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Cement: Cautious optimism - Views on News from Equitymaster
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  • Sep 3, 2003

    Cement: Cautious optimism

    If the mood in the stock market is any indication, cement stocks seem to be back on the average investor's radar. And why not! Cement is one industry that has grown consistently at around 8% in the past decade and still shows no signs of slowing down. In fact, if one were to consider the low per capita consumption of cement in the country, there is still a lot of potential for the industry to capitalise on. In this article, we try to compare some key parameters of four major cement companies in the country and also try and throw some light on their current valuations.

    ACC Gujarat Ambuja Grasim L&T
    Price 220 238 640 300
    OPM 10.2% 27.5% 17.0% 14.4%
    NPM 3.6% 12.8% 7.9% 4.6%
    EPS* 9.0 18.0 60.4 18.0
    P/E(x)* 24 13 11 17

    *FY04 Projections

    Although ACC's performance was far from impressive in FY03, where bottomline dropped 30%, one cannot afford to ignore a company that has a pan India presence and boasts of the largest distribution network in the country. Moreover, in the last six years, ACC has modernized to world standards, almost 50% of its capacity and has also raised capacity from 7 to 16 m tonnes. This will definitely help the company in improving its operating efficiencies and as a result any improvement in the prices will directly benefit earnings. Therefore, going forward, we expect the company's bottomline to improve substantially on the back of improved efficiencies as well as sales realisations. The stock is currently trading at Rs 220, a P/E of 24x its projected FY04 earnings. Although we expect the company to grow, the growth is not expected to be high enough to justify such high valuations.

    Gujarat Ambuja
    In the year, when all other cement majors reported a drop in their earnings on account of poor sales realisations, Gujarat Ambuja managed to improve its bottomline by almost 20%. This, more than anything else, underlines the resilience of the company and the capabilities of its management. As seen in the table above, Gujarat Ambuja operates at margins that are much higher than its competitors, and as a result, is in a better position to absorb fall in prices. Gujarat Ambuja, due to better brand recognition and awareness, also enjoys higher realisations for its cement, despite cement being a commodity. This also to a large extent helped the company weather the fall in realisation in the last two years. Moreover, its locational advantages enable it to export the surplus production making sure that its capacities are effectively utilised and hence give it the benefits of economies of scale.

    As far as the future performance is concerned, we expect Gujarat Ambuja's operating margins to decrease marginally, due to lower projected volume growth. The company might also face increased competition in its major market, i.e. the western region, particularly from Grasim who, after the acquisition of L&T's cement division, has gained an entry in the lucrative western market. Notwithstanding these minor glitches, Gujarat Ambuja's fundamentals still look strong and the company is well placed to benefit from the growth in the industry. The stock is currently trading at Rs 238 a P/E of 13x its projected FY04 earnings. Gujarat Ambuja is the most cost efficient player in the industry and therefore should command a superior valuation than most of its competitors in the industry.

    In FY03, although the cement division was responsible for bringing down Grasim's profitability marginally, the acquisition of L&T's cement division, reinforces the faith and the expectations that the management has from the cement division. With the company's other major business division of VSF expected to reach the peak of its cycle in FY04, cement division is likely to emerge as the mainstay of company's growth. Moreover, the acquisition of L&T's cement division will give Grasim an exposure to the lucrative markets of the western region and with its combined capacity of close to 30 m tonnes, the company is going to gain from economies of scale and better pricing power. The company is also likely to benefit from reduced freight costs. For example, Grasim supplies to Maharashtra from Madhya Pradesh and Andhra Pradesh, however, in the future it can do this through L&T's Wadi plant, thus saving on freight costs.

    The stock is currently trading at Rs 640, a P/E of 11x its projected FY04 earnings. Although the valuations seem to be lower than most of its counterparts, it should be borne in mind that in FY03, the company suffered a one time extraordinary loss of Rs 2.1 bn which affected the bottomline. With no such losses expected to occur in the near future, we expect the company to perform better.

    L&T finally paid heed to the advice of Boston Consulting Group and decided to demerge its cement division and hand over its management control to Grasim. The deal made perfect sense, as it not only unlocked value for the shareholders it now allows L&T to focus on its core business of engineering and construction. With the cement division gone, the balance sheet of the company looks much stronger and this will help the company in bidding for bigger international projects, where size of the balance sheet is an important factor. The stock is currently trading at Rs 300, a P/E of 17x its annualised FY04 earnings. It may be too early to comment upon the valuations of Larsen And Toubro (L&T) currently as the demerger is yet to be effected. However, we believe that post the demerger, L&T as a pure EPC player is likely to command better valuations than its peers.

    With capacity addition slowing down and demand growing at 9% per annum, the demand supply gap is narrowing and this will help in stabilising the prices. Consolidation is also likely to help in price stability, as bigger players would be in a better position to cut production, as and when required and this would help arrest the decline in prices. The Indian cement industry thus looks poised for higher growth trajectory on the back of favorable factors that have emerged in recent times. However the investors need to be cautious as valuations for most of the companies appear to be stretched in the short term.



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