The Hindu Business Line : Prism Cement: Sell

In the backdrop of excess supplies, declining prices and higher input costs, North-based cement players have seen their realisations and margins eroding in recent times. Though a cost-efficient player, Prism Cement has reported disappointing numbers for the September quarter.

The absence of newly commissioned capacities unlike its peers, intense competition in its target markets and higher input costs have sharply undermined sales and profit growth. Though the correction has trimmed Prism’s valuation and prices to rock-bottom levels, frontline cement companies may have a greater prospect of recovery, given the uncertain macro environment.

This suggests that investors in the mid-sized player may be better off paring their exposures in the stock and switching to frontline peers.

The Slowing North

Total cement production in the northern region rose 33 per cent from 17.4 million tonnes in April-August 2007 to 23.2 million tonnes this year. However, the increase in consumption in the same period was only 1.2 per cent. Competition in the northern market intensified as capacities added early this year by UltraTech Cement (3.3 million tonnes), Grasim Industries (3.3 million tonnes) and Shree Cement (1 million tonne) found their way into the market, forcing down capacity utilisation rates for existing players.

Prism Cement’s sales for the quarter ending September 2008 were down by 15.7 per cent on lower despatches, probably impacted by higher supplies from competitors in this region. Muted demand also saw cement prices in the northern markets soften by Rs 3-4 per bag over the June-September period.

Prism’s cement and clinker despatches were down by 1.5 per cent and 48 per cent respectively for the quarter, as the market remained swamped by supplies. With realisations trending lower, profits have also started declining. With ramping up of capacities by players like ACC, and competition to retain market share, a further softening in prices cannot be ruled out.

Margin worries

While volumes have been under pressure, Prism Cement’s September quarter results also showed a major setback to profit margins. An over 33 per cent increase in power and fuel cost and higher annual maintenance charges, led to the company’s net profit sliding by 71 per cent in the September quarter.

Though the net profits were also impacted by higher expenses on annual plant shut down, this accounted only for a small portion of the fall in margins.

The company now enjoys a zero debt status, any future borrowings to fund capacity expansion (likely to be commissioned by August 2010), could peg up interest costs. Being a player concentrated in North and Central India, Uttar Pradesh, Madhya Pradesh and Bihar (the newly commissioned capacity will mark a foray into Andhra Pradesh), it has the disadvantage of being centred in one region, where competition is high.

After touching a high of Rs 40 after our recommendation at Rs 34 per share in June, Prism Cement’s stock has undergone a 50 per cent correction, sharply underperforming the markets.

With a change in industry fundamentals and higher risks in the company’s region of operation, the profit outlook is weak for the coming quarters, capping upsides from the stock’s current price. But for investors with a really long-term perspective (over five years), others can shift to bigger peers such as ACC and Grasim Industries that have a volume advantage, to tide over these challenging times.