Shree Cement remains attractive, target Rs.3,900

Updated: Aug 25 2012, 07:43am hrs
We maintain our buy rating on Shree Cement with a 12-month target of R3,900. Our target price is based on one-year forward target EV/ebitda of 7.5x (25% discount to large-cap peers to factor in some of the risk of lower liquidity). We have not used an exit price-to-earnings (P/E ) multiple, given the company's aggressive depreciation policy vis-a-vis peers, leading to profits being relatively understated. At our target price, the stock would trade at a target exit EV/t of $135, which is at a 20-35% discount to its larger peers.

Shree Cements June quarter PAT of R3.51 billion was ahead of both our and Street expectations. We highlight three important takeaways from the results the annualised free cash flow (FCF) yields at 9% were well ahead of expectations; the steep 49% y-o-y dip in depreciation to R818 million suggests that the company may have run out of avenues to depreciate its assets aggressively; and the strong 11% q-o-q rise in average realisations to R3,805 per tonne suggests its brand differential is improving.

The company has changed its year-end to June (from March) and, so, the FY12 period was of 15 months. To incorporate this, we have revised our FY12 numbers based on the actual results and raised our FY13e and FY14e estimates by 5% and 4%, respectively. The adjustment to FY12 numbers on an actual basis is high at 180%, given that the fiscal year was extended by three months and the depreciation charge in June quarter fell 49%.

The stock has outperformed the Sensex by 92% over the last 12 months. Despite that, the stock is trading at an attractive 22% discount to replacement cost. Moreover, the sustainable FCF yield of more than 8% makes the stock look attractive even at current valuations and remains our preferred mid-cap cement pick.

The Competition Commission of India on July 30 imposed a penalty of R3.97 billion on the company. The company is contesting this and, accordingly, has not made any provision for it. On the operational front, lower-than-expected price rises and demand growth are key risks. Deutsche