Madras Cements

Investors can consider booking profit in the stock of Madras Cements and entering it at lower levels later. The stock's fundamentals do not warrant significant upside from here over the next few months.

Declining realisations in the southern markets due to excess supply have seen the company's net profit fall over 70 per cent in the December ending quarter. Despite the strong 33 per cent despatches growth, sales too have declined. Southern cement manufacturers have seen an erosion of pricing power with 23 million tonnes of additional capacity coming up in the southern region in the last two fiscal years. Supply has exceeded the demand growth and the capacity utilisation rates are correcting sharply. Regional demand growth year-to-date stands at 8 per cent, down from the 10 per cent in the last year.

Production cut backs have not helped (cement mills are running at 78 per cent utilisation) and prices have dropped by Rs 40-45/bag in the last four months.

Based on its trailing earnings, the stock of Madras Cements (current market price Rs 111) trades at a marginal discount (seven times) to its peer India Cements (eight times). However, on enterprise value per tonne basis, Madras Cements is dearer — at Rs 5,113 per tonne compared with Rs 3830/tonne of India Cements.

Pressure on profit

Even by selling an additional five lakh tonnes in the December quarter compared to a year earlier, the company's sales actually fell. Cement realisations in the southern region have been impacted by a combination of capacity additions, the Andhra Pradesh political crisis and inventory pile-ups. In Tamil Nadu, for instance, prices have seen a correction from Rs 270 levels a year ago to Rs 225 a bag.

At the operating level, limestone and coal prices have been upward bound, offering little respite on margins. On the power front, however, the company has been making significant savings as it has stepped up supply from captive sources (windmills). In the December quarter, the company's power/fuel expenses have fallen by 22 per cent year-on-year.

At the net level, company's significant interest burden (the interest cover fell to 2 times in the latest quarter) and the rising depreciation costs are a cause for worry. In the last quarter, the company's interest costs were higher by 24 per cent over the previous year at Rs 37.5 crore.

Depreciation charges stood 41 per cent higher at Rs 50.77 crore. These could be explained by the company's recent additions to capacity — two grinding units of total capacity 1.3 mtpa capacity (current capacity — close to 10 million tonnes). Profit before interest, depreciation and tax stood at Rs 113 crore (in the September-December '09 quarter), however after these charges it was just Rs 16 crore.

Madras Cements' key States of operation are Tamil Nadu, Andhra Pradesh and Karnataka. The Andhra Pradesh Government has recently signed agreements with the World Bank and is getting Rs 3,720 crore as assistance for its various urban infrastructure projects.

The coming months will see a recovery in cement offtake in Andhra Pradesh from the artificially depressed levels of recent months. Demand from the State of Tamil Nadu is also to go up with the metro rail projects on the anvil.

Though from here prices (in the South) have limited downside, it will take some time before they see their earlier highs. Sales will, thus, see muted growth on lower realisations in the near term.