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Shree Cement
OUTPERFORM (unchanged) Price target: Rs2,719
Summary
In 2Q FY11, Shree Cement’s revenue fell 21.1% yoy and net profit dropped 96.4% yoy. Lower realisation coupled
with high raw material and power and fuel costs were responsible for the weak performance. Given the weakness in
the power segment, we cut FY11 earnings estimate by 3.2%. However we maintain the FY12 earnings estimate as
company has indicated its willingness to go for contract sales of power in FY12, where the prices are stable.
Reiterate OUTPERFORM.
Results: key points
Revenue declines 21.1% yoy – Total income declined 21.1% yoy and 24.0% qoq to Rs7.18bn,
mainly due to a 24.2% fall in realisation. The excess capacity in the industry coupled with 0.18m
tonnes of clinker sales was the reason for the fall in realisation. Moreover, in the power segment,
too, there was 21.4% yoy drop in volume to 50.3m units.
High costs further subdued the performance – Raw material cost per ton rose 62.9% yoy and
power and fuel costs per ton were up 24.4% yoy. Moreover, staff costs, too, went up 35.7% yoy.
These increases resulted in EBITDA per ton decreasing 67.2% yoy and 48.1% qoq. Moreover,
because of its accounting policies, the company recorded higher depreciation at Rs1,285m (up
28.8% yoy).
Power business has still not recovered – Shree Cement’s power business was also weak
compared with last year. External sales were approximately Rs200m with EBITDA of Rs60m. If
we include inter segment sales also, revenue was down 41.6% yoy and the segment made
losses at the EBIT level.
Because of the cost and low spot prices, Shree Cement faced margin pressure in the power
business. In the past 4-5 months, power prices have remained subdued and have still not
recovered.
At current power prices, Shree Cement will not be able to make money by selling in the sport
market as fuel costs alone at Rs2.3/kWhr will be near the spot power prices.
Shree Cement’s power expansion project is progressing according to schedule and will be
commissioned in 1Q FY12.
We cut our FY11 EBIDTA estimates by Rs1.24bn…
We cut our power volume sales estimate for FY11 from 1.2bn units to 0.55bn units given that it
has only sold 0.2bn units in the first half and given the fact that at the current low power prices it
is unlikely that Shree will run its power plant at full capacity.
We have, however, maintained our earnings estimate for FY12 as the company is in negotiations
with buyers for contract sales. Please note that contract prices have still not collapsed to the spot
level and the three-month contract price is still at Rs4/kWh. According to our estimates, Shree
Cement will have surplus 2.8bn units in FY12 and we have taken power realisations at
Rs3.5/kWh, which is well below current contract prices.
Cement pricing environment
The key reason for the fall in EBITDA for all the leading cement players has been the bad pricing
environment in 2Q FY11. However, prices have started to rise from mid September. The graph
below gives the retail pricing in the Northern region.
The demand scenario:
In October 2010, industry leaders recorded strong growth. The top six players, who have around
52% market share, grew at 26%. This makes us believe that Industry growth will be around 18-
20% in October 2010. With 20% growth in October and adjusting for despatches of Bharti
Cement and Murali Agro, the YTD dispatch growth for the Industry is likely to be 7.9%.
The first week of November has not been that great for cement companies primarily because of
the festival season-lead lull in construction activity. Labour shortage is also dampening volume
growth. With the end of the festival season round the corner, we believe that volume will pick up
in the coming weeks.
Recommendation and valuation
We value Shree Cement at Rs2,719/sh, which translates into 15.2x FY12E earnings and 4.0x
FY12E EV/EBITDA. We think that near-term power issues will be sorted out once the company
negotiates contract sales. We reiterate OUTPERFORM.
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