Shree Cement: Regional champ at reasonable value:: Elara

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Regional champ at reasonable value
Foray into merchant power to stabilize cyclical cement earnings
Shree Cement Limited (SCL) has ventured into the profitable merchant
power business. It has a CPP capacity of 265MW which is expected to
increase to 565MW by the end of Q3FY12. The company expects to
sell the excess power in the open market on merchant rates. On
account of the increase in the CPP capacity, we expect the EBITDA
from power business to increase from INR1.3bn in FY10 to INR4.4bn in
FY12. The share of the power EBITDA in the total EBITDA is expected
to increase from 8% in FY10 to ~30% in FY12. Apart from providing
earnings growth, we believe the merchant power business will
provide stability to the cyclical cement business cash flows.


Capacity addition to push up volume to CAGR of~ 5%
SCL is in the process of increasing its clinker and grinding capacity by
1mn tonne and 1.5mn tonnes respectively. The expansion is expected
to be complete by the end of FY11. The capacity addition is likely to
provide volume growth from FY12 for the cement business of the
company. Due to the capacity addition, we expect cement volumes to
increase at a CAGR of ~5% between FY10 to FY12.
Lowest cost producer, highest margin earner in North

Despite its dependence on pet coke, SCL enjoys a cost advantage over
peers due to its efficient operations and captive power unit. In
Q1FY11, it had cost of INR2,323/tonne as compared to
INR2,712/tonne for other North Indian cement players. Due to lower
production cost, SCL enjoys the highest margins in the Northern
region. The cement division of SCL had earned EBITDA margins of
31% as compared to ~17% of other cement players.

Strong cash flows to further fortify balance sheet
At the end of FY10, the company had a net debt equity ratio of 0.05x
and gross cash and investments of INR20 bn. We expect the company
to generate free cash flow to firm of INR 36.8bn over next two years.

Valuation
At the CMP of INR 2,165 per share, Shree Cement is trading at 19.2x
and 12.6x its FY11 and FY12 earnings, respectively. On an EV/tonne
basis, it is trading at USD98/tonne and USD82/tonne of its FY11
and FY12E capacities, respectively. Despite having a low cost
structure, diversified revenue stream and a healthy balance sheet,
the stock is trading at ~44% discount to frontline cement
companies. Thus, we have assigned Accumulate rating on the stock
with revised target price of INR 2,501 per share. We have valued
cement business of the company at USD100/tonne (equivalent to
replacement cost) and power division on DCF basis.