Madras Cements: Buy

Over the next two quarters, even if demand is flat, higher realisation and a low base effect should aid bottom-line growth for the company.



With higher realisations pointing to better earnings, investors can buy the stock of Madras Cements, a leading cement manufacturer in the South. Over the next two quarters, even if demand is flat, higher realisation and a low base effect should aid bottom-line growth for the company. Currently, cement price is at Rs 305/bag in southern India, higher by Rs 40-45 over last year.

This provides cushion to margins against the increased fuel and power cost. Cement price in the southern markets should hold steady at present levels, given the players' proven pricing power in the market.

In the recent September quarter, Madras Cements reported 28 per cent sales growth and net profit more than tripled despite despatches not growing from the same quarter last year.

The company has been diverting despatches intended for Andhra Pradesh (prices are lower in the State compared with the region's average) to Tamil Nadu and Karnataka markets and gaining on higher realisations in these markets.

At the current price of Rs 105, the stock discounts its trailing one-year earningsby 7.8 times, slightly lower than that of its close competitor, India Cements.

Profit driven by realisation

Though cement demand has improved in the northern markets of the country, it is still muted in the south. The revival in Andhra Pradesh — the largest cement consuming state of the region — has not been significant. However, the sluggish demand scenario in the South is offset by firm price realisations for cement makers. . From Rs 220/bag in August last year, cement price has risen to Rs 300-305/bag now.

A close to 35 per cent increase in realisation has helped players of the region, including Madras Cements, post strong sales and PAT growth. For the six months ending September 2011, Madras Cements reported a sales growth of 18 per cent and net profit doubled. Higher realisation has not only compensated for drop in sales volumes but also offset the higher input costs.

Madras Cements imports nearly 55 per cent of its coal requirement and in the last one year, coal price in dollar terms has gone up 31 per cent (to $123/tonne in September). However, , the company's operating margins have improved.

In the September quarter, the operating margin (before interest, depreciation and tax) was 33.75 per cent, higher than 18.29 per cent reported in the September 2010 quarter and 32.74 per cent reported in the June 2011 quarter.

The savings in costs seem to be a result of the company's 100 per cent captive power capacity with commissioning of 40 MW thermal power plant in Ariyalur recently (total thermal power capacity currently is 150 MW). The company is also building a new thermal plant of capacity of 25 MW in its facility at R.R. Nagar.

Thermal coal prices are down from highs to $119/tonne now. But the rupee's sharp depreciation against the dollar over the last couple of months could offset benefits on this front. That said, if cement prices remain stable at current levels, there may not be much impact on operating margins.

Given that demand in the southern markets is likely to go up, cement prices may not correct.

Also, the low base of cement price in the last year will help the company post strong numbers in the coming quarters — in the December 2010 quarter, cement price was around Rs 265/bag while in the March-2011 quarter it was around Rs 260/ bag.

Equipped to face higher demand

Madras Cements' manufacturing capacity is 12 million tonnes per annum. The capacity utilisation is 70 per cent, which is higher compared to the regions' average of 60 per cent. With extended rains in the south, though demand is lacklustre at present, it is likely to improve from January.

Cement demand may see some boost from the metro rail project in Tamil Nadu and housing projects in Karnataka and Kerala. When demand picks up, Madras Cements will be in a good position to cater, with the company having added new grinding units and powered completely by captive power plants.

Thanks to increased capex activities over the last year, the company's outstanding loans have increased by 8 per cent during the period to Rs 2,886.5 crore now. However, its debt-to-equity stands at a still reasonable 1.5 and interest cover is also comfortable at five times. The risk to our recommendation is a sharp decrease in demand from current levels and correction in cement price to below Rs 250/bag levels.

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