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Madras Cements: Surprises on margins

Nov 3, 2006

Performance Summary
Madras Cements, a major player in the blended cement category in south India, announced outstanding numbers for the quarter ended September 2006. The company reported a 65.5% YoY growth in topline, while its net profit margins expanded by 1,450 basis points (14.5%). This, combined with reduced interest outgo, has aided the bottomline growth during the quarter.

Financial performance snapshot
(Rs m) 2QFY06 2QFY07 Change 1HY06 1HY07 Change
Net sales 2,461 4,073 65.5% 4,660 7481.4 60.6%
Expenditure 1,947 2,490 27.9% 3,641 4,535 24.5%
Operating profit (EBITDA) 514 1,583 208.1% 1,018 2,947 189.4%
EBITDA margin 20.9% 38.9% - 21.9% 39.4% -
Other income 10 17 65.7% 20 46 133.0%
Interest 70 42 -40.3% 141 84 -40.2%
Depreciation 166 184 10.9% 331 357 8.0%
Profit before tax/(loss) 288 1,374 377.0% 566 2,551 350.4%
Tax 100 474 373.5% 198 862 335.9%
Profit after tax/(loss) 188 901 378.8% 369 1,689 358.2%
Net margin 7.6% 22.1% - 7.9% 22.6% -
No of shares (m) 12.1          
Diluted EPS (Rs)*         174.4  
P/E (times)         20.0  
*trailing twelve month earnings

What is the company's business?
Madras Cements has a total capacity of 6 MT (million tonnes) and caters exclusively to the southern markets, with Kerala and Tamil Nadu being its principal markets. It accounts for 4% of the total cement capacity in the country. The company has 4 manufacturing facilities. The larger units are in Tamil Nadu (TN) and Andhra Pradesh (AP) while the mini cement plant is in Karnataka. It also has two ready mix concrete (RMC) plants near Chennai. It was the first company in south India to convert all its capacity to the dry process. While the company's management has constantly created value for its shareholders, it has not looked beyond the southern markets to diversify geographically, which is a useful strategy for a commodity business like cement.

What has driven performance in 2QFY07?
Demand drive topline growth: The company continues to report a robust topline growth for 2QFY07 as well, as is evident from 2QFY07 numbers. This was on the back of the continued strong demand for cement witnessed during the quarter in the southern region and strong realisations. It must be noted that cement consumption in the region has registered an impressive growth of 13% YoY and Madras Cements being a key player in the southern states of India has benefited from the same. In fact, the southern region continues to surprise on the demand side. Given the excess capacity situation in this region and assuming demand would grow in line with the industry average of 8% per annum, many expected cement prices to grow at a slower pace as compared to the other regions in the country. But this has been proven wrong. Since the company does not provide its volume sales numbers, it would be difficult for us to comment on the same. Considering the strong topline growth and consumption growth during the quarter, volume sales could be in line with the industry.

Operating profit triples: Operating margins expanded by 1,800 basis points YoY (18%), from 20.9% in 2QFY06 to 38.9% in 2QFY07 on the back of the volume growth and improved prices in the region. Though, the growth is witnessed at the operating profit level, cost concern continues with rising freight and transportation costs (increasing petroleum product prices in turn raise transportation costs). This was the main reason for a 27.9% YoY growth in total costs during the quarter. Despite this, overall costs have reduced costs as a percentage of sales, which could primarily be attributed to significant savings on power costs, which have gone down by 1,030 basis points YoY (10.3%). The reduction in power costs could be attributed to a 36 MW thermal power plant that has been commissioned. Also, the company has managed to reduce raw material costs and staff costs (reduction in manpower). EBDITA margins of over 39% in 1HFY07 is among the best in the industry and is therefore, commendable.

Cost break up (% of net sales) 2QFY06 2QFY07
(Increase)/ Decrease in stock 2.4% 0.6%
Raw materials consumed 15.2% 13.0%
Staff cost 4.9% 3.2%
Power and fuel 28.9% 18.6%
Transportation and handling 16.3% 12.2%
Other expenditure 16.3% 13.6%
Total cost 79.1% 61.1%

Bottomline leapfrogs: The net profit of the company grew by 378.8% YoY during the quarter on account of extraordinary growth in operating profits and reduced interest expenditure. Increased cash flow from operations has resulted in lower interest charges during the quarter.

Over the last few quarters: Over the last few quarters, it has been a volatile show on the margin front and is common for all cement companies. Cement realization started gaining pace in January 2006 and thereafter, there was no looking for cement manufacturers. We expect this trend to continue in the short-term.

Over the last few quarters 2Q06 3Q06 4Q06 1Q07 2Q07
Net profit amrgin 7.6% 4.0% 10.9% 23.1% 22.1%
EBITDA margin 20.9% 17.1% 22.3% 39.7% 38.9%

What to expect?
At Rs 3,490, the stock is trading at a price to earnings multiple of 20 times its trailing twelve month earnings. The company is setting up a cement plant in Tamil Nadu with a capacity of 2 MTPA at an estimated project cost of Rs 6.1 bn (just over Rs 3.0 bn per MT). It is also setting up additional clinkering facility in the state by installing a 4,000 TPD kiln to increase its production capacity by 2 MTPA at an estimated investment of Rs 4.4 bn. While this is a positive for the long-term, in the medium-term, this is expected to pressurize net margins, as interest and depreciation costs will increase. We expect cement prices to cool off by the middle of the next calendar year. Therefore, we believe that the risk-reward equation is skewed towards risks at the current juncture.

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