The Hindu Business Line : Dalmia Cement: Book profits

SHAREHOLDERS of Dalmia Cement could reduce exposure in the stock to take advantage of the sharp rise in the price; the stock has doubled over the past three months and may settle at a slightly higher level once it starts to trade on an ex-stock split basis.

That may be an appropriate time to cut exposures partially by selling half theholdings. Investors could switch to Madras Cements, which could deliver superior value over the next couple of years. As a fundamentally sound-play, the Dalmia Cement stock should be monitored to re-enter it at a lower level and/or at a later date.

We have a positive view on the company's track record; but a doubling of debt, higher financial charges and pressures on profitability, as the demand-supply balance in the Tamil Nadu and Kerala markets could be affected when its new capacity go on stream, are factors that could weigh on earnings growth in 2006 and 2007.

Dalmia Cement is close to completing an expansion project that would raise its capacity by 2-million tonnes to about 3.5 million tonnes. The company, as is its wont, is going through the debt route to bankroll the expansion. This explains the spurt in the debt levels over the past 12 months and a further expansion may be on the cards, as the project gets completed.

This project is a positive from a long-term perspective though it could dampen earnings growth the next couple of years. Dalmia Cement has for several years now stretched its modest capacity and consistently operated at full utilisation levels.

This has helped it show healthy profits over the past decade. Capacity constraint has, however, capped growth prospects and the current expansion will remove that bottleneck. It has also been completed at a competitive cost that should confer advantages over the longer term.

The company is likely to only gradually step up capacity utilisation, as otherwise it could have a detrimental impact on prices. This assumes importance because the demand-supply balance is not likely to favour producers for a few more years in the southern markets.

Discipline on the capacity utilisation levels will be a key factor in sustaining the higher price levels that producers now enjoy in this market. If there is any slippage on this front, all the producers will be affected.

Even as Dalmia Cement gets set to step up, over two/three years, the utilisation levels on expanded capacities, a few factors will influence its performance:

Over the next 18 months, its sugar division is likely to make a healthy contribution to earnings. Sugar prices are expected remain firm during this period and this augurs well for the company.

Its ability to curtail losses in its other businesses — none of which is significant by itself — would be critical; in the past the other businesses have been a drag on the company's performance.

The completion of a power facility is likely to lead to lower costs in the cement business. Dalmia Cement is also likely to be relatively less affected by the rise in energy and transportation costs, as its markets are proximate geographies to its manufacturing facility.

The stock trades at a price-earnings multiple of about 15 times its likely per-share earnings for FY 06. This does not appear rich; but the room for expansion of valuation may be limited over the next couple of years. We have buy recommendations on the stock at prices from Rs 160 to Rs 280 and the concerns outlined temper our view of the stock now.

Any exercise to cut debt by fund mobilisation through fresh equity issuance — a course the company has not adopted for over two decades — will be a positive; but any such proposal will come as a pleasant surprise and in our view, the odds on Dalmia Cement embarking on such a course are low.

In such a delicately poised market, Madras Cements may be a superior option, as its expansion plans are complete and it is also well on its way to reducing its debt.

The risk to our recommendation is a hostile bid by any of the majors as part of the consolidation process; the diversified nature of Dalmia Cement does, however, temper this risk to a large extent.

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