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Madras Cements: Costs pressurise margins

Aug 8, 2007

Performance summary
  • Topline of the company grew by almost 38% YoY on the back of improved realisations.

  • During the quarter, operating expense outpaced the topline growth leading to 110 basis points (1.1%) contraction in operating margins.

  • Though net profits grew by almost 28% YoY, net margins contracted by 170 basis points owing to hit on EBITDA margins, higher interest outgo costs and depreciation charges.

Financial performance snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 3,409 4,694 37.7%
Expenditure 2,045 2,866 40.1%
Operating profit (EBITDA) 1,364 1,828 34.0%
EBITDA margin 40.0% 38.9%  
Other income 29 20 -30.3%
Interest 42 81 91.9%
Depreciation 174 239 37.6%
Profit before tax/(loss) 1,177 1,528 29.8%
Tax 388 522 34.5%
Profit after tax/(loss) 789 1,006 27.5%
Net margin 23.1% 21.4%  
No of shares (m) 12 12  
Diluted EPS (Rs)*   274.8  
P/E (times)   12.4  

What is the company's business?
Madras Cements has a total capacity of 6 MT (million tonnes) and caters exclusively to the southern markets, with Kerala and Tamil Nadu being its principal markets. It accounts for 4% of the total cement capacity in the country. The company has 4 manufacturing facilities. The larger units are in Tamil Nadu (TN) and Andhra Pradesh (AP) while the mini cement plant is in Karnataka. It also has two ready mix concrete (RMC) plants near Chennai. It was the first company in south India to convert all its capacity to the dry process. 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 1QFY08?
Realisation led growth: Continuing with the trend witnessed over the last couple of quarters, the company reported a robust topline growth for 1QFY08 as well, with net sales rising by almost 38% YoY. This was on the back of the continued strong demand for cement witnessed during the quarter in the southern region and strong realisations. Since the company does not provide its volume sales numbers, it would be difficult for us to comment on the same. Considering the strong topline growth and consumption growth during the year, volume sales could be in line with the industry. The current topline growth is particularly driven by higher realisations, which have increased by 20%-30% across companies in the sector.

Cost break-up (% of net sales) 1QFY07 1QFY08
Increase / Decrease in stock -3.0% 0.7%
Raw material consumed 13.3% 12.1%
Staff costs 3.8% 4.1%
Power & Fuel 20.0% 18.3%
Transportation & handling 12.8% 14.4%
Other expenditure 13.2% 11.6%

Rising costs dent margins: Operating profits grew by almost 34% YoY, lower than the 38% growth in topline. During the quarter, operating expense outpaced the topline growth leading to 110 basis points (1.1%) contraction in operating margins over 1QFY07. The cost concern continues as freight and transportation costs rose again (increasing petroleum product prices in turn raise transportation costs). This was the main reason for a 40% YoY growth in total costs during the quarter.

It boils down to bottomline: Despite the strong topline growth, the same did not get reflected in the bottomline, largely owing to pressure on operating margins. Apart from hit on EBITDA margins, 170 basis points (1.7%) contraction in net margins during the quarter was witnessed on account of higher interest outgo costs as well as higher depreciation charges.

What to expect?
The company has chalked out plans to increase its capacity from 6 MTPA to10MTPA by FY09. While this is a positive for the long-term, in the medium-term, this is expected to pressurize net margins, as interest and depreciation costs will increase. The current growth is more led by improved realisations rather than improvement in physical performance. This scenario is likely to change once the planned capacities come onstream. Based on plans announced by major cement companies in India, a total of 70 MTPA to 75 MTPA of capacity will be added starting 2007. Though the company is acknowledged for its cost efficient cement manufacturing, going forward we believe that the company needs to diversify its operations across regions to de-risk revenues.

At the current price of Rs 3,404, the stock is trading at an expensive valuation of about US$ 100 on the enterprise value per tonne (EV/tonne) basis as per our FY10 estimates.

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