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Gujarat Ambuja: Better times ahead

Jul 28, 2004

Introduction to results
Gujarat Ambuja has finished FY04 (June year-ending) with impressive numbers. After a lacklustre 1HFY04, the second half saw a marked revival in industry demand for cement, which led to a sharp rise in prices. To put things in perspective, average prices were higher by 24% in 4QFY04 as compared to 1QFY04. Barring higher extraordinary income owing to write-back of depreciation charges, the performance is in line with our estimate.

(Rs m) 4QFY03 4QFY04 Change FY03 FY04 Change
Net sales 4,706 5,951 26.5% 17,423 19,681 13.0%
Other income 112 (69) -161.5% 363 505 39.1%
Expenditure 3,388 4,044 19.3% 12,657 14,311 13.1%
Operating profit (EBDITA) 1,318 1,908 44.8% 4,765 5,370 12.7%
Operating profit margin (%) 28.0% 32.1%   27.4% 27.3%  
Interest 208 179 -14.0% 879 784 -10.8%
Depreciation 409 460 12.7% 1,713 1,686 -1.6%
Profit before tax 813 1,200 47.5% 2,536 3,405 34.3%
Extraordinary items - (14) 173.3% - 430 -
Tax 30 14 -53.2% 315 467 48.4%
Profit after tax/(loss) 784 1,172 49.5% 2,221 3,368 51.6%
Net profit margin (%) 16.7% 19.7%   12.7% 17.1%  
No. of shares (m) 155.3 179.4   155.3 179.4  
Diluted earnings per share (Rs) 5.0 6.5   14.3 18.8  
P/E ratio (x)         14.3  

Background
Gujarat Ambuja, with a consolidated cement capacity of 12.5 million tonnes (9% of industry capacity) is the third largest player in the Indian cement industry. The company is particularly strong in the northern and western markets. However, with the commencement of its Chandrapur plant (Maharashtra), the company is catering to select southern markets as well. The company is the lowest cost producer of cement in the country and its products enjoy strong brand equity in a commodity business like cement.

What has driven performance in FY04?
The second-half recovery in demand:  The cement industry grew at a slower pace of 4.4% in 1HFY04 primarily on account of prolonged monsoon, which affected construction work. However, post November and December 2003, there was a clear recovery in industry demand. This was accompanied by improvement in price realisation as well. The graph below highlights the monthly despatches of Gujarat Ambuja (consolidated) and the YoY growth in the same. Against a 2% growth in sales in 1HFY04, the company has closed the year with a topline growth of 13% for FY04, which vindicates our view. Looking at the performance of Grasim, realisations have also been favorable in the last six months (Grasim’s average cement realisation was higher by 13% in 1QFY05). The cement sector is likely to register a 8% growth over the long-term.

Margins follow suit:  Cement, being a commodity, operates on high fixed cost. Whenever there is a sharp rise in the topline (especially led by realisations), the rise in operating profit in proportion to sales is significantly higher. Gujarat Ambuja’s performance in 4QFY04 and in FY04 has to be viewed in this context. To put things in perspective, operating margins were higher by 400 basis points YoY in 4QFY04. To understand the sensitivity of margins to realisation, against a 600 basis point decline in operating margins YoY in 1HFY04, for FY04 as a whole, margins are lower by only 10 basis points YoY, on the back of better prices. With pricing situation looking favorable for FY05, we expect margins to remain strong.

The second half push...
Parameter 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04
Sales growth 25.2% 31.4% 0.1% 3.6% 18.4% 26.5%
EBDITA margin 28.5% 28.0% 17.5% 23.8% 32.6% 32.1%
Net margin 14.2% 16.6% 4.8% 13.7% 26.0% 19.7%

What to expect?
The stock is currently trading at Rs 268, implying a P/E multiple of 14.3x FY04 earnings. We expect FY05 to be a favorable one, both in terms of recovery in volumes and prices. Despite Gujarat witnessing oversupply situation in the last few years and competition higher than the last decade, the fact that cement prices rose through FY04 is a positive in itself. Considering the company’s strong leadership presence in the western and northern regions, it is likely to benefit from increased infrastructure spending and housing demand. With demand-supply situation likely to improve for the better in the medium-term, we expect pricing situation to remain favorable. At the same time, Gujarat Ambuja has a higher risk, as it lacks the pan-Indian presence like its competitors viz. ACC (14.5% owned by Gujarat Ambuja) and Grasim.

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