Kotak Securities: BUY rating on Shree Cement; target price of Rs2,400

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Leveraged to petcoke? We recently met the management of Shree Cement to get a
better perspective of their evolving business structure. The company is investing
progressively to build a sizeable power portfolio and faces risks to earnings from higher
pet coke prices—coke is currently is the key fuel source for Shree Cement’s cement and
power businesses. We reiterate our BUY rating on SRCM with a revised target price of
Rs2,400/share taking cognizance of the increase in petcoke prices.


Pet coke prices raise concerns, but technology investments offer flexibility
The recent spike in pet coke prices has raised concerns on the fuel security for SRCM given its
increased dependence on the fuel for the expanded power capacities. We note that while rising
prices of fuel do not augur well for earnings of SRCM, investment in CFB boilers give SRCM the
flexibility to switch to alternative fuels (see Exhibit 7). We concede that dependence on marketprice
for both fuel and power tariffs increases the risk to earnings, however, we like SRCM’s
strategy of investing in power capacities to (1) de-risk the earnings from the cyclical nature of the
cement business, (2) capitalize on tax benefits available to captive power plants, and (3) benefit
from lucrative merchant tariffs in the short-term market,.
In this note, we discuss the economics of pet coke versus other fuels in detail. We note that 5%
higher pet coke prices in FY2011E could impact SRCM’s valuation by ~7% (See Exhibit 2).
Capacity addition targets on track, capex of Rs12 bn incurred in FY2010
SRCM has incurred a capex of Rs12 bn in FY2010 (Rs5.4 bn in FY2009), out of which, Rs6.1 bn
was spent on power capacities while the balance Rs5.7 bn was spent on cement business. We
believe power will continue to drive the near-term capex of SRCM as the company plans to add
another 350 MW by end-FY2012E. During the year, SRCM added ~90 MW of generating capacity
including a 46 MW of waste heat recovery plant. SRCM also commissioned 2 grinding units
aggregating 3 mtpa during FY2010, taking its total installed cement capacity to 10.2 mtpa.
Maintain BUY with a target price of Rs2,400/share
We reiterate our BUY rating on SRCM with a revised target price of Rs2,400 (previously Rs2,550)
as we take into account higher pet coke prices. We rate SRCM as one of our preferred picks in the
cement sector as we believe that current valuations are much below the replacement cost. Our
SOTP based valuation includes (1) Rs2,066/share for cement business based on 5.5X FY2012E
EBITDA and (2) Rs334/share for external power sales based on March 2012 based DCF to equity.
We note that CMP implies an EV/EBITDA of 4.6X on FY2012E cement EBITDA. Our valuations do
not include the proposed 300 MW capacity, which could further add ~Rs170/share to our target
price.