SRCM is well set to enhance capacity by more than 2x at a capital cost of $60-90/tonne
For a commodity company, prudence suggest we should not estimate its value at significant premium to replacement cost/t. However, we beg to differ in case of Shree Cement (SRCM). Why? Not because it is trading at $255/t, 85% over ACC and replacement cost, and we want to recommend buy. But, unlike majority cement players, wherein capital deployment is for servicing debt/equity (read dividends), SRCM’s capital allocation is for putting cement capacities—where cash RoCE >30%. Our analysis indicates that SRCM is well set to enhance capacity more than 2x at capital cost of $60-90/t (peers take anywhere between $100 and $160/t and 2x SRCM’s delivery time). A shorter payback compounds cash flows faster, which is again deployed in business to enhance market share without dilution. This implies that exit EV/t multiples will expand (as India remains a growth market) and we realign TP with P/CF of UltraTech at 20x FY18e. The revised TP stands at R19,590/share (earlier R17,806).
Q1FY17 was special: Good earnings, but tax rate is now on the rise
Adjusted for Ind-AS, net sales rose 29% y-o-y, driven by 19% y-o-y volume growth and 12% y-o-y realisation jump. On like-for-like basis, total blended cost/t dipped 10% y-o-y largely aided by lower energy and freight costs/t. Ergo, Ebitda/t for cement was R1,313/t, up from R683/t y-o-y. Depreciation at R1.5 bn fell 35% y-o-y as it appears that a large portion of existing gross block is now already written-off. While net income was R5 bn versus R1 bn a year ago, monitorable net cash flow at R6.6 bn was up 93% y-o-y. Tax rate was 22% in Q1FY17.
Realigning for Ind-As: Not much change in cash earnings
We have realigned our forecasts as per Ind-AS. Factoring in these key changes, we raise our FY17/FY18e EPS 31%/52%, respectively. These are 19%/3% ahead of FY17/FY18 consensus. There are no major changes on cash flow/earnings basis.
Outlook and valuations
We value SRCM using exit multiple of EV/t of $275 for FY18e, which implies cash P/E of 20x, in line with current trading cash PE multiples of large-cap cement peers. Further, cash EPS CAGR of 50% plus over FY16-18e is 4x higher than peers. We maintain buy with revised TP of R19,590 (earlier R17,806).
Capacity expansion: Challenges remain, but the focus is both on brownfield and greenfield expansions. Key sites considered are: Raipur (Chhattisgarh)—Proposed expansion through a new clinker capacity of 2.8mtpa with an estimated cost of R7 bn (excluding land and other infrastructure). The plant is expected to be commissioned by Mar’2018. Aurangabad (Bihar)—Proposed expansion by 2mtpa, taking total capacity of Aurangabad unit to 5.6mtpa. The management expects new capacity to be operational by end FY18e with an estimated cost of R2.9 bn (excluding land and other infrastructure). Nawalgarh (Rajasthan)—Environment clearance has been received and the company is in the process of land acquisition for the project. Ras (Rajasthan)—Environment clearance has been received for the expansion project. Gulbarga (Karnataka)—Environmental clearance and most of the required land has been acquired. The company has started work on setting up an integrated plant with clinker capacity of 2.4mtpa and cement grinding facility of 4mtpa. To our surprise, management stated that it did not have any definitive plan to think of expansion outside India.
Distribution cost savings: Focus on savings from a faster turnaround and direct distribution to customers, which are sustainable in nature. As mentioned in the annual report, SRCM has been taking cues from ‘Pizza Delivery’ mechanism and applying the concept to reduce lead distance, which will ultimately reduce the overall logistics cost.
Energy cost savings: While the annual report mentions Kcal/kg of clinker at 720 in FY16, this will further come down by 5% as the company has replaced a four-stage pre-heater in the Beawar unit with a six-stage pre-heater.
Our valuation framework
Our sectoral hypothesis assumes that cash generated by industry peers over the next few years will continue to be either repatriated to parent (Holcim subsidiaries) or used to service debt repayments/interest. Typically, residual cash may not yet be at threshold level to invest in new capacities. For SRCM, this is a double bonanza as incremental returns generated over peers over the forecast period is getting deployed in capex at a good discount (most equipment players do not have any large orders other than that of SRCM), giving us additional comfort. Accordingly, we have used an exit multiple of EV/t of $275 to estimate 12-month TP for the company.