Sunday, February 03, 2008
- "You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right."
Investing and Emotions
- "Individuals who cannot master their emotions are ill-suited to profit from the investment process."
- "Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble...to give way to hope, fear and greed."
Sense of Humour
- Warren Buffett, story from Benjamin Graham: A story that was passed down from Ben Graham illustrates the lemminglike behavior of the crowd: "Let me tell you the story of the oil prospector who met St. Peter at the Pearly Gates. When told his occupation, St. Peter said, “Oh, I’m really sorry. You seem to meet all the tests to get into heaven. But we’ve got a terrible problem. See that pen over there? That’s where we keep the oil prospectors waiting to get into heaven. And it’s filled—we haven’t got room for even one more.” The oil prospector thought for a minute and said, “Would you mind if I just said four words to those folks?” “I can’t see any harm in that,” said St. Pete. So the old-timer cupped his hands and yelled out, “Oil discovered in hell!” Immediately, the oil prospectors wrenched the lock off the door of the pen and out they flew, flapping their wings as hard as they could for the lower regions. “You know, that’s a pretty good trick,” St. Pete said. “Move in. The place is yours. You’ve got plenty of room.” The old fellow scratched his head and said, “No. If you don’t mind, I think I’ll go along with the rest of ’em. There may be some truth to that rumor after all."
Reliance Power 450 150 to 160
Emaar MGF 540 to 630 45 to 50
J. Kumar Infraprojects 110 Discount
Cords Cable Ind. 135 5 to 8
KNR Construction 170 Discount
Onmobile Global 440 20 to 25
Bang Overseas 207 20 to 25
Shriram EPC 290 to 330 Discount
IRB Infra 185 to 220 70 to 75
Wockhardt Hospital 225 to 260 Discount
Manjushree Extrusion 45 2 to 3
Tulsi Extrusions 80 to 85 9 to 11
SVEC Construction 85 to 95 8 to 10
In the next two years, invest in leading companies in key sectors and buy more when prices fall further.
Through much of 2006 and 2007, Indian markets traded above fair-value. We saw a fine example of reflexivity as traders profited from riding a strong uptrend and reinforced it further by taking long positions. In the past fortnight, we've seen the opposite effect. Once the sell off started, the downtrend was reinforced by margin calls.
The casual retail trader and the less committed Foreign Institutional Investors (FIIs) have been blasted out in the past 10-15 sessions. So have highly-leveraged operators. Only committed investors with deep pockets and traders who are prepared to go selectively short are now left in the game.
The entire cycle of fluctuation was prompted by changes in liquidity. We now have some clarity about policy trends in US and Indian interest rates. It can be summed up thus. The US is likely to continue cutting rates. The RBI is not, though rupee rates could soften a little anyhow.
A look at India's credit-deposit ratios and the liquidity in the banking system suggests that there is room for banks to cut commercial rates even though the RBI has chosen not to touch policy rates.
The incremental credit-deposit ratio is down to 0.65 from 0.95 a year ago. Deposits are growing at over 25 per cent and the recent market sell off is likely to bring more money back to banks. Credit is now growing at about 22-23 per cent, which is much lower than the 29-30 per cent logged in the past two fiscals.
Eventually, FII funding will also come back into the Indian market as the spread between US and Indian rates widens and the rupee strengthens. But this will be a slow process because most FIIs have taken mind-boggling losses speculating in subprime mortgages.
It's a good time to take a broad look at fundamentals. At current levels, the Nifty is valued at a price earning (PE) of 21-plus. That is still on the rich side. It means that long-term investors will be selective, even if they are optimistic about growth.
On the EPS front, the Nifty basket is likely to produce about 20 per cent growth in the second half of 2007-08. Assume first-half 2008-09 earning per share (EPS) will also grow at about 20 per cent. That means a PE ratio of up to 20 or so is acceptable for the optimistic growth investor, if we assume a fair-value price earning growth PEG of 1.
The 364-Day T-Bill is currently trading at around 7.4 per cent – that translates into the equivalent of a PE ratio of about 14 in terms of earnings yield. A value investor would therefore, be seeking stocks trading at below 14 PE.
While GDP continues to grow at excellent rates, there has been a slow down in consumer demand – much of the growth is driven by investment rather than consumer demand. Auto/ two-wheeler sales are flat and home loans are slow. Manufacturing capacities are tight and capacity expansions will take a while.
We have already seen tacit recognition of changes in the consumption-investment mix as infrastructure industries have jumped while consumer-driven industries have dipped. That trend could be accentuated through 2008. In fact, we could say that the consumption driven segment of the economy is going through a cyclical downturn.
Now, quite apart from the subprime turmoil, 2008 and 2009 are likely to see violent market fluctuations because of geo-politics. A new US president must cope with a toxic legacy. It's also unlikely that the UPA will get a walkover in the next general election. Both events will cause volatility.
Whatever you buy, it makes sense to modify investment methods in this context.
You should try to use those price dips to keep adding to a core portfolio. Say, for example, pick market leaders across 10 key industries and add to these holdings whenever the price is ok.
You cannot time the market but you can put a war-chest together for specific political events that are guaranteed to cause fluctuations.
The US election, for example, will take place in November 2008. The Lok Sabha elections will be whenever. Sometime during both events, there should be a temporary crash.
If you can invest a larger portion of corpus at those times, your net costs will be lower. As to time-frames, this should be money that can be left invested till at least the second half of 2009-10.
Investors can refrain from subscribing to the initial public offer of Wockhardt Hospitals being made at a price band of Rs 220-260 per share (revised).
Even at the revised offer price, the offer appears expensively valued vis-À-vis sector leader, Apollo Hospitals.
Wockhardt Hospitals is the fourth largest player in the Indian healthcare sector with a presence in western, southern and eastern India.
It plans to scale up its operations to 3,500 beds by 2010, from around 1,400 currently.
Wockhardt Hospitals focusses on tertiary care clinical areas such as cardiology and cardiac surgery, orthopaedics, neurology, urology, nephrology, critical care and minimally invasive surgery.
Wockhardt’s current earnings rely significantly on three out of its total of 15 facilities (one hospital in Mumbai and two in Bangalore contributed 69 per cent of income in nine months of FY-07).
Overall, the occupancy rates are at about 57 per cent; with occupancy at some of the facilities set up over the last couple of years yet to pick up to healthy levels.
With the company in a heavy investment phase, investors should expect lower profit realisations and relatively low return on capital in the initial years (7.5 per cent in nine months ended December 2007).
With the reduction in the size of this offer (from Rs 778 crore to Rs 652 crore at the higher end of price band) and aggressive plans to ramp up capacities over the next few years, further debt or equity offerings to raise more capital cannot be ruled out.
At end of December 2007, the company’s internal accruals stood at Rs 10 crore, which cannot make up for the shortfall.
Wockhardt Hospitals’ current earnings are relatively small; translating into per share earnings of Rs 0.9 (on post-offer equity base) for the nine months of FY2008 ended December 31, 2007.
It currently owns/operates 15 hospitals (1,400 beds), having invested Rs 370 crore in capex in recent years. Plans are afoot to add another 2,127 beds through six brownfield hospitals (operated/managed by company or group companies on long-term agreements with original infrastructure owners) by end-2008 and four greenfield (to be entirely built by company) by end-2009.
Two-thirds of the net IPO proceeds, after deducting issue expenses and corporate purposes, will be used to construct and expand these 10 hospitals.
The remaining sum may be used to prepay short-term loans. Such prepayment, if it materialises, could significantly reduce the high leverage in the balance-sheet (debt-equity ratio, including short-term debt, may be significantly reduced from 3.8 currently).
Wockhardt Hospitals’ network spans ten super-specialty and five regional specialty intensive care unit (ICU) hospitals with an 18 year track record and expertise in minimally invasive surgery (up to 10 per cent of surgical operations performed in FY07).
Wockhardt plans to leverage on these to reduce average length of stay (the turnaround time, which is crucial to realisations) and maintain revenues per bed of Rs 24 lakh per year.
Wockhardt’s strategy revolves around garnering in-patient revenues by focussing on areas such as secondary care and advanced tertiary care; both of which have strong growth prospects and potential for high margins. Personnel being critical to hospital business, attrition is a key risk.
However, Wockhardt Hospitals claims a 99 per cent retention rate (last 12 months) for its workforce of 160 full-time specialists. The attrition rate was 20 per cent for resident doctors.
With operating margins of 20.8 per cent in the last nine months, the company’s margins are among the highest in the listed hospital space.
The company’s ability to ramp up occupancy would be crucial to prospects, as it has greater dependence on its core in-patient business (75 per cent of revenues) for revenue than peers such as Apollo, which has a pharmacy and medical BPO business as well.)
Going forward, a higher reliance on brownfield expansion may provide some relief as brownfield hospitals are typically asset-light and allow a quicker payback period, provided occupancy rates are healthy. Litigation risks to seven of the present and proposed facilities also exist.
The company’s valuation at an enterprise value (EV) multiple of about 44 times its estimated FY-08 EBITDA (earnings before interest, tax, depreciation and amortisation) appears expensive. Apollo Hospitals, with 7,000 beds under operation and a more diversified profile, commands an EV/EBITDA multiple of around 20 times on FY-08 earnings while Fortis Healthcare enjoys around 42 times.
While Apollo enjoys strong brand equity, Wockhardt Hospitals also enjoys reasonable recognition in regions where it has been in operation for more than 8-10 years.
Given that the company is foraying into Tier-II cities (Madgaon, Nasik, Ludhiana, Jabalpur, Bhavnagar) packaging and pricing may be more important than the brand.
Taking into account the long gestation period in the hospital business and prospects for steady, rather than spectacular growth in earnings, the asking price for the offer appears stiff. It also does not offer any comfort on execution-related risks.
All IPO Reviews Via Businessline
Investors can consider applying to the initial public offer of real-estate company, Emaar MGF Land (EMGF), but should retain at least a three-year perspective. The company’s shares are on offer from February 1-8 at a price band of Rs 540-630 (revised).
Backed by a strong promoter with a global presence, EMGF has swiftly accumulated a solid land bank in India and has demonstrated its marketing abilities through strong demand for its recently launched residential projects. In its targeted pan-India presence and ambitious plans across segments, the company could well be compared to large players such as DLF and Unitech. The drawback would be its lack of track record in the Indian market. Successful execution of its plans would, therefore, hinge on the support from its international parent, Emaar, and domestic partner, MGF. The company now appears to have built a strong base — sufficient land bank, tie-ups with international construction players for project execution and a diversified portfolio with joint ventures in hospitality and infrastructure.
On the company and offer
EMGF is a real estate company incorporated in 2005, co-promoted by Emaar Properties of UAE and MGF Developments. The company is into residential, commercial and retail projects and has plans to foray into hospitality and airport projects. At the higher end of the price band, the offer would raise about Rs 6,400 crore to be utilised towards land acquisition, construction cost and loan repayment. Post-listing, the market capitalisation would be Rs 53,000-62,000 crore.
Strong promoter background
EMGF’s promoter, Emaar Public Joint Stock Company (Emaar), is an international real estate player with a presence spanning Saudi Arabia, UAE, Egypt and the US. Emaar PJSC is building the world’s largest tower and Mall in Dubai and is also involved in the prestigious King Abdullah Economic City in Saudi Arabia.
Apart from skill sets and cash infusion of over Rs 3,000 crore into EMGF, Emaar brings to the table an ability to forge business and funding ties. This lends confidence on two key success factors — execution capability and meeting fund requirements. Emaar’s interest in this venture is also evident from the agreement to route all its Indian projects only through EMGF.
MGF Developments, the other promoter, specialises in retail space and has an established presence in North India, with local knowledge to handle issues such as land identification, procurement and dealing with local procedures. That the company has managed to add 13,024 acres to its land reserves in a short span of time — a high proportion of it also being fully paid — suggests that the local partner’s knowledge has played a pivotal role.
Comfort from land holding
As much as 89 per cent of EMGF’s land reserve is fully paid, thus locking in to prices; reducing risks of escalation in prices at a later date. This proportion is higher than Emaar’s peers in the listed space. Though the land bank is spread across regions, the north accounts for 75 per cent. This probably arises from the MGF’s strength in the region and suggests caution in testing new waters.
EMRF has already made available for sale about 80 per cent of the 17.3 million square feet of residential projects under development. This provides comfort on the company’s execution capabilities, given that it otherwise lacks a track record in the country.
Of the total developable area of 566 million sq ft., residential segment accounts for over 75 per cent with about 15 per cent in commercial and the rest planned for retail and hospitality.
The focus on residential appears appropriate for two reasons. The demand for residential area is expected to be higher than the other segments over the long term. This would also enable the company to cash-in on projects, replenish the land bank and move ahead to other projects. This build-sell model prevents locking-in of capital. However, projects coming up over 2008 and 2009 are tilted towards the commercial and retail space, with plans to adopt a lease model.
This strategy appears to be targeted at building a high-grade asset basket, targeting Real Estate Investment Trusts (REIT). Even if EMGF is able to complete 50 per cent of the targeted 89 million sq ft of commercial space, it could garner a sizeable share of the REIT market.
In the residential segment, the company has chosen a strategy of ‘integrated master planned communities’ (similar to the integrated township concept) in many Tier-II and Tier-III cities.
This provides flexibility to the company to sell plotted land or full fledged housing, depending on the response in these areas. The sale of plotted land would also aid regular infusion of cash to meet working-capital requirement.
The strategy appears well thought out, as it may result in regular cash infusions, while building a portfolio of income-yielding assets.
Sound joint ventures
EMGF has used international joint ventures to access technology, and make up for lack of experience in dealing with local contractors. Exclusive tie-ups with Australia-based companies, Leighton International and Multiplex, and the US-based Turner Construction are cases in point.
The company has also formed a consortium with Dubai Aerospace Enterprise to venture into opportunities in port privatisation, modernisation and management in India. Given that this segment in the infrastructure space has just taken off in India, the move to focus on it appears well-timed.
The company’s foray into hospitality is supported by tie-ups with the Hyatt, Accor, Marriot and Four Seasons.
While the JV is desirable, we are cautious about prospects for up-market and luxury hotels in places such as Kolkata, where attractive pricing may remain a key.
No cheap valuations but..
EMGF has managed to break even within two years of incorporation; profits for the half year-ended September 2007 fully offset the earlier losses. Consolidated revenue for the half year stood at Rs 473 crore, while net profits were Rs 130 crore.
We conservatively estimate revenues crossing Rs 3,000 crore by FY-09 with per share earnings close to Rs 10.
This estimate does not factor in earnings from the hospitality segment and the leased commercial and retail spaces. The latter, especially, could provide significant upside to the earnings estimate.
EMGF’s operating and net profit margins for the half-year ended September 2007 stood at 39 per cent and 27 per cent respectively. This compares well with the industry average but is slightly lower than the leading players.
A recently accumulated land bank may explain the lower margins. This factor may see more steady margins on the company’s projects compared to peers, as the latter may witness contraction as they move over to recently replenished land reserves.
We are concerned about a chunk of EMGF’s present projects being concentrated in Mohali. While purchasing power in this location no doubt remains high, the market is yet to be tested for projects of such huge scale. Risks of excess supply also remain high.
As is the case with most other big players, Emaar’s targets for development appear aggressive given that no player has so far proven such capabilities.
While Emaar has a good track record, the size of total projects executed so far is only about 50 million sq ft (although huge developments are under way) across the world.
Investors with a long-term outlook can subscribe to the initial public offer of IRB Infrastructure Developers. A good track record in the build-operate-transfer (BOT) space, early-mover advantage in running toll roads and in-house capabilities in construction, road maintenance and toll collection suggest strong growth potential for this infrastructure company.
The offer price of Rs 180-220 appears stiff and the current market correction has provided an opportunity to enter a number of blue chips at reasonable valuations. We would, therefore, be comfortable recommending an ‘invest’ at the lower end of the price band. Our conservative estimate of the consolidated per share earnings for FY 2009 on the post offer equity base works out to Rs 3.1.
This is, however, without factoring in any increase in toll charges and traffic for the toll roads operated by the company, or revenues likely to flow from the company’s real-estate venture.
IRB Infrastructure Developers is primarily a holding company with wholly-owned subsidiaries, which are engaged in road and highway construction and maintenance. The group is at present involved in 12 BOT projects out of which 11 are in the operational phase (with maintenance and toll collection being done by the group). The company also plans to foray into real-estate . IRB plans to raise about Rs 100 crore to invest in one of the subsidiaries and also repay its own loans and that of its subsidiaries. Post-listing, the market capitalisation of the stock would be Rs 6,000-7,000 crore.
The toll model is normally considered risky, although the revenue potential is high if the project attracts high traffic. Being one of the early private players in the space, IRB has managed to negotiate lucrative business terms that have compensated for risks associated with the toll model.
For one, IRB’s existing BOT projects do not have any toll-sharing arrangement with the Government. With high-traffic segments such as the Mumbai-Pune Expressway, part of NH-4 and Pune-Nashik road in its portfolio, IRB is likely to enjoy a high internal rate of return on its projects compared to peers who have more recently entered the segment and have thus settled for less attractive terms.
While the current basket of 12 BOT projects would enjoy superior profitability, new bids may see relatively muted returns with the Government now actively looking at toll-sharing models. .
Two, the company has non-compete clauses in some projects, which would restrict the Government from building or operating any competing BOT projects that could possibly reduce the toll inflows for the company. Similarly, control over projects such as the Mumbai-Pune Expressway as well as the Mumbai-Pune portion of the NH-4 corridor (both under IRB’s purview) ensures that the company does not face any competition from adjoining corridors.
Three, the company may benefit from periodic hikes in toll rates, some of which may be significant if traffic numbers are encouraging. For instance, the Mumbai-Pune Expressway is likely to command 18 per cent increase in toll rates the coming year.
The above factors suggest that the timing and locational advantages of the existing portfolio may endow IRB with a clear edge in the toll road segment.
Pre-qualification and integration
While IRB’s operations have been concentrated in Maharashtra and Gujarat, its experience in BOT has earned it pre-qualification by NHAI in NHDP Phase V projects in other States such as Tamil Nadu, New Delhi and Uttar Pradesh. Additionally, IRB’s operations appear well integrated, with capability to build and maintain roads as well as manage toll collection. This integration reduces the need to outsource work, which, in turn, results in higher profit margins.
IRB’s order book as of October 2007 stood at Rs 2,325 crore. While this would convert to revenues over 2008-2010, we expect toll revenues (not included in the order book) to be the most significant revenue driver. Income from BOT projects (predominantly toll revenues) accounted for the largest chunk of the recent consolidated revenues of the company .
IRB posted consolidated sales of Rs 262 crore for the five months ended August 2007 and net profits after minority interest of Rs 24 crore. The reported numbers may not be indicative of the company’s future revenues for two reasons. Revenues of fully controlled subsidiaries have been only partly captured in the August 2007 financials, because of recent consolidation.
Two, a few other subsidiaries have also been consolidated post August 2007; and these have not been accounted. The recent consolidation is positive because earnings that would have otherwise accrued to special purpose vehicles (SPVs) will now directly accrue to the fully-owned subsidiaries.
As most of the projects under the subsidiaries are operational, risk of funding also appears minimal.
IRB and its subsidiaries carry high levels of debt. While repayment from the offer proceeds would reduce the debt, newer projects and a foray into real-estate could require further raising of funds.
IRB plans to venture into real-estate and has acquired 925 acres of land for building a township in Pune district. With its hands full in the infrastructure space, we are cautious about its capability as a real-estate developer. The offer closes on February 5.
The recent market decline has provided an attractive entry opportunity to the Suzlon Energy stock. An investment can be considered in the stock with a time horizon of 2-3 years. At the current market price, the stock trades at about 24 times its expected per-share earnings for FY09.
A strong order book, ongoing capacity expansion, and infusion of IPO funds into subsidiary Hansen Transmissions provide considerable visibility to the company’s earnings over the next few years.
Strong growth in volumes in the quarter ended December 2007 alleviates fears arising from a decline in profits. Suzlon Energy’s numbers threw a negative surprise this quarter; but this was attributable to one-off expenses such as relocation cost of projects and taxes incurred in certain hedging transactions.
Suzlon is now a fully vertically integrated energy equipment provider — a status that very few global players, such as Gamesa have managed to achieve. Apart from better management of costs, vertical integration is the key to handling supply disruptions — a major concern for many players in the wind energy equipment business.
The capacity expansion plan also appears to be on track and is expected to be in place by mid-FY09. The leverage on Suzlon’s balance sheet may receive some relief with the successful IPO from subsidiary Hansen, which had massive capex plans hitherto nurtured by the parent.
Removal of uncertainties surrounding the acquisition of REpower also strengthens Suzlon’s prospects for increasing its share in the promising European market.
Of the Rs 17,080-crore order book (December 2007), exports account for close to 85 per cent. Increasing exports and manufacturing units in other countries may result in a gradual compression in the high profit margins so far enjoyed by the company.
However, while Suzlon may not be able to achieve operating profit margins of over 20 per cent enjoyed earlier, we expect the company to maintain OPMs in the 12-17 per cent range due to backward integration. This would still remain superior to some international players.
A key risk to demand for wind turbines may arise from the deadline of December 2008 for the production tax credit, an incentive extended to wind energy projects in the US, which has not been reviewed so far. It is expected that this may still be passed in legislation in some other form. Initiatives by the European Union to encourage clean energy sources may also open up alternative markets in case of a slowdown in offtake in the US.
Investors with a two-three year perspective can consider buying the Maruti Suzuki stock. The company’s strong sales numbers in the backdrop of higher interest rates, its market leadership position in the compact car segment and improved product mix in the A2 (compact) and A3 (mid-size) segments are key positives that lend visibility to its earnings prospects.
At the current market price of Rs 904, the stock trades at an attractive valuation of about 15 times the trailing 12-month earnings, making it one of the cheapest stocks in the index basket. Considering the fall in market price in the recent corrections, we reiterate a buy on this stock.
The change in Maruti’s product portfolio over the last year in favour of cars such as the Swift, which is at the premium end of the compact segment, and SX4, the company’s midsized car, has consistently contributed to improved realisations over the past few quarters. For the first nine months of FY-08, realisations have improved by 8.5 per cent on a year-on-year basis.
For the latest quarter, net sales rose 27 per cent to Rs 4,674 crore and net profits stood at Rs 467 crore, up 24 per cent Y-o-Y. Revenues were driven by volume growth of 17 per cent and realisation growth of 10 per cent.
Although volumes may face a moderation in 2008 due to high base effect and capacity constraints for the Swift and SX4, a scenario of reduced interest rates (the RBI has asked banks to review lending rates, given their high net interest margins and comfortable liquidity position), additions to the product line and ongoing capacity expansion will help sustain momentum.
Concerns about competition from the Tata Nano have impacted the stock performance. But these may be overdone as the only model that might be affected is the M800. The M800 contributes to less than 10 per cent of the revenues. Also, Maruti has embarked on its long-term plan of shedding its ‘small car maker’ image to fight competition and retain its market share.
The recent move into the midsize segment, the forthcoming sedan version of the Swift, the introduction of ‘Splash’ at the upper end of the compact segment, the re-launch of the Grand Vitara, a multi-utility vehicle ( MUV), and the expected launch of Kizashi in the A5 (premium sedan) segment in 2010 are all pointers to this. Besides, the company is boosting exports by adding markets such as Indonesia, Chile and Egypt for its existing models like M800, Alto and Zen and by launching the ‘A Star’ to cater exclusively to Europe. The company expects to double units of the A Star from the initial 1 lakh by 2010. All this bodes well for volume growth in the next two-three years.
Margins to STAY subdued
Operating margins stood at 13.15 per cent for the current quarter. Although it has remained flat sequentially, it has declined from 14.62 per cent in the June quarter. Escalation in raw material costs, increase in other direct costs such as power and fuel due to ongoing capacity expansion, discount offers, higher promotion expenses and royalty payment for new launches, are expected to keep margins subdued in the medium term.
The company is also sprucing up its retail initiatives. It has rolled out a Rs 7,000-crore plan to set up mega display-only showrooms across India and build warehouses for spare parts and vehicles to reduce lead time in delivering these to customers.
With a high volume strategy to defend its market share being foremost priority, Maruti will have to work with thin margins for the near term, with better product mix being the only factor that will help cushion this to an extent.
Investors with a one-year perspective can consider exposure in the stock of Shree Cement. The company’s timely capacity-additions that could drive strong volume growth, healthy cash flows and high operating margins are key positives. At the current market price of Rs 1269 Shree Cement trades at about 9 times its estimated 2008-09 earnings.
The company is among the leading cement players in North India and has four plants located at Beawar and Ras in Rajasthan. The installed cement capacity of the company stands at about 8.3 million tonnes per annum, after recent capacity additions. The location of its manufacturing units enables Shree Cement to cater to the markets of Delhi, Haryana, Punjab, Uttar Pradesh (West) and Uttaranchal.
Shree Cement enjoys a 13 per cent market share in the Northern region where demand is expected to grow above a 10 per cent annualised rate until FY-10. The markets covered by Shree Cement — Haryana and Rajasthan — are likely to outpace the regional demand growth, driven by construction of hydropower and other infrastructure projects.
Demand growth in Delhi is expected to remain strong on the back of construction activities related to the Commonwealth games. Expected capacity additions in 2009 and 2010 could lead to moderation in cement prices in North India.
Volume growth could place Shree Cement on strong ground in this respect. Shree Cement has historically timed its capacity additions well before peaks in the cement cycle. This time round, even as the bulk of capacity additions by cement majors are expected after June this year, Shree Cement has already commissioned a new two-million-tonne capacity at Khushkera, Gurgaon in September 2007 and another 1.5-million-tonne grinding unit at the same location in December 2007. This could help the company capitalise on strong demand trends in the region.
The company appears well-placed to withstand cost pressures, with an operating profit margin that is significantly superior to similar sized players. The location of the company’s units help it to save on logistics costs. The State is also rich in limestone and gypsum, key inputs to cement production, also resulting in procurement advantages.
A captive power plant that meets a significant proportion of power requirements is a key contributor to cost savings. The company has recently commissioned a 18 MW thermal power plant to its existing 42 MW capacity and has further plans to augment captive power generation. Pet coke is used as fuel for the power plants, which is procured from a refinery in Panipat near the company’s plant.
Shree Cement reported a sharp decline in net profit, despite strong sales growth in the December quarter. For the quarter, net sales have increased 43 per cent to Rs.523.57 crores, on the back of higher despatches and firm realisations. However, despite higher volume growth and increased sales, the company recorded a fall in its net profit, mainly attributable to higher depreciation charges on the newly installed plants. The company follows an accelerated depreciation policy that results in cash profits being substantially higher than reported profits. The aggressive depreciation policy, while it results in subdued net margins, reduces tax incidence and bolsters cash flows.
Risks: Any significant fall in utilisation levels due to the capacity additions that would be coming on stream by FY-10 and the consequent drop in cement prices is a key risk to earnings. Rising costs of inputs are also a potential threat, in the face of limited pricing power.