As compared to the market leader, Gujarat Ambuja, ACC has under performed in the stock market over the last one year. We take a review of the company's performance in the recent quarter and whether the much expected 'faster margin expansion' is likely to happen in FY05 and beyond.
On a consolidated basis, ACC accounted for almost 12% of industry capacity in FY04 and an estimated 14% of industry production. It is particularly strong in the northern and the eastern regions with a capacity share of 16% and 8% respectively in the said regions. Though the company's benefits from a well-spread presence, its operating margins have been below its peers (especially Gujarat Ambuja). Given its large capacity and regional diversification, during periods when cement prices are rising, it is expected that ACC's margins will rise at a faster rate than its peers. But it has not been the case on a consistent basis.
Now that the average cement prices are expected to increase by around 5% to 6% in FY05 and the restructuring process is reaching its final phase, what does the future hold for ACC?
On the demand side, fueled by an outlay of Rs 400 bn on infrastructure projects and housing sector finance, the cement industry is expected to achieve an annual growth rate of 8.0% to 10.0% in the next 2 to 3 years. While growth in the medium-term is likely to arise primarily from housing sector growth, in the long-term, demand for cement from infrastructure spending will gather pace. As a leading player, we expect ACC to outpace industry growth rate in the next two to three years. As a matter of fact, there is a clear visibility on the demand side for the cement sector as a whole and the company in particular.
At the same time, we do not expect operating margins of the company to outpace its peers purely because of unfavorable demand-supply situation in the southern market. It is estimated that there is excess supply in the southern market to the tune of 40%. Compared to the western and northern markets, the demand-supply imbalance is unlikely to turn favorable in the next two to three years.
Though benefits of setting up of captive power facilities in select southern plants will be reflected in ACC's margins in FY05, the modernisation of the Chaibasa plant will reflect in operating margins in FY06. The company is setting up a 15 MW captive power plant in Chaibasa. This along with the modernisation programme will cost Rs 2.9 bn. Keeping in mind the sharp rise in fuel cost and increase in transportation charges in the recent past, we expect operating margins to expand only marginally in FY05. As a matter of fact, margins of Gujarat Ambuja and Grasim will continue to remain superior.
The stock currently trades at Rs 273 implying a price to earnings multiple of 26 times our expected FY05 earnings. Though the balance sheet of the company looks much healthier after the FCCB issue and there exists the scope of margin expansion beyond FY05, valuations are on the higher side on a relative basis and therefore, the under performance of the stock is not a surprise.
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