Shree Cement: Hold

Shree Cement's troubles with eroding profit margins became apparent in its March-2011 quarter numbers. Operating profits (before depreciation) had fallen 9 per cent, year-on-year, with power costs jumping 70 per cent. Reacting to the numbers and the choppy market conditions, the stock has lost 15 per cent of market capitalisation in the last three months.

Shareholders of Shree Cement may, nevertheless, stay invested for now, given the early signs of easing input costs as well as the increase in cement prices in 2011.

Crude oil has drifted from its peak of $127/barrel in April to $111/barrel now, down 13 per cent. Fuel costs, mainly of petcoke (petroleum coke), are likely to follow suit. Thermal coal, also a fuel used in kilns, is down 8 per cent in the last six months.

Moderating input prices apart, there is good news on the realisations front as well; the all-India average cement price stands at Rs 275/bag now, up 15 per cent since January. There has been a Rs 5-10/bag correction in price in the current month and is expected to revive, post-monsoon. In North India, the home market of Shree Cement, prices rule at Rs 265/bag now, rising from around Rs 215/bag in January. Shree Cement holds a 17 per cent share of the northern cement market.

At the current price of Rs 1,721, Shree Cement's stock is valued far cheaper than leading cement companies, including ACC and Ambuja Cements. The company trades at an enterprise value of Rs 5,600/tonne.

Cement: Outlook not bleak

With just three months over in the financial year 2011-12 and with the state elections dominating this period, government infrastructure activities haven't picked up pace. The allocation for rural and urban infrastructure development in 2011-12 is Rs 2.14 lakh crore. This is 23 per cent higher over last year's allocation. So, even if housing demand weakens on interest rate shocks, infrastructure demand can be expected to drive cement offtake.

On the price front, we expect manufacturers to hold up prices on production discipline. In the Northern markets, the excess supply of cement is not massive (around 20 million tonnes). By running at around 75 per cent capacity utilisation, companies can manage to keep prices up as they have demonstrated over the last one year.

Capacity additions may take place this year, albeit at a slower pace compared with last year. Rising cost of capital may leave manufacturers less willing to line up expansion plans at this point in time. Shree Cement has no cement-related capex in the near term. It recently added a grinding unit of 1.5 million tonnes per annum capacity and its total capacity stands at 13.5 million tonnes now.

In the March-2011 quarter, the company reported a 1 per cent increase in despatches at 25.7 lakh tonnes. Segment revenue was up 7 per cent, thanks to higher realisations. Operating margins (before depreciation), however, were down by 6 percentage points to 19 per cent on increase in fuel costs. Shree Cement imports almost its entire requirement for thermal coal and petcoke.

The company's total power and fuel expenses were 28 per cent of sales in the March quarter, up from 19 per cent in the same period last year. If weakness persists in crude oil price, price of petcoke as also other commodities may relent and offer relief to cement manufacturers.

Power: Not bright

Shree Cement, which ventured into power generation (for merchant sale) last year, has a capacity of 260 MW now. It is adding a further 300 MW over the next six months. In FY11, 20 per cent of Shree Cement's total revenue was contributed by its power segment.

The company sold a unit of power for Rs 4.50 (cost of production of a unit of power comes to around Rs 3/unit) in the March quarter and it was the best quarter of the year 2010-11. For the full year FY11, the segment, however, reported net loss of Rs 15.6 crore at the operating level. High cost of power manufacturing, on rally in price of imported coal, and lower tariff rates played spoilsport.

Merchant tariff rates will depend on whether the current supply deficits in power last over the medium term. Rates have fallen from a peak of Rs 7-8/unit last year to around Rs 4/unit now. And going ahead too, there may not be a sharp run-up in merchant tariffs, given that power producers have, over the last year, ramped up capacity significantly.

For the 300 MW of capacity addition the company would spend around Rs 400 crore over the next six months (it spent around Rs 800 crore in the last fiscal). Shree Cement is comfortably placed to fund this with cash of Rs 460.8 crore and a debt-to-equity ratio of 1.01 times as of end-March 2011.

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