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ACC: Coming into its own

Oct 27, 2004

Performance Summary
ACC, among the largest cement manufacturers in the country, has posted impressive numbers for the second quarter ended September 2004. While revenue growth has been aided by higher cement prices, there has been a sharp expansion in margins. Though the company's initiative to prune costs has been paying off, the expansion in margins has to be viewed with respect to lower purchases of cement from group companies. Since 2QFY04 was also a weak period, the expansion in margins is magnified. Nevertheless, the company's performance in 2QFY05 is impressive.

(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Cement sales - MT 3.7 3.7 0.2% 7.6 7.6 0.5%
Net sales 7,497 8,853 18.1% 15,595 18,332 17.5%
Expenditure 6,993 7,354 5.2% 13,868 14,963 7.9%
Operating profit (EBDITA) 505 1,499 197.0% 1,727 3,370 95.1%
EBDITA margin (%) 6.7% 16.9%   11.1% 18.4%  
Other income 250 337 35.0% 438 233 -46.9%
Interest 243 197 -19.0% 492 405 -17.7%
Depreciation 442 444 0.5% 878 883 0.6%
Profit before tax 69 1,195 - 796 2,313 190.7%
Extraordinary income/(expense) - - - (125) - -
Tax (210) 409 - (50) 716 -
Profit after tax/(loss) 279 786 181.8% 720 1,598 121.9%
Net profit margin (%) 3.7% 8.9%   4.6% 8.7%  
No. of shares (m) 178.3 178.3   178.3 178.3  
Diluted earnings per share (Rs)* 6.3 17.6   8.1 17.9  
Price to earnings ratio (x)         14.4  
(* annualised)            

What is the company's business?
Associated Cement Companies (ACC) is the oldest cement manufacturer in the country. ACC has a total capacity of 17.6 million tonnes (12% of total Indian capacity) and is the second largest player in the Indian market. With 11 plants and a 9,000 strong dealer network, ACC is one of the few cement companies to have a pan India presence. It is particularly strong in the northern and the eastern regions with a capacity share of 16% and 8% respectively in the said regions.

What has driven performance in 2QFY05?
The story is unfolding: Cement demand grew by 4.7% in 1HFY05 as compared to 4.8% in the corresponding period of the previous year. However, the company has underperformed the industry in 1HFY05, even on a consolidated basis. But value sales is higher owing to better cement prices. To put things in perspective, average realisation for Ultra-Tech, another cement major, increased by almost 20% in 2QFY05. Since ACC has presence in the southern market as well, where prices are lower, the overall growth is likely to be lower. Like in FY04, we expect a accelerated growth in cement demand in the second half of FY05, which will further benefit cement majors, including ACC. With no new capacity expansion in sight for another year and a half, the long awaited 'cement story' is unfolding.

Margin expansion magnified: While raw material cost as a percentage of sales has increased (due to higher coal prices), unlike other cement majors, ACC has witnessed a decline in power cost as a percentage of sales. ACC has been increasing contribution from captive power units over the years. Upon the completion of the Chaibasa captive power plant and the acquisition of Tata Power's power facilities in Wadi, we expect further savings on this side. Another key reason for this sharp rise in margin expansion is that the company has stopped sourcing cement and other materials from group companies, which has been highlighted in the table. To that extent, the benefit seems to be magnified. Post the 1HFY05 results, we will have to upgrade our operating margins for FY05.

The expenditure side…
(Rs m) 2QFY04 2QFY05 Change 1HFY04 1HFY05 Change
Raw materials 1,159 1,386 19.6% 2,284 2,856 25.0%
% of sales 15.5% 15.7%   14.6% 15.6%  
Wages and salaries 518 532 2.7% 993 1,054 6.1%
% of sales 6.9% 6.0%   6.4% 5.7%  
Power and fuel 1,794 1,888 5.2% 3,664 3,903 6.5%
% of sales 23.9% 21.3%   23.5% 21.3%  
Freight and handling 2,459 1,026 -58.3% 2,160 2,459 13.8%
% of sales 32.8% 11.6%   13.9% 13.4%  
Purchase of cement and others 1,231 450 -63.5% 1,843 878 -52.3%
% of sales 16.4% 5.1%   11.8% 4.8%  
Other expenses 1,831 1,982 8.2% 3,636 4,159 14.4%
% of sales 24.4% 22.4%   23.3% 22.7%  

Lower interest cushion: Lower interest charges (cash raised from the FCCB issue has been utilised towards retiring certain high cost debts) has enabled the company to improve the net margins significantly. This despite lower other income, is commendable. However, if one were to adjust for the extraordinary expenses in 1HFY04, the net profit growth for 1HFY05 is actually 87% as against 122%.

What to expect?
The stock currently trades at Rs 259 implying a price to earnings multiple of 14.4 times 1HFY05 annualised earnings. The company's 1HFY05 performance is above our estimates on two fronts. We have been conservative on the realisation growth. Though we do not expect the growth rate to continue at the same level for the rest of the fiscal, we need to upgrade our estimates. Secondly, the cost savings arising out of lower purchases also need to be factored in. Though the company's performance is impressive, we believe others like Grasim, Ultra-Tech and Gujarat Ambuja are better placed to capitalise on the growth opportunity in the export market as well (read Middle East). To that extent, one needs to tone down optimism.

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