the country. It has close to 9% of the country's total cement capacity and has the western and northern regions as its principal markets. With plants that are believed to be highly efficient, Gujarat Ambuja is amongst the lowest cost producers of cement in the country. Besides, the company is also the largest exporter of cement and this helps it enhance capacity utilisation. Holcim Mauritius, an indirect wholly-owned subsidiary of Holcim (Europe), acquired a 14.8% stake from the promoters of the company at Rs 105 per share. The acquisition price includes Rs 15 per share as non-compete fee.

What has driven performance in 4QFY06?
Quantum jump in prices: Volume sales on a standalone basis increased by 15% YoY in 4QFY06, which is significantly higher than the industry growth rate. As per the company, higher contribution from portland cement as compared to ordinary cement was one of the reasons for the outperformance. Much of the growth was accounted for by the month of May 2006 in which cement sales of the company increased by as much as 20% YoY (34% of the last quarter volume sales). Higher volumes was accompanied by a significant rise in cement realisation. As per our calculation, realisations were higher by as much as 37% YoY to Rs 150 per bag (Rs 109 per bag in 4QFY05). Not only were prices higher in the domestic market but also on its exports to the Middle East (US$ 47 per tonne or around Rs 108 per bag). As per the company, newer contracts on the exports front are entered into at around US$ 55 per tonne, which will start reflecting in its performance from October 2006. Given the stable demand prospects, we expect price realisation to improve from the current levels, albeit at a much slower pace.

Fixed costs are fixed! In the case of cement manufacturers, the cost of power per metric tonne as well as the employee cost per metric tonne do not increase in proportion with the rise in cement prices, which is why as a percentage of sales, they have declined considerably (table below). For instance, the power cost stands the same at Rs 532 per tonne in the fourth quarter. However, costs like raw material and freight are largely variable in nature (depending upon how much one produces and sells, these costs fluctuate). Freight costs per MT sold was higher by 49% YoY in the fourth quarter. This is on account of transporters increasing freight rates in light of the hike in diesel prices. However, it has to be borne in mind that in 4QFY05, operating profit declined by 5% YoY due to higher coal prices and to that extent, the rise in operating profit is inflated. In our view, further increases in cement prices will add to the operating profit thereby, resulting in margin expansion. We are positive on the margin front over the next one year.

Consolidated cost break-up…
(% of net sales) 4QFY05 4QFY06 TmFY05 TmFY06
Inc/Dec in stock in trade -0.4% 0.2% 1.1% -0.4%
Raw material consumed 5.8% 6.0% 5.0% 5.9%
Staff costs 3.7% 3.2% 4.0% 3.9%
Power & Fuel 23.6% 17.3% 24.3% 21.0%
Freight & Forwarding 19.5% 20.3% 18.8% 19.4%
Other expenditure 17.9% 14.6% 20.2% 18.2%
Total expenses 70.0% 61.6% 73.5% 68.0%

Associates add to the profits: Despite a significant reduction in other income and exchange losses as compared to gains in the same period last year, the consolidated net profit was higher by more than 100% YoY in 4QFY06 owing to doubling of the share of profits in associate companies. Lower interest outgo also helped matters. Excluding the exchange-related losses, net profit in 12mFY06 has actually jumped by 87% YoY, which is commendable.

Over the last few quarters: As is evident from the graph, operating profit margins have witnessed significant expansion, though much higher than our estimates. Gujarat Ambuja's operating margins used to be around these levels in the early 2000s largely on account of sales tax benefit in the Gujarat region. Without any fiscal benefits, to expand margins in a highly competitive environment, is commendable.

What to expect?
At Rs 99, the stock is trading at a price to earnings multiple of 14.9 times trailing twelve month earnings and at EV/tonne of over US$ 200, which in our view, is very high for a cement company in India. Despite being one of the most efficient producers of cement, potential margin expansion and long-term capacity expansion plans, we remain concerned about current valuations.

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