Madras Cements

The Madras Cements share has run up nearly 53 per cent to the current price of Rs 101, from the time we gave it a “Hold” rating in February. At this price, the stock trades at a price-to-earnings ratio of seven times. Though not at a premium to its closest rival,

India Cements (price-to-earnings ratio of 9 times), significant upside could be capped for the stock from the current level owing to the excess supply situation in the southern cement market which may contribute to lower utilisation and weaker prices.

After the recent two-million-tonne addition to capacity, there have been no capex announcements from the company on diversification to regions other than the South. Investors can use the price run up to book profits on the stock.
Excess supply

The southern market, which was a key driver of cement industry growth throughout 2008, has started showing signs of weakness this year. Despatches growth of 13 per cent in March and April has decelerated to 4 per cent in May.

What is of more concern than the moderating demand growth is the huge volume of capacity additions expected in the region. In May, the region saw the highest growth in capacity addition of nearly 25 per cent year-on-year (to 6.58 million tonnes) against the all-India growth of 12 per cent (18.66 million tonnes).

The capacity utilisation rate, which was 95 per cent in March for the southern cement companies, dipped to 80 per cent in May. The fall in utilisation rates will see fixed cost burden rising for companies, especially on recently commissioned capacity, and could pressurise margins.

Of the total 40-50 million tonnes of additions outlined for 2009, 50 per cent are planned in the southern region. Though these new capacities will come up only in phases, the relatively high prices in the southern market suggest room for correction.

Prices which continue to hold at an all-India high level of Rs 277 per 50 kg bag (Rs 259 last year) may see a decline if the current excess-supply worries persist and the market does not find new demand drivers.

In the North, the price per bag is Rs 234, only Rs 4 higher than the last year’s level. Madras Cements’ high regional dependence could make it quite vulnerable to these developments. Madras Cements has plants operating mainly in Tamil Nadu, Andhra Pradesh and Karnataka and unlike India Cements does not have a toehold in the promising western market.
Margins dip

The company’s sales for the full year FY-09 were up a strong 26 per cent helped by additions to the volume and higher realisations. Margins, however, took a dip on the spurt in coal, fuel and power prices during the year. The operating margins for FY-09 dipped 7 percentage points to 31 per cent.

The company’s margins did not reflect a material savings in power costs even in the last quarter of the year, despite a cooling-off of the imported coal prices. Power and fuel costs as a proportion of sales were 23 per cent in March ’09 quarter compared to 18 per cent in the previous year. A deficit power situation has, in fact, impacted profitability for many of the South-based players.

To counter this, companies are now building their captive power plant units. Though Madras Cements has 180 MW of wind power, it is not able to exploit it to its advantage due to certain government restrictions on the usage of banked wind power. The company is thus augmenting the capacity of its coal-based power plants by an additional 65 MW by investing nearly Rs 280 crore in two power plants.

With this, the company’s total captive power capacity (coal based) will stand raised to 135 MW and it will be self-sufficient in power. The new power plants are expected to be commissioned in a period of 18 months from now. Transportation costs of cement companies might trend up in the coming quarters following the hike in petrol-diesel prices and the recent announcement of service tax on goods moved by rail and waterways.

Though Madras Cements’ operating profit for FY-09 inched 4 per cent higher, profit after tax declined by 11 per cent.
Price rally

Against the Sensex’s run-up of 65 per cent and the India Cements’ and Dalmia Cements’ sprint of 39 per cent and 63 per cent since the March ‘09 lows, Madras Cement has risen nearly 71 per cent. Given the risks to the earnings outlook for players in the region, investors can consider taking advantage of the opportunity to book profits in the stock.