Sanghi industries limited (SIL) is a Gujarat-based cement company, with capacity of 4.1mt. Around 90% of its volumes are sold in Gujarat. An integrated cement unit, SIL owns a 63MW captive power plant and a port. SIL is one of the lowest cost cement producers due to its quality limestone, location advantage and strong integration across the manufacturing value chain (SIL’s cost/t of Rs 2,766 v/s industry average of Rs 3,603). SIL’s strength lies in its access to 1 billion tonne of quality marine limestone reserves, which should allow it to sustainably add capacity over the next 15 years.

We expect SIL’s margins to expand by 8.4pp over FY17-20, led by its three-pronged strategy: (i) commissioning of a waste heat recovery system (WHRS), (ii) focusing more on the coastal mode of transportation by way of acquisition of ships and (iii) achieving a favourable revenue mix with higher proportion of Portland Pozzolana Cement (PPC).

In our view, SIL is a strong candidate for a re-rating, led by (i) expected increase in its capacity from 4.1mt now to 8.2mt over the next 30 months and (ii) anticipated scale benefits led by diversification into new higher-priced markets. We expect Ebitda CAGR of 33% over FY17-20, with improved pricing and positive operating leverage leading to 26% CAGR in Ebitda/t. This is likely to drive PAT CAGR of 61% to Rs 2.63 bn over FY17-20. We expect RoE to increase by 11pp to 16.8% in FY20, led by a sharp uptick in profitability. We initiate coverage on SIL with a Buy rating and a target price of Rs 157 (23% upside; valuing its present capacity of 4.1mt at $120 EV/tonne; incremental capacity of 4.1mt likely to be added by FY20 at $78/t at a 35% discount to replacement cost of $120/t).

Capacity-led re-rating is on the cards; diversification will bring in scale

SIL targets to increase its cement grinding capacity from 4.1mt now to 8.2mt over the next 30 months by adding one more line of clinker unit at its existing location, as well as split grinding units of 2mt each in Kutch and Surat. The new grinding units would be largely utilised to cater to the better-priced markets of Mumbai and Kerala, which can be tapped by way of coastal movement—an efficient mode of cement transportation. While diversification into the newer markets will provide scale, it will also result in improved profitability. We also see SIL as a strong re-rating candidate, as the expected increase in capacity over the next few years should help it achieve significant scale benefits.

Valuation and view

At CMP of Rs 127/share, SIL trades at EV/Ebitda of 8.0/5.9x on FY19e/20e earnings (adjusted for CWIP related to doubling of capacity). It trades at EV/t of $115/80 on FY19/20 capacity. We value SIL’s present capacity of 4.1mt at EV/tonne of $120 and proposed capacity expansion of 4.1mt at $78/t (35% discount to replacement cost of $120/t) to capture the low capital cost for incremental capex. Hence, we value its overall capacity of 8.1mt (with additional debt of `12 bn for additional capacity) at $99/t. Incremental cost of capacity addition is lower at $45/t, as against the industry standard of $120/t, as the expansion is brownfield in nature and a significant amount of capex has been incurred toward the ancillary set-up. We thus initiate coverage on SIL with a Buy rating and a target price of `157/share, implying upside of 23% from the current levels.

—Motilal Oswal