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Shree Cement: Scaling costs squeeze margins! - Views on News from Equitymaster

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Shree Cement: Scaling costs squeeze margins!
Nov 7, 2007

Performance summary
  • Topline grows 48% YoY largely led by over 10% YoY growth in realisations.
  • The operating costs continue to grow at a faster rate compared to topline growth, resulting into 2.1% contraction in EBITDA margins.

  • Subdued operating profit growth, increased depreciation and finance charges pressurise net margin, which has expanded by merely 1.8%.

  • If one excludes other income, net margins have actually contracted by 6.8% YoY.

Financial performance snapshot
(Rs m) 2QFY07 2QFY08 Change 1HFY07 1HFY08 Change
Net sales 3,160 4,664 47.6% 6,244 8,922 42.9%
Expenditure 1,733 2,652 53.0% 3,442 5,088 47.8%
Operating profit (EBITDA) 1,427 2,011 41.0% 2,802 3,835 36.9%
EBITDA margin 45.2% 43.1%   44.9% 43.0%  
Other income 43 291 579.3% 73 417 471.2%
Interest 27 85 213.3% 81 124 53.2%
Depreciation 338 688 103.2% 601 1,046 73.9%
Profit before tax/(loss) 1,104 1,530 38.6% 2,193 3,083 40.6%
Tax 326 468 43.4% 511 851 66.6%
Profit after tax/(loss) 778 1,062 36.6% 1,682 2,231 32.7%
Net margin 24.6% 22.8%   26.9% 25.0%  
No of shares (m)       35 35  
Diluted EPS (Rs)*         70.3  
P/E (times)         20.0  
*trailing twelve month earnings

What is the company's business?
Shree Cement, promoted by Bangur group is North India’s largest cement producer with installed capacity of almost 6 MT. The company, apart from being an efficient cement manufacturer, is the market leader in the north, with a market share of 16% within the region. It is also one amongst the least cost producer in India and is self sufficient in meeting power requirement. Riding on the back of rise in demand, improved realisations and reduction in interest outgo, the company has been able to improve its overall performance. With the improvement in the financial position, the company plans to increase its capacity to 9MTPA by the end of 2008.

What has driven performance in 2QFY08?
Firm realisations, robust demand: On account of robust demand and favourable pricing scenario, the company continued to report strong numbers for the quarter and half year ended September 2007. In 2QFY08, North India witnessed 11.4% YoY growth in demand. Shree Cement being one of the major players in northern region has benefited from the same. The topline grew by almost 48% YoY largely led by over 10% YoY growth in realisations. The same has been the reason for 43% YoY growth in topline for 1HFY08.

Scaling cost shrunk margins: The operating costs continue to grow at a faster rate compared to topline growth, thus impacting the EBITDA margins. Once again, rising freight charges and power costs squeeze operating margins. The power & fuel costs and transportation & handling charges as a percentage of sales basis have increased by 2% and 2.8 % in 2QFY08 resulting into 2.1% contraction in EBITDA margins. Rising freight charges has been a fallout effect of transporters increasing freight rates on the back of rising liquid fuel prices. Coal is a key input required for cement production and accounts for 15% to 20% of the total operating cost. Though company utilises low cost pet coke, it reported subdued operating profit growth on account of rising pet coke prices. The pet coke price per tonne has increased by nearly Rs 175 only to settle at Rs 4,025 per tonne. Though in recent quarters the company has witnessed power cost pressure, going forward, it will be in a position to save power costs with the commissioning of captive power plant.

Cost break-up
(as a % of net sales) 2QFY07 2QFY08 1HFY07 1HFY08
Increase / Decrease in stock 0.3% -2.4% 0.8% -2.1%
Raw material consumed 11.5% 11.0% 11.5% 11.5%
Purchase of traded goods 0.6% 0.3% 0.5% 0.3%
Staff costs 3.7% 3.5% 3.7% 3.5%
Power & Fuel 16.9% 18.9% 16.1% 19.1%
Transportation & handling 12.3% 15.1% 13.3% 14.9%
Other expenditure 9.6% 10.5% 9.2% 9.8%

Other income boost: The growth in net margins has not maintained pace with operating profit growth as the depreciation and finance charges have increased significantly during the 2QFY08. The company has recently raised debt to fund its capital investment plans as it plans to increase its total capacity to 9 MT by the end of FY09. Had not the company witnessed six-fold growth in other income the net profits would have grown by merely 5% resulting into 6.8% contraction in net margins.

During 2QFY08, on account of sale of CERs (certified emission reductions or carbon credits) the company has accrued Rs 160 m. The same has been included in other income. The company has the option to sale CERs by July 2010, and hence such income will keep accruing periodically till FY11 giving a boost to net margins.

What to expect?
At the current price of Rs 1,405, the stock is trading at an expensive valuation of over US$ 200 on the enterprise value per tonne (EV/tonne) basis as per FY07 numbers.

On the demand front, we expect the northern region to grow in line with the industry. North India is expected to witness demand growth rate of over 7%, driven in part by the forthcoming Commonwealth games, which will result in increased spending on infrastructure by the government. However, with the growth in the sector and waning demand supply gap, producers have lined up capacity expansion plans either by brownfield or greenfield expansion route.

We recommend investors to exercise caution on the valuations front as in the future the current level of high realisations may not be sustainable. Once the large stream of new capacities become operational by the end of 2008, the increased supply is likely to impose pressure on the cement prices.

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