Buy Shree Cement: 3QFY11: Top Picks: Ambit

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Shree Cement - Power Diversification To Drive Growth
Shree Cement (SRCM) is a north-India based manufacturer with 13mn
mt of cement capacity (Dec 2010). It has the largest market share, 18%
(similar to Ambuja Cement) in the north. We expect demand CAGR in
this region to be 10% in FY11-13 (9% CAGR in FY05-10).

SRCM has captive power of 265MW and has been selling its surplus
power since FY09. It is adding a further 300MW of merchant power in
1HFY12, and this should increase Power sales’ share of total EBITDA
from 5% in FY10 to 34% in FY12. This in turn should help SRCM
overcome the negative impact of declining cement profitability in
FY11-12.
Key Investment Drivers
 Power sales to bolster profits from FY12: We expect timely
commissioning of 300MW of merchant power capacity in Rajasthan by
1HFY12 to augment SRCM’s surplus power capacity to ~400MW in FY12.
Subsequently, the share of power sales in EBITDA should surge from 5% in
FY10 to 32% over FY12-13. As operating margin (OPM) for the power
sales is expected to remain stable at ~40% (compared to 25% OPM for the
cement business), the increased share of power sales should help the
blended operating margin to firm up from FY12 onwards (FY10 – 41%,
FY11E – 26%, FY12E – 28%).
 Cement sales volume CAGR of 7.3% during FY11-13E: SRCM’s
cement and clinker sales volume should grow at 7% CAGR during FY11-
13 on account of incremental 4mn mt of cement capacity being
commissioned in CY10. We expect lower cement realisation and higher
fuel costs to result in a 40% YoY decline in EBITDA/mt in FY11 to Rs836,
and by another 4% YoY in FY12E. However, fresh power sales should
moderate this adverse impact and the blended operating margin should
recover by 200bps in FY12E.
 Strong cash flow to fully support ongoing capex: Operating cash flow
of Rs32bn over FY10-12E should help SRCM finance its capex requirement
of Rs26bn related to the cement and power businesses and should help
the company turn net cash positive by FY12E.
Valuation, Recommendation and Outlook
Our DCF-based valuation model suggests a fair value of Rs2,643 for the stock,
implying 35% upside from current levels. With a 1.6x P/B valuation of
Rs774/share for the power business, the target price values the cement
business at 6.5x its FY12 EBITDA and at an EV/mt of US$102. These valuations
are in line with other regional Indian companies of comparable size and at a
~25% discount to the pan-India cement majors.
We expect cement prices to remain volatile over the next nine months as
incremental capacity addition should keep price increase under check.


Shree Cement is the largest cement manufacturer in
northern India with total cement capacity of 12mn mt
and captive power capacity of 265MW.
It is promoted by Kolkata-based industrialists, Mr. P.D.
Bangur and Mr. B.G. Bangur. The promoter group
currently owns 65.6% in the company with Mr. B.G.
Bangur as the executive chairman.
Shree Cement is adding a 1mn mt cement grinding unit
in Jaipur, Rajasthan by December 2010 and up to
300MW of thermal power plants (to be sold as
merchant power) in Rajasthan by 1HFY12.