Stock Fundamentals

Why you should hold the stock of Shree Cements

Keerthi Sanagasetti | Updated on November 29, 2020 Published on November 29, 2020

Expansion plans in the East, where supply is in excess, and UAE operations are a concern

While the pandemic led to a drop in cement sale volumes in the initial months of lockdown, prices remained buoyant throughout the year, following a demand pick- up in the rural and semi-urban pockets. Order pipeline for infrastructure and construction companies has also demonstrated resilience, giving a further fillip to cement prices, which remained healthy even in the seasonally weak monsoon months.

Thanks to the uptick in pan-India cement prices and good operational performance of the cement manufacturers (through consistent cost savings), cement stocks have found favour with investors.

Shree Cements, a market leader, particularly in the Northern and Eastern segments, has rallied by more than 25 per cent since our last buy call in November 2019. At the current price, the stock trades at an enterprise value of 23 times its FY21 estimated EBITDA (EV/EBITDA).

This is at a premium to other major cement players that currently trade at an enterprise value of 8-16 times their estimated one year forward EBITDA. But the premium should be seen in the light of its cost advantage over peers in terms of power and energy costs, coupled with the company’s expansion plans in the pipeline.

We are confident on the earnings growth potential, following the company’s timely execution of its previous expansion projects in the past (since 2015). But its expansion plans in the Eastern region, which is already experiencing a drop in prices due to intense competition and supply glut, and the company’s plants in the UAE, which is witnessing a weakness in cement demand, remain a concern.

In the last three years, the stock’s enterprise value has been in the range of 20-26 times its one year forward EBITDA, indicating a limited upside from current levels. Investors in Shree Cements can hence continue to hold the stock.

 

Better-than-industry metrics

The stock has been enjoying premium valuations on account of better-than-industry metrics for quite some time. This is thanks to lower power cost (led by captive power plants of about 750 MW capacity, including Waste Heat Recovery System) and logistics cost (aided by centralised locations).

In the recent September quarter, Shree Cements reported a 12.4 per cent y-o-y drop in variable cost, owing to sharp cuts in employee cost, lower lead distance and existing stock of low-priced pet coke. In this period, while the company’s operating cost per tonne dropped to ₹3,046 per tonne, its peers reported operating cost in the range of ₹3,800 to ₹4,400 per tonne.

Despite a near-term increase in pet coke prices, the cost savings for the company are expected to continue in the coming quarters. This is because while pet coke prices surged by more than $10 (per tonne) since the September quarter, thermal coal is still priced 8-10 per cent lower than pet coke. Besides, the management has guided that the current run-rate of both freight cost and employee cost is here to stay.

The company has also beat its peers on volume numbers. In the September quarter, while the major players in the industry reported a 2-8 per cent uptick in sale volumes, Shree Cements’ volumes surged by 14.2 per cent y-o-y to 6.53 million tonnes. This was predominantly led by demand from rural and Tier 3 and Tier4 cities.

Growth story to continue

 

With an installed capacity (consolidated) of 40 million tonnes per annum (MTPA), Shree Cements enjoys about 24 per cent market share. The company’s sale volumes predominantly flow from the North (65-66 per cent) and East (about 25 per cent) regions, where demand, after seeing a rampant recovery post lockdown, is expected to remain healthy, on the back of upcoming infrastructure and affordable housing projects.

Another 8-9 per cent of the sale volumes for the company flow from the Southern region, where the plant utilisation has improved to 67 per cent in the September quarter, compared to 30-35 per cent in the year-ago period.

The company is now all set to increase its capacity to 57 MTPA ( mainly in the North and East regions) in the next three years and to 80 MTPA (in other regions as well) in 6-7 years. While two of its grinding units with 6 MTPA capacity in Odisha and Maharashtra are all set to commission in the third quarter of FY21 , another unit in Chhattisgarh (about 4 MTPA) is expected to be commissioned in another 18-20 months.

This, coupled with its limestone reserves (acquired through auctions) of 665.8 million tonnes — the highest in the industry —, could augur well for the company in the long term.

The management has hinted at an annual spend of ₹1,200- 1,400 crore worth of capex in FY21 and another ₹1,200 crore in FY22, based on the current expansion plans.

The company’s consolidated borrowings dropped to about ₹1,800 crore in the September quarter from ₹2,300 crore at the end of March quarter, thanks to healthy cash inflows. The balance sheet is, however, currently cash positive, considering its liquid assets (cash & bank balances and current investments) worth over ₹4,000 crore.

Price disparity a deterrent

A key risk for the company’s growth story lies in its expansion plans in the Eastern region, which is already experiencing a drop in prices due to intense competition and supply glut. Also, the company’s plants in the UAE (4MTPA installed capacity) are witnessing a weakness in demand due to weak economic conditions in the aftermath of muted oil prices. The UAE operations which currently contribute 7 per cent to the company’s consolidated revenues have reported losses since the March quarter. However, the company managed to cut its losses to ₹9 crore in the September 2020 quarter from ₹51 crore in March 2020 quarter. With weak demand even in the neighbouring countries, profitability for the UAE plants may remain muted in the near to medium term, acting as an overhang on the company’s consolidated earnings.

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Published on November 29, 2020
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