Madras Cements: Hold

Relief on costs, volume additions from new capacities and the advantage of operating in a region with high demand potential where prices too are lending support suggest reasonable earnings growth for Madras Cements after a subdued December quarter. At the current market price of Rs.66, the stock trades at just four times trailing earnings, the stock is at a discount to most large cement players and offers promise of upside.
Demand looks strong

The demand for cement is growing at a strong pace in the Southern region with production and consumption numbers growing neck to neck. When production rose by 10 per cent year-on-year in the period April-January (2008-09) the region had consumed close to 12 per cent more than what it did during this period last year. A fairly tight supply situation is seen for at least a few quarters in this region.

Madras Cements’ current capacity is 8 million tonnes and it will increase to 10 million tonnes by this month-end through a new 2 million tonne per annum plant at Ariyalur, Tamil Nadu. The company, as of now, has no other capex plans.

The company’s competitor India Cements is upgrading its plant in Andhra Pradesh by increasing its capacity by another 1.2 million tonnes and this might be completed some time before the end of 2009. But for these, there are no large-scale new volume additions coming up in the Southern region.

Madras Cements has been seeing strong demand over the last few quarters with orders from infrastructure projects in Andhra Pradesh and Tamil Nadu. For the quarter ending December 2008, the company’s cement sales volumes rose by 7.3 per cent to 1.5 million tonnes from 1.4 million tonnes in the December quarter last year.

This growth in despatches is among the highest in the industry, next to ACC that recorded 8 per cent increase in despatches in the quarter.

While volume growth for Madras Cement has been strong, prices in this region too lent support to revenues. But for the Rs 5-6 cut in prices on the back of the excise duty reduction in December 2008, cement prices continue to hover at a high Rs 260 per bag in the Southern region.

Cost side relief

The company’s raw material costs can be expected to moderate considerably over the next few quarters, on global coal prices easing off. The company imports nearly 75 per cent of its coal requirements. International coal prices have eased off from $195 in July last year to $85-90 currently.

On the power front, the company has been relentlessly adding up its windmill capacity to reduce dependence on the State grid and coal/diesel fired DG sets, which are an expensive source of power.

Madras Cements windmill capacity rose by 23 megawatts over the past year through new additions and currently stands at 146 mega watts. Wind mills are the cheapest source of power with the per unit cost at Rs 1.75-2.00 (power from grid comes at Rs 4.45/unit and that from coal gen-sets at Rs 5-6/unit).

The company is also putting up two grinding units one each at Salem and Chengalpattu in Tamil Nadu to save logistics cost by reducing the distance moved by trucks. These are strategic locations, both with respect to fly-ash availability and target markets. Government’s recent cut in diesel prices will also help reduce the logistics expenses.
Financials

The December quarter results of Madras Cements had several dissapointing aspects, with net profit declining by 43 per cent even as sales growth stood at 19.5 per cent year on year.

Lower revenues reported by the windmill segment, higher depreciation and interest costs contributed to the performance. Compared to Rs 30 crore in the first quarter and Rs 40 crore in the second quarter, the company’s wind mill segment reported only Rs 6 crore revenues in the December quarter.

The fall in windmill performance has been common to all windmill units in this region, and is attributed to seasonal factors. As operations normalise over the next quarter, the contribution may see improvement in the coming quarters. The 61 per cent year-on-year increase in depreciation charges is attributable to the company’s commissioning new windmills by the end of second quarter, from which revenues didn’t flow in for the quarter.

Profits were also dented by a sharp rise in interest expenses. This is attributed to both higher interest cost and higher borrowings. The company borrowed Rs 300 crore last year towards its capex plans and working capital requirements. High interest costs were partially due to high cost short term borrowings from the money market; which has seen rates receding sharply.

The current and the coming quarters could see interest burden easing as the impact of lower market interest rates is felt on the numbers. Newly commissioned capacities and still healthy volume growth in cement, apart from the contribution from the windmills, may lead to better revenue growth.