Shree Cement's UAE foray, domestic expansion make it an attractive stock

As Shree Cement surprised investors by posting better than expected operating performance for the December 2017 quarter last week, it also did the same with its plans for establishing a footprint outside India. 

The company, which has so far focused on its expansions plans in the domestic arena to fuel growth, is now acquiring about 93 per cent stake in UAE-based Union Cement Company (UCC) at an enterprise value of $305 million. Since UCC has 3.3 million tonne (MT) clinker and four MT cement capacity, the deal valuation works out to be about $76 per tonne, which analysts say is attractive. The deal value is at 17 per cent premium to UCC's market cap, but much lower than the acquisition price paid by its competitors for acquiring assets in the Middle East market, say analysts at Kotak Securities. Binod Modi at Reliance Securities, too, says that the deal appears attractive considering costs incurred by select cement companies in the Middle East, including JK Cement.

UCC had generated revenues of $154 million and earnings before interest, tax, depreciation, and amortisation (Ebitda) of $34 million in calendar year (CY) 2016, about 12 per cent and 15 per cent lower, respectively, than the year-ago period. However, even considering 100 per cent acquisition being funded by debt (assuming 10 per cent interest rate), the deal will not be earnings dilutive, say analysts. In the near term, the deal may weigh on the sentiment as similar investment in asset creation in India would have generated higher returns. Nevertheless, analysts say that there is good scope for margin improvement and earnings growth for UCC assets too. Since 2016 has been a year of downturn for cement demand in the Middle East (declining crude oil prices impacted economies), Modi of Reliance Securities foresees better demand in the UAE supporting margin improvement. Further, UCC's capacities are in close proximity to the ports, and hence it has good access to export markets too.

Meanwhile, Shree Cement continues to expand its domestic capacities too. During the quarter, the company has lighted up its clinkerisation unit of 2.6 MT in Chattisgarh. Over FY18-19, the company is expanding its capacities by about 9.2 MT. The de-bottlenecking at its Bihar grinding unit, a new cement grinding unit in Bihar, a clinker unit in Gulbarga district of Karnataka, etc, put together, will take its overall capacities to about 43 MT by FY19, which is likely to support volume growth, say analysts. Since Shree Cement is among the most profitable cement companies in India, the volume growth should also mean strong increase in profits.

For the December quarter, the company has seen a healthy 8.3 per cent year-on-year increase in sales volume (including clinker) to 5.33 MT despite demand weakness in its key markets of Rajasthan and Bihar, in the backdrop of sand shortage (which hurts construction activities). The higher than expected average realisations and reversal of Rs 403 million pertaining to District Mineral Foundation (DMF) provisions aided Ebitda growth amid cost pressures. The company, hence, was able to offset the substantial jump in per tonne power and fuel cost (up 44 per cent year-on-year and 18 per cent sequentially) caused by ban of petcoke usage and per tonne freight cost. The costs increased by 31 per cent year-on-year and two per cent sequentially in the December quarter. The Ebitda of Rs 5.7 billion (up 22 per cent year-on-year and two per cent sequentially) translates into Ebitda per tonne of Rs 1,057, better than Rs 975 reported in the year ago period.

Moving forward, as the seasonally strong quarters for cement demand starts, growth is likely to catch pace further. With the improvement in demand outlook in Eastern and Northern markets, along with new capacities of the company, Modi maintains his positive stance on the stock. Analysts at Kotak Securities expect the company's volumes and revenues to grow at a compound annual growth rate (CAGR) of 11.7 per cent and 15 per cent, respectively, between FY17-20. Those at Edelweiss say that notwithstanding current cost challenges, they maintain a long-term positive view on the cement sector in India given imminent rise of industry clinker utilisation and maintain Buy ratings on Shree Cement (target price Rs 22,854) given superior return on equity profile over peers in India. The stock trades at Rs 18,856 levels. 

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