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Shree Cement: Margins under pressure - Views on News from Equitymaster
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Shree Cement: Margins under pressure
Aug 29, 2007

Performance summary
  • On account of robust demand, the company achieved 38% YoY growth in topline.

  • The growth in cost of operations has outpaced the topline growth, resulting in 180 basis points contraction in EBITDA margins.

  • If one excludes other income, net margin contraction of 380 basis points owing to higher tax outgo and increased depreciation charges is relatively more damaging than EBITDA margin.

Financial performance snapshot
(Rs m) 1QFY07 1QFY08 Change
Net sales 3,083 4,258 38.1%
Expenditure 1,708 2,435 42.6%
Operating profit (EBITDA) 1,375 1,823 32.6%
EBITDA margin 44.6% 42.8%  
Other income 30 126 317.8%
Interest 54 39 -27.0%
Depreciation 263 358 36.1%
Profit before tax/(loss) 1,089 1,552 42.6%
Tax 184 383 107.8%
Profit after tax/(loss) 904 1,169 29.3%
Net margin 29.3% 27.5%  
No of shares (m) 35 35  
Diluted EPS (Rs)*   92.6  
P/E (times)   13.4  
*trailing twelve month earnings

What is the company's business?
Shree Cement, promoted by Bangur group is North India’s largest cement producer with installed capacity of almost 6 MT. The company, apart from being an efficient cement manufacturer, is the market leader in the north, with a market share of 16% within the region. It is also one amongst the least cost producer in India and is self sufficient in meeting power requirement. Riding on the back of rise in demand, improved realisations and reduction in interest outgo, the company has been able to improve its overall performance. With the improvement in the financial position, the company plans to increase its capacity to 9MTPA by the end of 2008.

What has driven performance in 1QFY08?
Robust demand: During the quarter ended June 2007, the demand for cement grew by 10% in the country. On account of robust demand and favourable pricing scenario, the company has achieved impressive 38% YoY growth in topline. Considering the strong topline growth and consumption growth during the year, volume sales could be in line with the industry. Further, the demand in the northern region is strong on account of infrastructural activity and booming real estate and housing sectors.

Cost break-up (as a % of net sales) 1QFY07 1QFY08
Increase / Decrease in stock 1.4% -1.8%
Raw material consumed 11.5% 12.1%
Staff costs 3.7% 3.6%
Power & Fuel 15.3% 19.3%
Transportation & handling 14.1% 14.6%
Other expenditure 9.4% 9.3%

Power cost takes toll: The growth in cost of operation has outpaced the topline growth resulting in 180 basis points contraction in EBITDA margins. Cost of operation grew by almost 43% YoY, mainly on account of increase in power and fuel expenses. 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 15% of operating sales in 1QFY07 to 19% in 1QFY08.

Other income push: In line with the operating margins, net margins have contracted by 180 basis points. If one excludes the other income effect, the net margins have actually contracted by almost 380 basis points owing to higher tax outgo and increased depreciation charges.

What to expect?
At the current price of Rs 1,215, the stock is trading at an expensive valuation of over US$ 200 on the enterprise value per tonne (EV/tonne) basis as per FY07 numbers.

On the demand front, we expect the northern region to grow in line with the industry. North India is expected to witness demand growth rate of over 7%, driven in part by the forthcoming Commonwealth games, which will result in increased spending on infrastructure by the government. However, with the growth in the sector and waning demand supply gap, producers have lined up capacity expansion plans either by brownfield or greenfield expansion route.

Hence we suggest investors to exercise caution as in the future, the current level of higher realisations may not sustain. Once the large stream of new capacities become operational by the end of 2008 to meet the robust demand growth, it is likely to result into a downturn in cement prices.

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