The Ambuja strength…

Performance summary

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Gujarat Ambuja, one of the most cost-efficient manufacturers of cement, declared its 1QFY05 results today. Though growth numbers, as is evident from the table below, are higher at the first look, the numbers are not strictly comparable (due to the merger of a subsidiary with the company). Domestic sales of cement was higher by 9% during the quarter under review.

(Rs m)	1QFY04	1QFY05	Change
Net sales	3,781	5,994	58.5%
Expenditure	3,173	4,322	36.2%
Operating profit (EBDITA)	608	1,672	175.0%
EBDITA margin (%)	16.1%	27.9%
Other income	146	122	-16.8%
Interest	195	210	7.6%
Depreciation	408	503	23.2%
Profit before tax	151	1,081	618.0%
Extraordinary income/(expense)	87	-	-
Tax	89	176	96.9%
Profit after tax/(loss)	148	905	510.4%
Net profit margin (%)	3.9%	15.1%
No. of shares (m)	176.4	176.4
Diluted earnings per share (Rs)*	3.4	20.5
Price to earnings ratio (x)		17.6
(* annualised)

Background

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Gujarat Ambuja, with a total capacity of 12.5 million tonnes (MT), is the third largest producer of cement in the country. It has close to 9% of the country's total cement capacity and has the western and the northern region as its principal markets. With plants that are believed to be highly efficient, Gujarat Ambuja has come to be known as the lowest cost producer of cement in the country. The company also has a 14.4% stake in ACC, the country's second largest cement producer. Besides, the company is also the largest exporter of cement and this helps it enhance capacity utilisation.

What has driven performance in 1QFY05?

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Volumes gaining momentum:  It has been a slow start for the cement sector. Like in 1HFY04, cement demand grew at a relatively slower rate of 4.7% in 1HFY05 (April to September 2004). However, Gujarat Ambuja has managed to outperform the industry by a fair margin (domestic sales higher by 9%). Also adding to the momentum is the sharp rise in export volumes at around 33% (largely to the Middle East). The graph below highlights the overall despatches growth for Gujarat Ambuja since July 2003. We believe that the demand outlook for the sector continues to remain promising.

Favorable prices are a sweetener:  Not only has cement demand grown, but also the prices have strengthened, especially in the key northern and western markets. With demand likely to exceed production and no sharp rise in supply in sight for the next one year, there is an upward bias in cement prices. Unlike the last decade, the medium-term outlook for prices is more favorable. While higher prices and better capacity utilisation have enabled the company to improve operating margins, power and fuel costs have increased as a percentage of sales in 1QFY05 (table below). As per the company, the direct cost of production increased by 14% per tonne due to surge in coal and oil prices globally.

The expenditure side...

(Rs m)	1QFY04	1QFY05	Change
Raw material	278	205	-26.4%
% of sales	7.4%	3.4%
Salaries	229	235	2.7%
% of sales	6.1%	3.9%
Power and fuel	974	1,598	64.1%
% of sales	25.7%	26.7%
Freight and handling	779	1,068	37.1%
% of sales	20.6%	17.8%
Other expenditure	914	1,216	33.1%
% of sales	24.2%	20.3%

What to expect?

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The stock currently trades at Rs 360 implying a price to earnings multiple of 17.6 times 1QFY05 annualised earnings. While the performance of the company at the topline level is in line with our estimate, at the margin level, we have exercised caution in our estimates. This is because of the higher oil prices, which not only impact power cost, but also the freight cost. Coming back to the demand side, from a medium-term perspective, we expect demand to grow at more than 8%. Prices are also expected to be higher by more than 5% on an average. Consequently, Gujarat Ambuja is likely to continue its outperformance.