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Shree Cement: Find out what’s in the bag… - Views on News from Equitymaster

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Shree Cement: Find out what’s in the bag…
Dec 4, 2007

The booming demand for cement, both in India and abroad, has attracted global majors to India. Demand has been driven by a booming housing sector and increased activity in infrastructure development such as state and national highways. Multinational cement companies have been aggressively picking up stakes in large Indian cement companies. The improved realisations and the growth prospects of the industry have been enticing global majors. Cement industry has witnessed all time high realisations in past few quarters on account of demand running neck to neck with supply. In short to medium term the cement prices are expected to remain firm as the bulk of the lined-up capacity expansion will come on stream in FY09.

Cement industry tracks the GDP growth rate. To put it in another way, the sector grows at 1.2 to 1.3 times the GDP growth rate. It is thus expected that cement industry will continue to grow at compounded annual rate of 8% to 10% in next five years. Given the need for infrastructure such as roads, ports etc to support the growth of the economy the demand is only expected to rise in future. The booming real estate, construction, retail sectors and the governments’ attempt to erase the power deficits will continue to drive the demand for the commodity.

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. Shree Cement is a major player in the northern region and one amongst the least cost producers. When compared to Ambuja Cement, which is considered the least cost producer, Shree Cement fares well on cost front. The cost per tonne of production in FY07 for the company at stood Rs 1,576, while for Ambuja Cements the cost of production per tonne stood at RS 1,881. This indicates that it is one of the most profitable companies within the sector. However, one must note that going forward, the company needs to de risk its revenues geographically, to maintain its current positions of being the least cost and most profitable cement producer. The company is foraying into southern markets as a move to derisk revenues, however, considering the reach of heavyweights such as ACC, Gujarat Ambuja and Grasim industries, the company needs to further expand its reach.

While we are positive on the sector, what is concerning us is the fact that current high realisations will not sustain once the capacities start flowing in starting 2008. With huge capex plans already under various phases of implementation, the industry may see some supply glut from 2HFY09. And with this the all time high 30%+ EBITDA margins will get eroded impacting returns to share holders.

Further, the fact that the current valuation levels already seem to have factored in the medium term growth prospects in the sector is a matter of concern. At the current juncture, we believe that the valuations of most of the stocks are stretched on an EV per tonne valuation basis. Hence caution needs to be exercised.

  • To read our view on Shree Cement, please click here.

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