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Shree Cement: Research meet excerpts
Oct 10, 2007

We met the management of Shree Cement recently to get the company’s view on the cement sector, its performance and the future prospects of the industry and the company. Here are the key takeaways from the same. Industry outlook as indicated by the management: Historically, the cement sector has grown at the rate of 1.3 times the economy. As the country’s GDP is expected to grow at 8% to 9% in the coming years, the sector is expected to grow at 11% to 12%.

With the growth in the sector and waning demand supply gap, cement producers have lined up capacity expansion plans either through the brownfield or greenfiled expansion route. With huge capex plans already under various phases of implementation, the industry may see some supply glut from 2HFY09. However, the industry is operating at 100% utilisation levels and is enjoying EBITDA margins of over 30%. With the commissioning of additional planned capacities, the industry is expected to operate at 85% to 90% utilisation levels (if the industry witnesses an oversupply situation). But based on historical scenario even at 85% to 90% utilisation levels, the EBITDA margins of around 25% are sustainable.

Cement prices are a factor of demand and supply. If the industry is able to maintain equilibrium going forward then the cement prices will be sustained at current levels.

Expansion plans: Riding on the back of a rise in demand and improved realisations, Shree Cement has been able to improve its overall performance. The company has increased its cement production capacity at a CAGR of 29% in the past three years and by FY09 the company’s cement production capacity will grow at a rate of almost 18%. Currently, the company has got 4 lines under operation and plans to add 2 more lines. The company has also outlined plans to set up 2 grinding plants. These projects are expected to come on stream by FY09 taking the company’s total production capacity to 9.1 MTPA from the current 5.6 MTPA. The company has a track record of completing its projects on or before schedule and in line with its performance till date the upcoming projects are on schedule.

Cost savings: The key raw material required to manufacture cement is limestone, fly ash and coal. Shree Cement is self sufficient in limestone production. The company has got its own mines, which have enough reserves to serve the current requirements and the future expansion plans. The company’s cost of operation has increased over a period of time and mainly on account of increased utilisation of fly ash. The company has made investments at thermal power plants with dedicated facilities to ensure exclusive and assured long-term fly ash supplies. Going forward, the company plans to negotiate more long-term contracts for supply of ash considering its expansion plans.

Coal is a key input required for cement production and accounts for 15% to 20% of the total operating cost. However, in order to minimise costs, Shree Cement sources low cost pet coke as fuel instead of coal for its cement production and for captive power plants. For the same the company has signed long term supply contracts with IOC (8,000 tonnes per month) and Reliance. Domestically procured fuel with committed supplies enables the company to save about 20% in cost as compared to the landed cost (if imported) of pet coke.

The company has gradually reduced its dependence on state grid power, another move the company has made to curtail cost of operations. The company has set up captive power plants (63 MW), which satisfy 90% of its current requirements. In order to be self sufficient in power (100% captive utilisation) the company has chalked out 2 power projects of 18 MW each. The projects are under implementation and are expected to be commissioned in December 2007.

Funding: The company has raised debt for all its expansion programmes upto Unit VI that are expected to come on stream by FY09. Thus, at present there are no plans for raising any funds in the next 2 years. The company has raised approximately Rs 5.6 bn to fund its expansion plans. The company’s average interest cost has increased by 0.7% to 7.7% in FY07 as compared to 7% in FY06. The aggressive plans outlined by the company to scale up its operations have necessitated raising funds at a little higher rate. However, operational efficiencies and optimal utilisation of funds with a judicious mix of rupee and fully hedged foreign currency loans has enabled the company to lower its risks.

What to expect?
On the demand front, we expect the northern region to grow in line with the industry driven in part by the forthcoming Commonwealth games, which will result in increased spending on infrastructure by the government and on account of the ongoing construction activity.

The Cement Manufacturers’ Association of India (CMA) has estimated cement consumption to go up to 241 MT by FY12 considering 10% growth in cement demand. This level of demand growth would require new capacity to the tune of 80 to 100 MT. Capacity additions announced till date will add up approximately 70 to 75 MT to the existing capacity (165 MT), the bulk of which will come onstream from CY09 onwards (i.e by FY10). Thus, we believe the current scenario is likely to reverse once the planned capacities come on stream (the industry is expected to face excess supply situation), exerting downward pressure on current high realizations and in turn, affect shareholder returns.

At the current price of Rs 1,625, the stock is trading at an expensive valuation of over US$ 250 on the enterprise value per tonne (EV/tonne) basis as per its FY07 numbers. Thus, while the near term scenario is favourable, from a long-term standpoint, we advise investors to practice caution.

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