Cement Sector- Initiating Coverage-10 May 2017.pdf

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Cement Sector

Initi

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g C

over

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South India – On Course To Realise Its True Potential India’s southern region has some highly developed states with vast potential for cement demand, given the favourable demographics and income levels. During FY06-FY10, cement demand growth in this region had been higher than the all India average on account of higher government spending and robust housing and commercial segments. However, over the past five to six years, demand in the region witnessed considerable contraction as government spending dried up, political scenario worsened and the housing segment across the country weakened. Over the past 12-18 months, we have started witnessing a decent recovery in cement demand driven by higher spending in bifurcated states of Andhra Pradesh and Telangana and central government-sponsored low-cost housing programme in Tamil Nadu and Karnataka. We are quite upbeat about the demand prospects in the southern region and believe that cement prices will also remain elevated despite low capacity utilisation level. The combination of factors like: 1) Higher-than-industry volume growth, 2) Better pricing environment, and 3) Efficient operations will likely result in much better profitability for cement players. We initiate coverage on Dalmia Bharat (DBL) and Sagar Cements (SCL) with a Buy rating and Accumulate rating on The Ramco Cements (TRCL) to play this upcycle in the southern region. We believe these companies, despite the recent run-up in their share prices, still offer significant upside potential. Common investment thesis among these companies is efficient plant operations (resulting in very high EBITDA/mt), massive operating leverage (capacity utilisation less than 60%), higher-than-industry volume growth (FY16-FY19E volume CAGR of 8%-15%) and stable cement prices in its markets (prices in the southern region have been relatively stable at higher levels compared to other regions). The stocks under our coverage provide 10%-20% upside potential and have possibility of further earnings upgrade if demand growth turns out to be better-than-expected, leading to faster realisation of operating leverage. Key risks to our positive call include government intervention in cement prices, lower demand growth leading to increased competition and an adverse political scenario.

Demand is improving at the margin while supply dries up: After years of sluggishness, the southern region showed some green shoots of demand growth in FY17. For the region as a whole, volume growth in FY17 was in excess of 5% whereas some of the listed companies witnessed volume growth in high-teens. This volume growth can be partly attributed to a combination of weak base of the previous year and increased government spending on sectors like irrigation and housing. We believe this demand growth is sustainable as the momentum for key demand drivers of cement has just started and it is likely to continue, given the intention of various state governments to increase spending on capex coupled with growth-oriented schemes driven by the central government. We expect the southern region as a whole to grow at higher-than-all India average for the next couple of years whereas incremental supply in the region will be minimal.

Cement prices stable and costs under control: Cement prices in the southern region have been higher than the all India average for the past two to three years. Despite lower capacity utilisation level of the industry, pricing resilience has been quite remarkable in this region which has helped the industry to survive the excess supply situation. Since the middle of 2014, prices in the southern region have been higher by at least 15% compared to the all India average. Key reasons for higher prices include lower blending, higher input costs compared to players in the northern region and higher lead distance in certain cases.

We have Buy rating on DBL and SCL and Accumulate rating on TRCL: We initiate coverage on three companies with Buy rating on DBL and SCL with up to 18% upside, and Accumulate rating on TRCL.

Mangesh Bhadang Research Analyst [email protected] +91-22-3926 8172

View: POSITIVE Recommendation summary

Company Rating TP (Rs) Upside (%)

DBL Buy 2,806 17%

TRCL Accumulate 775 10%

SCL Buy 951 18%

Source: Nirmal Bang Institutional Equities Research

Market-cap CMP Target Up/ EV/E (x) P/B (x) RoE (%)

Company Rating Rsbn US$mn (Rs) price down(%) FY18E FY19E FY18E FY19E FY18E FY19E

Dalmia Bharat Buy 215 3,311 2,406 2,806 17% 12.2 10.2 4.2 3.5 15.4 17.6

Sagar cement Buy 17 259 806 951 18% 11.5 8.6 1.9 1.7 8.6 12.5

The Ramco Cements Accumulate 169 2,596 706 775 10% 11.9 10.8 3.9 3.3 17.0 17.0

Source: Company, Nirmal Bang Institutional Equities Research

10 May 2017


4 Cement Sector

Table of Content

Summary of stock recommendations…………………………………………………...…………..….…05

Demand growth in southern region to be superior compared with the rest of India…….……..…….08

Pricing environment is stable with reduced volatility…………………………………………….………13

Supply outlook………..…………………………………………………………..………...………….……15

Profitability snapshot of southern players……………………………………………….………..……...16

Snapshot of key states with possible demand potential………………………………………………..19

Companies

Dalmia Bharat ……………………………………………………………………….…………..….………27

Sagar cement ………………………………………………………..…………...…….…………………..39

The Ramco Cements……………………………………..……………………...…….…………………..51


5 Cement Sector

Summary of stock recommendations

Dalmia Bharat - The best growth story in cement space (Rating: Buy, CMP: Rs2,406, TP: Rs 2,806, Upside: 17%)

DBL, according to us, is probably the best and successful growth story in the cement space in India. From a capacity of mere 1.2mnmt in FY06, DBL has been able to grow 20.0x to a 25mnmt company by FY16, placing it among the top four cement companies in India. Now that a significant scale has been achieved through inorganic and organic routes, we expect the company to report much higher volume growth for the next few years along with increased market share. Apart from this, DBL has been able to achieve growth while focusing on improving efficiency as well. DBL boasts of significantly lower operating costs which help it to generate one of the highest EBITDA/mt among peers. DBL has various firsts to its credit like being the largest slag cement company in India, having one of the lowest electricity consumption patterns in the country, having one of the lowest carbon footprints in the world and a much higher cement-to-clinker ratio among peers. Given the scope for much higher volume growth, presence in regions where cement prices have been favourable and stable and also completion of a major capex programme, DBL is all set to achieve superior earnings growth driven by the excellence exhibited in the past in capex as well as opex. Moreover corporate restructuring - which is on the verge of completion - will create a pure play cement company, unlike a holding company in the past, which will further help shore up its financials and achieve better valuation multiples given its size. We have factored in 12.7%/20.6%/75.6% CAGR in sales, EBITDA and net profit over FY16-FY19E, respectively.

We initiate coverage on DBL with a Buy rating and a target price of Rs2,806. We believe DBL offers huge operating leverage as its plants currently operate at ~55% of their capacity. This operating leverage coupled with cost leadership and a presence in regions where pricing is in favour, like southern and north-east regions, makes DBL an exciting play in the cement space. We have valued the company based on the average of EV/EBITDA and EV/mt multiple. Our target multiple for EV/EBITDA calculation is 12.0x which is in line with the multiples we have assigned to other companies like ACC and Ambuja Cements. Our target price based on this method comes out to Rs2,806, up 17% from the current market price.

Exhibit 1: Earnings-based valuation Exhibit 2: Asset-based valuation

Particulars (Rsmn)

FY19E EBITDA 27,682

Target multiple (x) 12.0

Enterprise value 3,32,180

Net debt 40,685

Equity value 2,91,495

No. of shares (mn) 88.8

Value per share (Rs) 3,283

Particulars (Rsmn)

FY19E capacity (mnmt) 25.0

Target multiple (US$) 150.0


Net debt 40,685




Source: Company, Nirmal Bang Institutional Equities Research Source: Company, Nirmal Bang Institutional Equities Research

Exhibit 3: Target price of Rs2,806, up 17% from the current market price

Particulars (Rs)

Value based on earnings multiple 3,283

Value based on asset valuation 2,329

Average value per share 2,806

Target price 2,806

CMP (Rs) 2,406

Upside (%) 17%



6 Cement Sector

Sagar Cements - Beneficiary of demand reecovery in southern region (Rating: Buy, CMP: Rs806, TP: Rs951, Upside: 18%)

SCL is an Andhra Pradesh-based cement player with current capacity of 4mnmt which is slated to increase to 5.3mnmt by FY19. Despite its small size, SCL is a relevant and significant player in the market following the various initiatives taken by the company in the past like building a strong brand, control over variable costs, judicious capital allocation, upcoming waste heat recovery (WHR) project, introduction of sulfate-resistant cement and its overall understanding of the market. We believe SCL is in a sweet spot as its recent inorganic growth is likely to help in achieving higher volume growth and cement prices in its key markets are also at a high level which helps improve profitability. Recent acquisitions by the company will lead to a substantial reduction in operating costs as we expect the move to reduce lead distance as well as improve the blending ratios. We have not fully factored in the cost reduction on account of acquisitions and expansion in our estimates as we await more clarity on the same. Once the cost reduction benefits are visible, earnings growth will be superior. We have factored in 22%/25%/36% CAGR in sales, EBITDA and net profit for SCL over FY16-FY19E.

We have assigned Buy rating to SCL with a target price of Rs951. We have valued the stock based on our usual method of the average of earnings (EV/EBITDA) and asset-based valuation (EV/mt). We have used target multiples of 7.0x FY19E EV/EBITDA and US$80 EV/mt to value SCL’s business. The target multiples are in line with our assigned multiples for mid-sized regional cement companies, and are at a reasonable discount to our target multiple for UltraTech Cement.


Particulars (Rsmn)

FY19E EBITDA 2,372

Multiple 7.0

EV 16,605

Net debt 3,633

Equity value 12,972


Value per share (Rs) 636

Particulars (Rsmn)


Target EV/mt (US$) 80.0

Enterprise value 29,480

Net debt 3,633

Equity value 25,847




Exhibit 6: Target price of Rs951 is the average of both valuation methodologies

Particulars (Rs)

Value based on earnings multiple 636


Average value per share 951

Target price 951

CMP (Rs) 806

Upside (%) 18%



7 Cement Sector

The Ramco Cements - Best in class profitability awaiting operating leverage (Rating:Buy, CMP: Rs706, TP:Rs775, Upside: 10%)

We like The Ramco Cements limited (TRCL) as it has several advantages in the southern region like (1) Cost efficiency (100% captive power plant and lower operating costs) and premium product pricing, resulting in superior profitability, (2) beneficiary of demand uptick in the southern region (strong brand image, large market share in Tamil Nadu and Kerala), (3) Completion of major capex, and robust operating cash flow expected to deleverage the balance sheet and improve return ratios, and (4) elevated but justified valuations given the return ratios. TRCL is highly efficient in its operations, as despite running on lower utilizations the company has been able to control its costs well. The company has been reporting higher EBITDA/mt compared to most other cement companies in India for the past few quarters. This best in class profitability is awaiting operating leverage to open up as the current utilization of the company is only 50% which leaves ample scope for further volume growth. We are building in sales/EBITDA/PAT CAGR of 11%/15%/17.5% over FY16-19E respectively. The revenue growth will be driven by 9.6% volume CAGR and a mere 2% pricing CAGR. Lower pricing growth in our assumption corresponds to already higher prices in its key regions. After declining in 9MFY17, we expect operating costs to increase by ~4% in FY18 and FY19. This will translate to higher EBITDA/mt for TRCL compared to other companies. Key downside risks to our call include government intervention in cement pricing, severe draught in Tamil Nadu impacting volumes for the company and increase in input costs.

We have assigned an accumulate rating on TRCL with a target price of Rs775. We have valued the stock based on our usual method of average of earnings based valuation (EV/EBITDA) and asset based valuation (EV/MT). We have used target multiples of 12.0x FY19 EV/EBITDA and US$160 EV/mt to value the business. The target multiples are slightly higher than our assigned multiples for mid-sized cement companies on account of better return profile and huge operating leverage. We believe TRCL is a must have stock in portfolio on account of credible management and best in class profitability.


Particulars (Rsmn)

FY19E EBIDTA 16,090

Multiple 12.0

EV 1,93,078

Net debt 2,312




Particulars (Rsmn)




Net debt 2,312






Particulars (Rs)


Value based on asset valuation 749


Target price 775

CMP (Rs) 706

Downside 10%



8 Cement Sector

Demand growth in southern region to be superior compared with the rest of India

Recent trends suggest that demand is improving at the margin

FY17 was a weak year for the cement sector with demand contraction of 1.3% YoY for the industry. However, amidst this dismal performance from the industry, the southern region stood out with better volume as well as prices. After years of sluggishness, the southern region showed some green shoots of demand growth in FY17. As per the quarterly volume data of four predominant south-based cement companies, volume growth for these companies was in high teens compared to volume contraction reported in the past. Even for the region as a whole, volume growth in FY17 was in excess of 5%. This volume growth can be partly attributed to the combination of weak base of last year and increased government spending on sectors like irrigation and housing. We believe this demand growth is sustainable as the momentum for key demand drivers of cement has just started and it is likely to continue given the intention of various state governments to increase capex coupled with growth-oriented schemes driven by the central government. We expect the southern region as a whole to grow at higher-than-all India average for the next couple of years.

Exhibit 10: Volume growth of south-based companies in high-teens for the past few quarters

Note: Data pertains to 4 south-based companies like India Cements, The Ramco Cements, Orient Cements and Sagar Cements; Source: Company, Nirmal Bang Institutional Equities Research

For the purpose of understanding how cement demand can shape up in this region, we have looked at long-term demand trends. The pattern of demand growth in this region can be classified into three phases.

The first phase is the years FY08-FY10 wherein demand growth was in high single digits. This time period coincides with the booming cement markets in the country where the real estate boom coupled with higher government spending and better rural income post MNREGA was driving demand growth. Moreover, during this period, housing schemes like India Awas Yojna was being implemented in full flow by Andhra Pradesh under its then chief minister, Mr. Y.S.R. Reddy.

Exhibit 11: Three phases of demand growth in the southern region

Source: Cement Manufacturers Association or CMA, Company, Nirmal Bang Institutional Equities Research

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Cement Demand Growth in South (% YoY)

High Growth period driven by higher government spending

for housing schemes and

booming real estate markets

Extremely weak period for cement demand with lack of government spending, weak or stagnant real estate market. Andhra Pradesh saw a huge

decline in cement demand during this period (accentuated by state bifurcation) with contraction

in demand for 6 years in a row.

Early signs of demand improvement in place with

recovery in Andhra Pradesh

and Telangana. Karnataka and Tamilnadu demand to revive

soon


9 Cement Sector

The next phase of depression lasted for a prolonged period from FY11 to FY16. This time period was characterised by the drop in government expenditure on account of high fiscal deficit and slowdown in property markets across India as the interest rate cycle reversed. Cement demand contracted in four out of six years during this phase. This prolonged demand compression is likely to be followed by volume growth over FY17-FY19E, in our view. We expect the southern region to deliver higher-than-industry demand growth on the back of increased activity in irrigation and housing segments.

Higher spending in irrigation and housing sector to be key drivers

We believe the private real estate as a sector still has some time to recover in India. The Real Estate Regulation and Development Act (RERA) is likely to have negative connotations on the sector in the medium term. This coupled with higher inventory in the system is likely to slow down new launches and thereby real estate construction. However, we believe that there are four key cement drivers for the southern region as a whole which are likely to drive cement demand growth at a higher rate than all India growth. These four drivers are: a) Irrigation projects, b) Government spending on housing, c) Metro rail and road construction, and d) Various projects with higher cement intensity like Polavaram dam, new capital construction in Andhra Pradesh (Amravathi) and the Sagarmala project.

Exhibit 12: Key cement demand drivers in the southern region


Massive increase in irrigation spending likely

The irrigation spending in Andhra Pradesh and Telangana has picked up pace from last year. The budgetary allocation for irrigation in both states witnessed a significant pick-up after the recent bifurcation. In the budget for 2017-18, Andhra Pradesh has proposed 18.3% increase in total expenditure. The sector wherein most growth is coming is irrigation where allocation has been increased by a massive 57.3% - from Rs81.2bn to Rs127.7bn. Similarly, Telangana’s irrigation spending witnessed a further boost from its high level with 55.7% increase in allocation - from Rs145.6bn to Rs226.7bn. In Karnataka, the government increased allocation for water resources department by 35.8% - from Rs106.3bn to Rs144.3bn. This massive increase in spending is likely to result in higher cement consumption, in our view.

Other development that we witnessed during our visit to Andhra Pradesh in March 2017 is concrete lining of the canal system in the state. Earlier, the micro canals in the state were lined by earthwork. This resulted in water seepage leading to canals drying out earlier than anticipated in the summer season. Recently, the state government started lining the walls of these canals with concrete to avoid water seepage. This project witnessed decent amount of cement consumption in the past and is likely to witness higher off-take going forward as well.

• Various projects like Polavarmdam, new capital construction in AP and Sagarmala project to drive cement demand

• Work on Kochi and Hyderabad metro going on. Work at Vijaywada, Thiruvanantapuram, Visakhapatnam, Kozhikode, to start soon

• Massive road construction planned by NHAI

• Telangana government has invested heaviliy for housing for urban as well as rural poor

• TN record in the last 4 years for PMAY schemes is impressive. We expect the momentum to continue as PMAY scheme picks up pace

• AP and Telangana have allocated huge sums for irrigation projects in the state

• Concrete Canal lining is one of the key demand driver at micro level

Irrigation projects

Government Housing

Polavaram / Amaravathi / Sagarmala

Metro and road construction


10 Cement Sector

Exhibit 13: Massive increase in budgetary allocation for irrigation in the southern states

State 2015-16 2016-17 2017-18 Growth

Key proposals Actual Revised Budgeted YoY %

Andhra Pradesh

45.5 81.2 127.7 57.3% Polavaram project is estimated to receive Rs72.51bn. This is more than a 100% increase as compared to the revised estimate for 2016-17.

Telangana 95.4 145.6 226.7 55.7% The government aims to provide irrigation to 10mn acres in the state.

Karnataka 81.6 106.3 144.3 35.8% Rs30bn is estimated to be spent on 21 different projects. This includes development of canal in the Cauvery basin.

Source: State budget documents, Nirmal Bang Institutional Equities Research

State-sponsored housing project is another important cement demand driver

Affordable housing segment in India is in vogue these days on account of the government’s ‘Housing For All’ initiative. Under this scheme, the central government provides assistance to individuals in terms of interest subsidy or direct benefit of upto Rs1.5lakh depending on the type of house constructed. Moreover, key highlight of state budgets of southern states was higher expenditure allocated for the housing schemes making use of some the central government’s flagship projects. In the past, schemes like Indira Awas Yojna and Rajiv Awas Yojna were implemented spiritedly in southern states. In fact, data on state-sponsored housing in urban areas indicates that southern states were leaders in the implementation of these schemes. In our recent report on affordable housing, we have mentioned that some of the beneficiaries of this scheme are likely to be southern states like Tamil Nadu, Andhra Pradesh and Karnataka. In the near term, various southern states are likely to up their spending on housing schemes using the incentives provided by the central government.

Tamil Nadu will be an important state to watch out as the government has come up with a slew of measures for the affordable housing segment. The state government has earmarked considerable funds for different programmes to provide housing facilities in rural and urban areas. It has launched a mission for housing the poor last year by dovetailing funds from many schemes to pursue this. It continues to strive for creating ‘hut-free’ villages and ‘slum-free’ cities in Tamil Nadu. Under the Pradhan Mantri Awas Yojana (PMAY), the government in Tamil Nadu will construct 1,76,000 houses in 2017-18 at a unit cost of Rs1,70,000. Of this, the central government’s contribution will be Rs72,000 per house while the state government will contribute Rs98,000. Roughly Rs17.5bn has been budgeted for the same. Apart from this, 20,000 houses will be constructed in 2017-18 under the Chief Minister’s Solar Powered Green House Scheme.

In Telangana, the government is providing two-bedroom houses for the poor. To encourage the implementation of Two-bedroom Housing Scheme, the government is providing sand free of cost. In addition, the government has entered into a pact with 31 cement companies to provide cement at Rs230 per bag as opposed to the market rate of Rs320 per bag. The contractors are slowly taking up the projects and progress has been satisfactory till date.

Update on Polavaram project

Indira Sagar (Polavaram) project is located on Godavari river near Ramayyapet village of Polavaram Mandal in West Godavari district of Andhra Pradesh. The project is multipurpose major terminal reservoir project on Godavari river for development of irrigation, hydropower and drinking water facilities to East Godavari, Vishakhapatnam, West Godavari and Krishna districts of Andhra Pradesh. The project will provide irrigation to 2,91,000 hectares(CCA) and hydropower with installed capacity of 960MW apart from 23.44tmc (663.7mcm) drinking and industrial water supply to Vishakhapatnam township and steel plant and diversion of 80tmc waters to Krishna rriv. The ultimate irrigation potential of the project is 436,800 ha and annual power generation will be 2369.43mn units. In addition, 540 villages will also be provided with drinking water facilities in the command area. The project implements Godavari-Krishna link under interlinking of rivers project. The project envisages transfer of 80tmc of surplus Godavari water to Krishna river which will be shared between Andhra Pradesh (AP), Karnataka and Maharashtra in the proportion of 45tmc by AP and 35tmc by Karnataka and Maharashtra as per the decision of the GWDT Award.


11 Cement Sector

Exhibit 14: 2BHK houses constructed by the government in Siddipet district of Telangana

Source: The Hindu newspaper

In Andhra Pradesh, the government has planned to build 1,10,000 houses in FY18 under the affordable housing project scheme. A sum of Rs14.6bn has been allocated for housing under the Pradhan Mantri Awas Yojana (PMAY) and NTR Rural Housing schemes in the state.

Karnataka also has massive plans for housing in the state. In the budget for 2017-18, the state government has allocated a large sum to build 7,00,000 houses out of which 6,00,000 houses will be built in rural areas. Even if the government achieves half of the state’s target, the resultant cement consumption can be huge.

Exhibit 15: Number of houses built under PMAY-U during FY14-FY17 (X)

Note: The data pertains to aggregate houses constructed in the past four years; Source: Ministry website, Nirmal Bang Institutional Equities Research

Exhibit 16: Number of houses sanctioned for construction under PMAY-Urban scheme as of April 2017 (X)

Source: Press Information Bureau, GoI, Nirmal Bang Institutional Equities Research

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account for 43% of houses sanctioned under PMAY Urban scheme.


12 Cement Sector

Possibility of higher cement despatches from the southern region to other regions

On account of the presence of limestone clusters in the southern region, this region has generally been a net exporter of cement to nearby regions. States like Maharashtra, Odisha and West Bengal are the recipients of cement on account of either scarcity of limestone in these states or easy logistics because of proximity. While the eastern region witnessed good demand growth in the past, Maharashtra, which is a key state for volume growth of companies in the southern region, has witnessed subdued demand in the past year or so. With the uptick in urban infrastructure, metro rail-related work, increased road construction and railway station redevelopment, we expect cement demand in the state to improve which may increase the inter-state export of cement between Andhra Pradesh and Maharashtra.

Moreover, the government in its report on ‘Sagarmala’ had conducted origin-destination analysis for various classes of goods. For cement, the report indicated possible opportunity of 9mnmt-10mnmt of cement being moved through the coastal route by 2025. Out of that, roughly 5.5mnmt-6.0mnmt cement is expected to be despatched from Andhra Pradesh. With better development of coastal infrastructure, we expect higher amount of cement being despatched from states like Andhra and Karnataka, thereby improving the utilisation of existing capacities. Exhibit 17: Huge opportunity for coastal movement of cement in the southern region

Source: Sagarmala report by the Ministry of Shipping

Exhibit 18: Current inter-state flow of cement in India



13 Cement Sector

Pricing environment is stable with reduced volatility

Prices in the southern region have been higher than all India average for the past few years

Cement prices in the southern region have been higher than the all India average for the past two to three years. Despite lower capacity utilisation level of the industry, pricing discipline has been quite remarkable in this region. Since the middle of 2014, the ratio of average cement price in the southern region has been higher than 1.0x compared to the all India average price. In fact, this ratio hit a high of 1.25x in January 2016 and has since tapered off, hovering around 1.15x, which means that prices in the southern region are at least 15% higher than the all India average. There are various reasons for higher prices including lower blending, higher input costs compared to players in the northern region and higher lead distance in certain cases. Between the three key cities of southern region, Hyderabad witnessed higher volatility in cement prices in the past on account of huge imbalance in the demand-supply scenario and the presence of multiple small cement companies. If we exclude the prices in Hyderabad, then prices in other cities like Chennai and Bengaluru have been more stable and much higher than the all India average.

Higher prices have offset the impact of weak volume in the past and supported the earnings of various companies operating in the region. As we expect the demand environment to improve, we believe that prices are likely to remain stable, thereby aiding profitability growth. In fact, post demonetisation, the southern region has been the only region with the least impact on demand as well as pricing.

Exhibit 19: Cement prices in the southern region are generally higher than all India average

Exhibit 20: Cement prices in the southern region compared to average all India price (Rs/bag)

Source: Crisil, Nirmal Bang Institutional Equities Research Source: Crisil, Company, Nirmal Bang Institutional Equities Research

Volatility in cement prices has declined: Cement prices in the southern region have been highly volatile in the past, especially in Andhra Pradesh. However, over the past few months we have seen that volatility in cement prices has come down substantially. During 4QFY15, volatility in prices in the southern region was at its high but it subsequently declined to the lowest level. However, given the steep price hike that we witnessed in April 2017, volatility is expected to increase mildly.

Exhibit 21: Volatility in cement prices in southern region at its lowest level

Source: Crisil, Nirmal Bang Institutional Equities Research

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430

Jan

-12

Ap

r-1

2

Jul-1

2

Oct

-12

Jan

-13

Ap

r-1

3

Jul-1

3

Oct

-13

Jan

-14

Ap

r-1

4

Jul-1

4

Oct

-14

Jan

-15

Ap

r-1

5

Jul-1

5

Oct

-15

Jan

-16

Ap

r-1

6

Jul-1

6

Oct

-16

Jan

-17

Ap

r-1

7

South All India Average ex Hyderabad (Rs/bag)

(Rs/bag)

0

5

10

15

20

25

30

35

40

Jan

-13

Ma

r-1

3

Ma

y-1

3

Jul-1

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p-1

3

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v-1

3

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-14

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r-1

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Ma

y-1

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y-1

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p-1

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v-1

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Ma

r-1

6

Ma

y-1

6

Jul-1

6

Se

p-1

6

No

v-1

6

Jan

-17

Ma

r-1

7

Volatility in southern prices measured as std dev


14 Cement Sector

Southern region witnessed strong MoM price hike in April 2017 after weakness for a couple of months

Cement prices in the southern region witnessed a big MoM advance after relatively weak prices for the past two months. Dealers in Chennai stated that the price hike was notified to them at short notice. Prices in Chennai rose by around Rs20-Rs30 per bag while Hyderabad showed an uptick of Rs35-Rs40 per bag. However, the sharpest rise in this region was witnessed in Bengaluru where prices rose by Rs40-Rs50 per bag. Dealers indicated a fall in demand from the beginning of the current month, but were not sure whether it could be attributed to the hike. Dealers expect the demand to improve slightly, but remain unsure about future price prospects and whether the hiked prices can sustain. Some dealers also indicated that uncertainty coupled with lack of construction activity during the monsoon season will make it very tough to sustain the hiked prices. Some regions also saw follow-on pricing hikes in the second week of April 2017 as well.

Protest from CREDAI on higher cement prices

The Confederation of Real Estate Developers’ Association of India (CREDAI), which is an apex body of real estate developers in India, has protested against this massive price hike undertaken by cement companies. This body has been vocal in the past with respect to arbitrary cement price hikes undertaken by companies. In fact, on various occasions its members have even boycotted buying cement of premium brands to protest against the price hike.

CREDAI stated it has received numerous complaints and protest mails from its members across India about cement companies hugely jacking up prices of cement, thus negatively affecting the deliverability of affordable housing projects. Cement prices have witnessed a sudden jump of 20% to 40% in a short span of two months across India, while there are reports that cost of production of cement has not changed much. While the government laid emphasis on the housing industry and recognised its need, especially the affordable housing segment, by awarding it infrastructure status, this unjust price rise may increase construction costs which will have to be passed on to the consumers. CREDAI has regularly requested the central government for its swift intervention to put an end to the collusive practices in the industry and rein in price hikes so that it may contribute to the government’s goal of ‘Housing for All’ by 2022.

Here is the verbatim account of what the CREDAI president stated:

“We are pained by the complaints of unjustifiable and collusive jacking up of cement prices by cement manufacturers across India which have a potential to create unnecessary roadblocks and impediments in achieving the goals of Housing For All by 2022 envisioned by our Prime Minister. On earlier occasions too the Competition Commision of India has pulled up cement manufacturers for collusive pricing and imposed hefty fines on them. It is estimated that Rs100 rise in cement per bag results in increase in construction cost by at least Rs50 per square foot in the entire project. We are in talks with other affected parties like Builder’s Association of India as well as National Highway Builder’s Federation for possible joint action against this artificial price rise.”

Where do we think cement prices can go from here?

While the comments made by the property developer’s body are a threat to higher cement prices, we believe that historical instances like this have not yielded much result in favour of developers. We expect some correction in cement prices in the near term as the hike in April 2017 has been too steep. However, we believe that cement prices in the southern region will be resilient and that cement companies will pass on the increased cost burden to consumers by way of higher prices. We do not have pricing estimates for individual cities, but for companies in our coverage we have factored in 3%-6% increase in realisation from a low base.

More recently, a group of ministers (GOM) constituted by the Andhra Pradesh government, held talks with the cement companies to look into the steep price hike taken by the companies in the month of April. The construction industry already reeling under the pressure of low demand has alleged that the cement companies have created artificial scarcity in the market by deliberately stopping production intermittently. We expect the pricing in the southern region to be stable in the near-medium term as we expect some uncertainty on back of GST implementation etc.


15 Cement Sector

Supply outlook

No significant capacity addition planned

Southern region is likely to witness fewer additions to supply compared with other regions. Out of total supply of close to 40mnmt of capacity which is slated to come up in India, the southern region will only see addition of 8.5mnmt of capacity. Moreover, a large part of this capacity is expected to come up in Karnataka, which predominantly supplies cement to Maharashtra, and as a result will not impact the prices in the southern region much. While capacity utilisation may not touch a very high level, we expect a marginal improvement every year which should be enough to support the prices at higher levels.

Exhibit 22: Cement capacity addition across India

(mnmt) FY16 FY17 FY18E FY19E

Northern region 6.90 0.50 0.00 2.50

Eastern region 1.10 6.35 12.45 1.10

Southern region 3.00 - 3.95 4.60

Western region 1.20 1.00 3.00 3.50

Total 12.20 7.85 19.40 11.70

Total capacity 408.69 416.54 433.94 445.64

Addition as % of total capacity 3.0 1.9 4.5 2.6

Total demand 269.52 265.96 277.52 296.41

Addition as % of total demand 4.5 3.0 7.0 3.9

Source: Crisil, Nirmal Bang Institutional Equities Research

Exhibit 23: Cement capacity coming up in the southern region

Company Location FY18E FY19E

Zuari Cement Karnataka 3.20 -

Shree Cements Karnataka - 3.00

KCP Andhra Pradesh - 1.60

NCL Industries Andhra Pradesh 0.75 -

Total

3.95 4.60

Source: Crisil, Nirmal Bang Institutional Equities Research; Exhibit 24: Capacity utilisation will see marginal improvement after the trough in FY16

Source: CMA, Nirmal Bang Institutional Equities Research

92%

84%

72%

65%

59%56%

53%51% 50% 51%

53%55%

40%

50%

60%

70%

80%

90%

100%

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

E

FY

18

E

FY

19

E

Utilization (%)


16 Cement Sector

Profitability snapshot of southern players

Exhibit 25: Financial and valuation snapshot

Market-cap CMP Target Up/ EV/E (x) P/B (x) RoE (%)

Company Rating Rsbn US$mn (Rs) price down(%) FY18E FY19E FY18E FY19E FY18E FY19E

Dalmia Bharat Buy 215 3,311 2,406 2,806 17% 12.2 10.2 4.2 3.5 15.4 17.6

Sagar cement Buy 17 259 806 951 18% 11.5 8.6 1.9 1.7 8.6 12.5

The Ramco Cements Accumulate 169 2,596 705 775 10% 11.9 10.8 3.9 3.3 17.0 17.0

Source: State budget documents; PRS India, Nirmal Bang Institutional Equities Research

Exhibit 26: EBITDA/mt of southern players has been generally higher in recent quarters . . .


Exhibit 27: . . . so has been the volume growth

Source: Company, Nirmal Bang Institutional Equities Research;

0

200

400

600

800

1,000

1,200

1,400

TRCL DBEL SRCM UTCEM JKCE ICEM ACEM HEIM SGC ACC JKLC PRSC MGC

Southern players exhibited higher

EBITDA/mt in 3QFY17 on account of better

(EBITDA/mt (Rs))

22.1 21.6 20.0 20.0

5.9 4.6 4.0

0.5

(1.6) (1.7)(3.7) (4.5)

(8.8) (9.2)(11.1)

-15

-10

-5

0

5

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15

20

25

TR

CL

ICE

M

OR

CM

NT

DB

EL

MG

C

SR

CM

JKL

C

SG

C

PR

SC

UT

CE

M

HE

IM

JKC

E

AC

EM

AC

C

BC

OR

P

Volume growth (y-y %)

(YoY %)


17 Cement Sector

Exhibit 28: Lower RoE for southern companies is a result of lower capacity utilisation

Source: Bloomberg, Nirmal Bang Institutional Equities Research

Exhibit 29: ROE expected to shoot up in the coming years Exhibit 30: With a favourable demand scenario, operating profit margins to go up


Exhibit 31: Snapshot of the EBITDA growth Exhibit 32: Free cash flow profile looks promising for Ramco

and Dalmia


0

5

10

15

20

25

Shr

ee C

emen

t

Ram

co C

cem

ent

Ultr

atec

h

JK C

emen

t

JK L

aksh

mi

Cem

ent

Hei

delb

erg

Cem

ent

AC

C

Dal

mia

Cem

ent

San

ghi C

emen

t

Man

gala

m C

emen

t

KC

P L

td

Orie

nt C

emen

t

Birl

a C

orp

Am

buja

Sag

ar C

emen

t

Indi

a C

emen

t

Lower utilization levels have resulted in lower ROE for the south based companies with the exception of Ramco which has a superior EBITDA despite weak utilisations

(%)

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

TRCL DBEL SGC

ROE %

FY17E FY18E FY19E

0%

5%

10%

15%

20%

25%

30%

35%

TRCL DBEL SGC

OPM%

FY17E FY18E FY19E

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

TRCL DBEL SGC

EBITDA growth %

FY17E FY18E FY19E (2,000)

0

2,000

4,000

6,000

8,000

10,000

12,000

TRCL DBEL SGC

FCF

FY17E FY18E FY19E


18 Cement Sector

Exhibit 33: Our estimate vs consensus

(Rsmn) Our estimates Consensus estimates Deviation (%)

TRCL FY18E FY19E FY18E FY19E FY18E FY19E

Sales 45,517 50,178 44,618 49,566 2.0 1.2

EBITDA 15,045 16,090 13,015 14,548 15.6 10.6

PAT 8,045 9,064 7,542 8,811 6.7 2.9

DBL FY18E FY19E FY18E FY19E FY18E FY19E

Sales 82,829 92,052 84,383 96,138 (1.8) (4.3)

EBITDA 23,519 27,682 21,283 25,106 10.5 10.3

PAT 7,141 10,327 5,341 8,204 33.7 25.9

SCL FY18E FY19E FY18E FY19E FY18E FY19E

Sales 12,041 14,539 10,790 14,173 11.6 2.6

EBITDA 1,729 2,372 1,907 2,666 (9.3) (11.0)

PAT 709 1,149 642 1,133 10.5 1.4



19 Cement Sector

Snapshot of key states with possible demand potential

Andhra Pradesh - Largest producer of cement in India

Andhra Pradesh (AP) is the eighth-largest state in India covering an area of about 1,63,000sqkm. On its formation in 2014, Telangana became the newest state in India, making it the 12th-largest state in the country. The states of AP and Telangana account for the country’s largest reserves of limestone. The states together are home to about 40 cement plants out of the total 209 in the country. The AP-Telangana region is also home to Nalgonda cluster- one of the seven cement clusters in India. The states have an installed capacity of 60.2mnmt (15% of India’s total cement capacity) and demand of 16.7mnmt. As a result of this, Andhra Pradesh and Telangana are cement-surplus states exporting it to other states and surrounding markets. Major urban demand within these states comes from cities like Hyderabad, Warangal, Vizag and Vijaywada.

Exhibit 34: Consistently high growth in GSDP post 2013

Source: Government websites, Nirmal Bang Institutional Equities Research

Government spending

The common theme between the budgets of these two states has been increased spending on irrigation, which augurs well for increased cement consumption. Budgetary allocation for irrigation in Andhra Pradesh has been increased by 57% from the revised estimate of 2015-16 whereas the same in case of Telangana has been increased by a massive 169%. Spending on rural development is also higher, which will help rural income and in turn boost rural demand for cement.

The gross state domestic product (GSDP) of Andhra Pradesh for 2016-17 is estimated at Rs6.03trn, which is 13.2% higher than the estimate for 2015-16. Total expenditure for 2017-18 is estimated at Rs1,570bn, a 18.3% increase over the revised estimate of 2016-17. Departments of rural development, irrigation and health welfare witnessed increase in allocation for 2016-17. On the other hand, the department of municipal administration witnessed a 21.8% decrease in allocation for 2016-17. Irrigation allocation to the department of major and minor irrigation increased 57.3% for 2017-18, over the budget estimate of 2016-17. We expect these measures to positively contribute to higher cement demand.

The GSDP of Telangana for 2016-17 is estimated at Rs5.83trn, which is 15% higher than the revised estimate for 2015-16. Total expenditure for 2016-17 is estimated at Rs1,304bn, a 30.3% increase over the revised estimate of 2015-16. A sum of Rs241.3bn is expected to be spent on irrigation in the state, which is a massive increase of 169% over 2015-16. Moreover, 0.2mn two bed-room houses are budgeted to be built for eligible poor people. Mission Bhagirath scheme to provide drinking water supply to all houses in the state has also been allocated a significant sum. All these measures are expected to prop up cement demand in the state.

Exhibit 35: Andhra Pradesh state budget highlights

Andhra Pradesh (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)

Total expenditure 1356.0 1327.0 (2.2) 1569.0 18.3

Revenue deficit (48.7) (46.0) - (4.2) -

Fiscal deficit (205.0) (191.6) - (230.5) -

Primary deficit (82.4) (69.6) - (82.7) -


0%

2%

4%

6%

8%

10%

12%

14%

16%

0

1,000

2,000

3,000

4,000

5,000

6,000

FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16

Nominal GSDP (INR mn) (LHS) GSDP growth (RHS)

(Rsmn)


20 Cement Sector

Exhibit 36: Telangana state budget highlights

Telangana (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)


Revenue deficit 37.2 2.0 - 45.7 -

as a % of GSDP 0.6 0.0 - 0.6 -

Fiscal deficit (234.7) (218.9) - (261.0) -

as a % of GSDP (3.5) (3.4) - 3.5 -

Primary deficit (157.6) (141.9) - (149.6) -

as a % of GSDP (2.3) (2.2) - (2.0) -


Exhibit 37: Andhra Pradesh expenditure details

Andhra Pradesh (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)

Capital expenditure 215.2 204.6 (4.9) 310.9 52.0

Revenue expenditure 1141.7 1123.1 (1.6) 1259.1 12.1


Debt + interest 178.1 177.6 (0.3) 227.9 28.3


Exhibit 38: Telangana expenditure details

Telangana (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)


Revenue expenditure 972.1 868.7 (10.6) 1085.1 24.9

Total expenditure 1304.2 1121.9 (14.0) 1496.5 (33.4)

Debt + interest 108.6 108.6 0.0 158.0 45.5


Exhibit 39: Increased allocation for irrigation, panchayat raj and rural development

Andhra Pradesh (Rsbn) Department

2016-17 budgeted

2016-17 revised

Change (%)

Comments

Rural development 114.72 145.31 26.7 Under National RURBAN Mission, six clusters (Alur, Nandalur, Cheepurupalli, Sompet, Nujendla and Chendarlapadu) have been selected. Rs5.02bn has been allocated under Pradhan Mantri Gram Sadak Yojana.

Water resources (Irrigation)

81.2 127.7 57.3 Polavaram project is estimated to receive Rs72.51bn. This is more than a 100% increase as compared to the revised estimate in 2016-17. Under the scheme NTR Jala Sri, 120,000 new bore wells have been sanctioned. Rs440mn has been allocated in this regard.

Panchayat raj 56.96 66.1 16 Rs65.62bn has been allocated for MGNREGS.

Urban development 66.61 52.07 (21.8) Rs10.61bn has been allocated for capital development operations.


Exhibit 40: Substantial increase in spending on irrigation in Telangana

Telangana (Rsbn) Department

2016-17 revised

2017-18 budgeted

Change (%)

Comments

Irrigation 145.6 226.7 55.7 The government aims to provide irrigation to 10mn people in the state. Manair River Front Project will be implemented at an estimated cost of Rs 5.06bn. A provision of Rs1.93bn has been proposed for the project in the budget.

Social welfare 68.9 103.8 50.6

It is proposed to procure and distribute 8.4mn sheep to 4,00,000 Yadava community families in the state over the next two years. Under the scheme, it is proposed to distribute 20 female and one male sheep to each eligible family enrolled under a Sheep Development Cooperative Society at 75% subsidy.

Rural development 63.5 74.4 17.3 Rs30bn is budgeted to be spent under MNREGA.

Panchayat raj 39.91 72.8 82.4 Current projects to convert WBM roads to BT roads, and maintenance of BT roads will be continued.



21 Cement Sector

Demand-supply scenario

Andhra Pradesh and Telangana together have been the largest producers of cement in India. With the abundance of limestone, AP and Telangana have been cement-surplus states for a long time. Over the past15 years, cement capacity in these states has gone up from 6.8mnmt in 2000 to 37.8mnmt in 2016. However, capacity utilisation in the southern region as a whole has been languishing at 55.4% since FY15. We expect no major capex in Andhra Pradesh in the next three years.

Exhibit 41: AP-Telangana region is a cement-surplus region due to the presence of Nalgonda cluster


Exhibit 42: Cement demand growth has fallen behind GDSP growth for some time now

Source: CMA, Government websites, Nirmal Bang Institutional Equities Research

Exhibit 43: Per capita cement consumption has started to pick up once again

Source: Government websites,, Nirmal Bang Institutional Equities Research

0

10

20

30

40

50

60

70

FY

00

FY

01

FY

02

FY

03

FY

04

FY

05

FY

06

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07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

E

Capacity Demand

(million metric ton)

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%


Cement demand growth Nominal GSDP growth

0

50

100

150

200

250

300

65,000,000

70,000,000

75,000,000

80,000,000

85,000,000

90,000,000

95,000,000

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

E

Population (LHS) Per capita cement (in kg) (RHS)

(kg)


22 Cement Sector

Exhibit 44: Major cement brands

Installed capacity (mt) Brand

India Cements 7.09 Coromandel King-Sankar Sakthi- Raasi Gold

Penna Cement 6.5 Penna Power, Penna Premium

UltraTech Cement 5.6 UltraTech

Jaiprakash 5 Jaypee Cement


Tamil Nadu- Large number of players in a competitive market

In the 2017-18 budget, Tamil Nadu government has formulated five priority missions - namely, water resource management, poverty reduction, housing for poor, skill building and clean Tamil Nadu. The budget has laid down a strong foundation for cement demand in the coming financial year. The government has decided to rejuvenate Kudiramamath, a programme to maintain and manage water bodies within the state. As Tamil Nadu is a water-deficit state, the government has increased the allocation to Rs3bn in 2017-18. The government has also proposed to take over irrigation, ground water recharge and other drinking supply projects in the state through an approval of Rs2.5bn. The total allocation for the water resources department is Rs48bn, up 41% from the revised estimate of 2016-17. Under the highways department, the state has allocated a total of Rs100bn. In addition to this, the government has allotted Rs37bn for the Chennai metro rail project.

Exhibit 45: GSDP has grown consistently at a CAGR of 9% since FY06


Exhibit 46: Cement capacity has far exceeded the state’s demand since FY09


0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0

2,000

4,000

6,000

8,000

10,000

12,000


Nominal GSDP (Rsmn) (LHS) GSDP growth (RHS)

(Rsmn)

0

5

10

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25

30

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40

FY

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FY

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FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17

E

Capacity Demand



23 Cement Sector

Exhibit 47: Per capita cement consumption is expected to pick up after a flattish trend


Exhibit 48: Cement demand growth has lagged GSDP growth for a while now

Source: Government websites, CMA, Nirmal Bang Institutional Equities Research

Karnataka- Consistent demand growth since the last decade

Karnataka is the seventh-largest state in India covering an area of about 1,92,000sqkm. The states of AP and Telangana account for the country’s largest reserves of limestone. Karnataka is home to 13 major cement plants and has a total installed capacity of 37.8mnmt. (9.4% of India’s capacity). Major urban demand for Karnataka comes from clusters like Bengaluru, Mysore, Kochi and Trivandrum. The state has a GSDP of US$154bn and has posted a CAGR of 17%.

Exhibit 49: GSDP has grown from Rs4bn in 2006 to over Rs8bn in 2016


0

50

100

150

200

250

300

0

10,000,000

20,000,000

30,000,000

40,000,000

50,000,000

60,000,000

70,000,000

80,000,000

90,000,000

FY01

FY02

FY03

FY04

FY05

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

E


(kg)

-10%

-5%

0%

5%

10%

15%

20%

25%

30%



0%

2%

4%

6%

8%

10%

12%

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000


Nominal GSDP (Rsmn) (LHS) GSDP growth (RHS)

(Rsmn)


24 Cement Sector

Government spending

Exhibit 50: Karnataka state budget highlights

Karnataka (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)

Total expenditure 1,634.0 1,644.0 0.6 1,865.0 13.4

Revenue deficit 5.2 10.6 - 1.4 -

as a % of GSDP 0.1 0.1 - 0.0 -

Fiscal deficit (256.6) (241.5) - (333.6) -

as a % of GSDP (2.3) (2.2) - (2.6) -

Primary deficit (129.9) (118.6) - (192.0) -

as a % of GSDP 1.2 (1.1) - (1.5) -

Source: State budget documents, PRS India, Nirmal Bang Institutional Equities Research

Exhibit 51: Karnataka expenditure details

Karnataka (Rsbn)

2016-17 budgeted

2016-17 revised

Change (%)

2017-18 budgeted

Change (%)


Revenue expenditure 1302.4 1318.1 1.2 1447.6 9.8

Total expenditure 1634.2 1644.8 0.6 1865.6 13.4

Debt + interest 200.5 200.8 0.2 226.9 13.0


Exhibit 52: Increased allocation for irrigation, urban & rural development and social welfare

Karnataka (Rsbn) Department

2016-17 budgeted

2016-17 revised

Change (%)

Comments

Irrigation 113.89 106.32 -6.6 Rs30bn is estimated to be spent on 21 different projects. This includes development of canal in the Cauvery basin at a cost of Rs5.1bn.

Urban development 110.29 105.62 -4.2 Bengaluru metro rail work for the line between Silk Board to K. R. Puram will be commenced at a cost of Rs42bn.

Rural development 127.61 127.44 -0.1 Rs22bn has been allocated for the Rural Water Supply Scheme. Rs 15.85bn will be provided for ensuring rural sanitation and creating an open defecation-free state.

Social welfare 91.1 92.58 1.6 Rs3bn has been allocated to distribute buffalo-cow or sheep/goat to 100,000 SC/ST families. Rs1bn has been allocated for LPG connections to SC/ST families living below the poverty line.


Exhibit 53: FY10 saw a spurt in capacity which is expected to be above demand for years to come


0

5

10

15

20

25

30

35

40

FY

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FY

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13

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14

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16

FY

17

E

Capacity Demand



25 Cement Sector

Exhibit 54: Population as well as per capita cement consumption has shown steady growth


Exhibit 55: Post FY13, cement demand growth has lagged GSDP growth


Exhibit 56: Major cement brands

Installed capacity (mt) Brand

ACC 5.30 ACC

JK Cement 3.00 JK Super Cement

Orient Cement 3.00 Birla A1, Orient Gold

Sagar Cements 2.75 Bharathi

Chettinad Cement 2.50 Chettinad Builder's Choice


0

50

100

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200

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300

0

10,000,000

20,000,000

30,000,000

40,000,000

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FY

01

FY

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FY

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FY

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FY

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FY

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FY

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(kg)

-10%

-5%

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26 Cement Sector



Initi

atin

g C

over

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Reuters: DALA.BO; Bloomberg: DBEL IN

Dalmia Bharat

The Best Growth Story In Cement Space We initiate coverage on Dalmia Bharat (DBL) with a Buy rating and a target price of Rs2,806,up 17% from the current market price. DBL, according to us, is probably the best and successful growth story in the cement space in India. From a capacity of merely 1.2mnmt in FY06, DBL has been able to grow to a 25mnmt company by FY16, placing it among the top four cement companies in India. Now that a significant scale has been achieved through inorganic and organic routes, we expect the company to report much higher volume growth for the next few years along with increased market share. Apart from this, DBL has been able to achieve growth while focusing on improving efficiency as well. DBL boasts of significantly lower operating costs which help it to generate one of the highest EBITDA/mt among peers. DBL has various firsts to its credit like being the largest slag cement company in India, having one of the lowest electricity consumption patterns in the country, having one of the lowest carbon footprints in the world and a much higher cement-to-clinker ratio among peers. Given the scope for much higher volume growth, presence in regions where cement prices have been favourable and stable and completion of a major capex programme, DBL is all set to achieve superior earnings growth driven by the excellence exhibited in the past in capex as well as opex. Moreover corporate restructuring - which is on the verge of completion - will create a pure play cement company unlike a holding company in the past, which will further help shore up its financials and achieve better valuation multiples given its size. We have factored in 12.7%/20.6%/75.6% CAGR in sales, EBITDA and net profit over FY16-FY19E, respectively. We have valued DBL stock based on our usual method of the average of earnings and asset-based valuation. Our target multiples for DBL at 12.0x FY19E EV/EBITDA and US$150 FY19E EV/mt are higher than that of some pan-India players like ACC and Ambuja Cements but lower compared with UltraTech Cement. We believe that given the vast earnings potential and aggressive management approach, the higher multiples are justified. Our target price on the DBL stock is Rs2,806, up 17% from the current market price. Key risks to our call include demand slowdown in DBL’s key markets affecting the pricing and aggressive acquisition in future leading to strain on its balance sheet. Excellence in opex and capex to generate best return ratios in the industry: DBL has reduced its operating costs by 24% over the past few years on account of higher blending, increased usage of alternate fuel and higher production from its new and modern plants. The cost at which DBL has acquired capacity or has grown organically averages close to US$90/mt compared to much higher replacement cost. This trait of excellence in opex as well as capex is likely to generate much higher return ratios for DBL as its assets start operating close to their optimum capacity. Restructuring complete, pure play cement company to have much higher multiples: As DBL has grown its cement business through acquisitions right from 2006, the erstwhile corporate structure of the company had its cement business under various subsidiaries and associate companies along with other businesses not related to cement. Over the years and through a series of measures, DBL developed a much leaner structure and is now a large pure play cement company with huge operating leverage.

BUY

Sector: Cement

CMP: Rs2,406

Target Price: Rs2,806

Upside: 17%


Key Data

Current Shares O/S (mn) 89.0

Mkt Cap (Rsbn/US$mn) 214.1/3.3

52 Wk H / L (Rs) 2,422/813

Daily Vol. (3M NSE Avg.) 311,413

Share holding (%) 2QFY17 3QFY17 4QFY17

Promoter 57.4 57.3 57.8

DII+FII 13.3 13.8 13.4

Others 29.3 28.9 28.8

One -Year Indexed Stock Performance

Price Performance (%)

1 M 6 M 1 Yr

Dalmia Bharat 11.3 20.7 186.6

Nifty Index 1.3 10.5 18.4

Source: Bloomberg

Y/E March (Rsmn) FY14 FY15 FY16 FY17E FY18E FY19E

Revenues 30,158 35,141 64,380 73,140 82,829 92,052

YoY (%) 8.1 16.5 83.2 13.6 13.2 11.1

EBITDA 4,640 5,999 15,773 19,511 23,519 27,682

EBITDA (%) (26.5) 29.3 162.9 23.7 20.5 17.7

Adj. PAT (84) 30 1,908 3,800 7,141 10,327

YoY (%) - - - 99.2 87.9 44.6

EPS (Rs) (1) 0 21 43 80 116

RoE (%) 0 0 5 9 15 18

EV/EBITDA 13.73 19.3 10.9 13.9 11.2 9.2

EV/mt (US$) 53.41 73.9 105.3 167.0 162.5 156.5

P/E (x) - - 57.3 56.2 29.9 20.6


7090

110130150170190210230250270290310

May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17

DALMIA BHARAT LT Nifty 50

10 May 2017


28 Dalmia Bharat

The best growth story in the cement space

DBL is probably the best growth story in the cement space in India. From mere 1.2mnmt capacity in FY06, DBL currently has 25mnmt capacity, placing it among the top four players in the cement industry in India. DBL has pursued aggressive brownfield and greenfield /organic and inorganic capacity expansions along with focus on regions where it can attain a higher market share. Barring UltraTech Cement, none of the cement companies in India have been able to mirror the performance of DBL. While higher leverage was a cause for concern to DBL some time back, the focus on improving efficiency and controlled capital costs of acquisitions helped the company to achieve excellence in capex as well as opex.

Exhibit 1: Well executed expansion plan over the past decade


Till 2006, DBL had capacity of 1.2mnmt with a very old plant in India. The story of 20x capacity expansion started from there. Over the next five to six years, DBL commissioned greenfield plants in AP and Tamil Nadu along with acquisition of 45% stake in OCL India. During this time, DBL got immense help from the private equity investors like Actis and KKR through their equity funding. Moreover, DBL was able to successfully overcame the crisis in southern region where overcapacity and demand contraction resulted in weak earnings and created survival problems for various players operating in the region. After completion of this capex, DBL acquired cement plants at strategic locations in north-east region from Adhunik and Calcom along with Jaypee’s capacity in Jharkhand. Finally, acquisition of additional stake in OCL India completed the capex plan of DBL to touch 25mnmt capacity, the fourth-largest in India after Aditya Birla Group, Holcim and Shree Cements.

Exhibit 2: Impressive growth in capacity


Up to 2006

• Very old cement plant of 1.2mnmt

• First to produce specialty cement

2006-12

• Acquired 45.4% stake in group company OCL India

• Entry of PE investors with one of India’s largest PE deal in cement space

• Completed large capex plan to build greenfield capacities in AP and TN

2012 till now

• Enhanced stake in OCL to 74%

• 2nd phase of organic expansion in Karnataka, West Bengal and Assam

• Inorganic expansion at strategic locations in East and North East

• Simplification of corporate structure

• Capex completed in FY15; huge operating leverage at play

0

5

10

15

20

25

30


Expansion at Dalmiapuram,

TN

New unit in Cuddapha,

AP

New unit in Ariyalur,

TN

Capacity acquisition

in NE

New Capacity atBelgaum, KArnataka

and acquisition of Jaypee Bokaro in

Jharkhand

Increased stake in OCL to74%

(mnmt)


29 Dalmia Bharat

Excellence in both opex and capex

Another interesting fact about DBL has been that apart from its pursuit of higher capacity and market share, the company also focused on improving efficiency at its existing plants and doing capex at optimum costs. We believe this trait will be the single-most factor which will improve the company’s return ratios as the plants start operating at optimum capacity. DBL has attracted talent at both factory as well as senior management level to achieve excellence in operations. The appointment of Mr. Mahendra Singhi from Shree Cements as whole time director and group CEO was one such example of achieving efficiency by using experienced human capital.

Huge improvement in operating efficiency over the past few years

DBL has been able to reduce its operating costs by 24% over the past four years. Part of the decline can be contributed to:

a) Higher production from new plants (most DBL plants are modern plants with higher efficiency),

b) Higher blending ratio and higher cement-to-clinker ratio (OCL produces slag cement which has very high cement-to-clinker ratio),

c) Modernisation and upgradation of plants leading to industry-leading lower electricity consumption and specific heat consumption,

d) Increased usage of alternate fuels like pet coke.

Exhibit 3: Consistent decline in variable costs over the past four years


Exhibit 4: Grey cement electricity and fuel consumption Exhibit 5: White cement electricity and fuel consumption


1,000

1,100

1,200

1,300

1,400

1,500

1,600

1,700

FY14 FY15 FY16 FY17E

Variable costs (Rs/mt)

Variable costs have reduced by 24% over

the past four years

64%

66%

68%

70%

72%

74%

76%

78%

80%

82%

84%


Blended cement as % of Total

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%


Use of alternate fuel as % of total fuel mix


30 Dalmia Bharat

DBL increased the proportion of blended cement in its overall product mix from 71% in FY14 to 82% in FY17. Blended cement is not only more environment friendly over the usual cement varieties, but it also improves operating costs as the clinker factor in total output reduces. Moreover, blended cement uses waste products like fly ash and slag which are considered environmental hazards. Slag is the waste produced by steel plants and its use in cement has been as a cost-effective additive which helps in conservation of limestone reserves. Fly ash is the waste produced by coal-based power plants; its increasing use in cement manufacture has helped in doing away with environmental problems in its disposal. DBL enhanced the use of fly ash and slag in cement substantially as compared to its historical benchmarks. DBL also moderated the consumption of power in the manufacture of cement. DBL reduced power consumption per tonne of cement manufactured from 74 units in FY14 to 67 units in FY16, establishing a new benchmark in Indian cement industry. While the use of pet coke instead of coal was driven by lower pet coke costs, the plants of DBL are equipped with multi fuel inputs making them flexible when it comes to using different fuels, depending on their price. The usage of alternate fuels including pet coke and other things like municipal waste, carbon black and saw dust increased from 15% in FY14 to 80% in FY17. Also, the company’s plants in southern region have already achieved 100% pet coke and other alternate fuel usage in their fuel mix. All these measures coupled with the focus on keeping lead distance below 300km resulted in lower operating costs for DBL.

Organic and inorganic acquisitions realised with efficient deployment of capital

DBL has followed a zonal approach in creating capacity and acquiring companies. Current footprint of the company is largely based in eastern and southern regions. While a large part of capacity in souther region has grown organically, most of the capacity in eastern region came up through the inorganic route. Around 50% of existing capacity of DBL was created through acquisitions. The average cost of acquisition and capex for a new plant of DBL has been around US$91/mt compared to replacement cost of around US$130-US$140/mt. This efficient deployment of capital will help generate higher return ratios for the company over the long run.

Exhibit 6: Cost of organic and inorganic acquisitions for DBL


Below we have looked at the timeline of past key acquisitions and capacity creation by DBL.

Acquisition of equity stake in OCL India: DBL acquired 21.7% stake in OCL India in October 2007. The company progressively increased its stake to 45.4% in 2010 to 48% in FY14 and 74.6% in FY15 (owning the entire promoter shareholding). In November 2016, DBL announced the amalgamation of OCL India with DBL. After this amalgamation and restructuring exercise is complete, DBL will be a single cement entity of the group with a very simplified structure. This move will not only help consolidate and use the cash flow efficiently, but will also lower administrative costs, in our view. In FY15, OCL India launched its premium Konark DSP-Dhalai special brand of cement, which currently accounts for 16% of its total sales. This launch helped improve average realisation of operations in the eastern region. As the share of Konark DSP in the company’s total sales mix improves, a further improvement in realisation is expected.

Acquisition of Calcom Cement (North East): DBL acquired 50% stake in Assam-based Calcom Cement in January 2012, increasing its stake to 75.6% in November 2012. At the time of the acquisition, Calcom’s grinding and clinker capacity was 1.3mnmt and 0.3mnmt, respectively, which was subsequently expanded to 2.1mnmt of grinding and 1.3mnmt of clinker capacity.


31 Dalmia Bharat

Acquisition of Adhunik Cement (North East): DBL acquired Meghalaya-based Adhunik Cement (1.5mnmt capacity) in September 2012.

Acquisition of Dalmia Cement East (erstwhile Bokaro Jaypee Cement): DBL acquired 100% stake (in two stages) in Bokaro Jaypee Cement (2.1mt split grinding unit) from Jaiprakash Associates in 2014 (with a 30-year slag and clinker supply agreement). The acquisition enabled the company to enter new and growing markets of Bihar and Jharkhand. Following the acquisition, DBL replaced its erstwhile brand with Dalmia brand in the premium category.

Strong brands and market presence

DBL, over the years, created successful brands in cement, helping the company achieve higher market share and realise beter prices. DBL’s brand portfolio comprises Dalmia DSP, Dalmia, Dalmia Ultra, Dalmia Super Roof, Vajram, Konark and Konark DSP. These brands are positioned as premium brands across all its existing markets. Focus on branding of cement has helped in increasing the recall value of the brands. Moreover, higher capacity in existing markets coupled with brand visibility helped the company to gain market share. The company has also launched various specialty cement products which are used in lining of oil wells, railway sleepers and air strips among other downstream applications. The strategy of the company is to create a mother brand named Dalmia and sell other sub-brands under the main brand. This strategy helped the company to successfully replace its erstwhile brand to Dalmia brand and even charge a premium. Exhibit 7: Brand portfolio of DBL

Source: Company

Market share of ~11% in key markets

Along with scale, the focus of the company is to improve market share in its existing markets. We have classified DBL’s geographic reach in three segments - South, East and North East. Market share of the company in all these regions has improved over the past two to three years. In southern region, where fragmentation is very high, DBL has close to 7.5% market share with 12mnmt capacity. In eastern region, the company has 15% market share with 9.3mnmt capacity and in north-east region it has 21% market share with 3.6mnmt capacity.

Exhibit 8: Region-wise gain in market share over nine-month period Exhibit 9: Consistent improvement in market share

Region 9MFY16 9MFY17 3QFY16 3QFY17

South 6.7% 7.4% 6.5% 7.7%

East 15.1% 15.1% 15.2% 15.0%

North-East 16.7% 20.6% 18.9% 20.6%

Average 10.4% 10.8% 10.7% 11.0%


8.1%

9.0%

10.5%

11.0%

6%

7%

8%

9%

10%

11%

12%


Market share in operating markets (%)


32 Dalmia Bharat

Restructuring in last leg; pure play cement company with simplified structure now

As DBL has grown its cement business through acquisitions right from 2006, the erstwhile corporate structure of the company had its cement business under various subsidiaries and associate companies along with other businesses not related to cement. DBL had given an assurance of creating a pure play cement company and simplifying the existing structure. In 2010, the company was known as Dalmia Cement (Bharat) with operations in cement, sugar and power businesses. In March 2010, the company’s board decided to hive off the sugar and cement businesses. As a result, Dalmia Bharat Enterprises (DBEL) was created with cement, power and refractory assets. The cement and thermal power business was housed under DBEL as two wholly-owned subsidiaries — Avnija Properties and DCB Power Ventures.

In FY16, DBL acquired KKR’s 15% stake in Dalmia Cement (Bharat) or DCBL through a preferential issue of 75,00,000 equity shares and a part cash consideration. Subsequently, DBL acquired a 100% ownership in Dalmia Cement (Bharat) and KKR became the largest institutional shareholder in DBL. This restructuring helped DBL simplify its corporate structure while extending its successful partnership with KKR.

DBL also announced the amalgamation of OCL India (OCL) and Dalmia Cement East Bokaro) with Odisha Cement , a 100%-subsidiary of OCL. Adhunik Cement (DBL’s subsidiary) was amalgamated with Dalmia Cement (Bharat) following a transfer of 99MW power assets from Dalmia Cement Bharat Power Ventures to DCBL. This restructuring provided a single cement company with 75% stake in OCL and 76% stake in Calcom. Rest of the cement assets were part of DCBL, an operating company of DBL.

In November 2016, this structure was further simplified with OCL being amalgamated with DBL. This resulted in a more simplified structure with now only Calcom remaining as a 76%-owned subsidiary.

Exhibit 10: Simplified corporate structure to be achieved in the next few months

Source: Company

Final stage transaction overview – OCL India amalgamating with DBL

Amalgamation of Dalmia Bharat (DBL) and OCL India (OCL)

OCL India to be renamed as DBL

Transfer of business undertakings of OCL India to Dalmia Cement (Bharat) (DCBL)

DBL shareholders to receive two shares of OCL India for every share held in DBL


33 Dalmia Bharat

Leverage not a concern anymore; free cash flow and capex completion to ensure debt reduction

DBL has grown its capacity 20x in the past 10 years. Naturally, the debt of the company is on the higher side and was a cause for concern a couple of years ago. Over the past few years, higher cash flow from operations and conclusion of capex programme resulted in comfort over its balance sheet. Over the next few years, increased capacity utilisation, cost leadership and better pricing in key markets will lead to reduction in debt level, in our view. During the time of higher debt, DBL refinanced its debt to not only reduce interest costs but also increase the debt tenure to improve current liquidity. The longer the tenure of debt, the repayment terms become easier and interest rates competitive. Longer tenure enhances free cash availability in the initial years when capacity utilisation is usually lower. Net debt of the company declined from a high of Rs63.7bn to Rs56.6bn in FY17 and we expect it to go down below Rs40bn by FY19.

Exhibit 11: Gross debt to come down from its high level


Exhibit 12: Net debt-to-equity ratio to slip below 1.0x by FY18E Exhibit 13: Better negotiations with bankers led to lower debt costs


-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

FY13 FY14 FY15 FY16 FY17E FY18E

Gross Debt (Rsmn) Cash (Rsmn)

(Rsmn)

0.89

1.16

2.06

1.55

1.29

0.98

-

0.50

1.00

1.50

2.00

2.50

FY13 FY14 FY15 FY16 FY17E FY18E

(x)11.0%

10.0%

9.4%

8.7%

7.0%

7.5%

8.0%

8.5%

9.0%

9.5%

10.0%

10.5%

11.0%

11.5%


Average interest costs


34 Dalmia Bharat

Valuation

We initiate coverage on DBL with a Buy rating and a target price of Rs2,806. We believe DBL offers huge operating leverage as its plants are currently operating at ~55% of their capacity. This operating leverage coupled with cost leadership and presence in regions where pricing is in favour like southern and north-east makes DBL an exciting play in the cement space. We have valued the company based on the average of EV/EBITDA and EV/mt multiple. Our target multiple for EV/EBITDA calculation is 12.0x which is in line with the multiples we have assigned to other companies like ACC and Ambuja Cements but lower when compared with The Ramco Cements. Our target price based on this method comes out to Rs2,806, up 17% from the current market price.


Particulars (Rsmn)

FY19E EBITDA 27,682

Target multiple (x) 12.0


Net debt 40,685

Equity value 291,495

No of shares (mn) 88.8


Particulars (Rsmn)


Target multiple (US$) 150.0


Net debt 40,685

Equity value 206,815




Exhibit 16: Target price of Rs2,806, up 17% from the current market price

Particulars (Rs)

Value based on earnings multiple 3,283


Average value per share 2,806

Target price 2,806

CMP (Rs) 2,406

Upside (%) 17%



35 Dalmia Bharat

Company background

Dalmia Bharat is a part of the Dalmia group founded by Mr. Jaidayal Dalmia in 1935. Headquartered in Delhi, the group has interests in cement, sugar, travel, magnesite, refractories and electronics businesses.. The group, which had its cement interests spread out under a number of companies (Adhunik Cements, OCL India etc), recently got restructured under a single company called Dalmia Bharat .

Dalmia Bharat is India’s fourth-largest (capacity-wise) multi-spectrum cement player with double-digit market share. In addition to OPC and PPC, the company is a pioneer in super specialty cements used in oil wells, railway sleepers and air strips. With the recent restructuring, the company has consolidated its 45.4% stake in OCL India as well as acquired the brands Adhunik Cement & Calcom Cement in the north-east region. As a result, the group now has cement capacity of 21.8mtma.

Dalmia Bharat’s most recent greenfield expansion was in Belgaum, Karnataka. Dalmia Bharat has also set up over 53 wind mills in Muppandal (Tamil Nadu) to generate captive power for its plant. The company enjoys significant market share in southern region, especially in its focus areas of Tamil Nadu and Kerala. In addition to operating efficiency, the company has consistently been voted as one of the most eco-friendly cement companies in India. In terms of geographical break-up, the company has 52% of its capacity in eastern region and 48% in southern region.

Exhibit 17: Corporate history

Source: Company presentation, Nirmal Bang Institutional Equities Research

Exhibit 18: Shareholding pattern


57.3

8.9

4.9

28.9

Promoter FII DII Public


36 Dalmia Bharat

Exhibit 19: Key shareholders (%)

Promoter 57.34

KKR (strategic partner) 16.86

Morgan Stanley Asia 1.4

Birla Sunlife Asset Management 1.17

DSP Blackrock Investment Managers 0.81

Goldman Sachs Group 0.78

Vanguard Group 0.66


Exhibit 20: Board members and management team

Name of the director Designation Experience

Mr. Pradip Khaitan chairman, non- executive, non- independent director

He holds LLB degree from the University of Calcutta. A partner in Khaitan & Co., solicitors and advocates, he has legal and commercial experience. Mr. Khaitan serves as director in several public limited companies such as CESC,, Electrosteel Castings, Graphite India Hindustan Motors, India Glycols OCL India, Pilani Investment & Industries Corporation, TCPL Packaging etc.

Mr. Jai Dalmia Executive director

He holds a BE degree in electrical engineering from Jadavpur University and a master’s degree in electrical engineering from the University of Illinois, Urbana, Champagne. He was co-opted as a director of the company in February 2011 and elevated to the post of managing director in April 2011. Mr. Dalmia has more than 40 years of experience across industries; with special focus on refractory, sugar and cement sectors.

Mr. Y. H. Dalmia Executive director

He holds a B.Com (Hons.) degree from the University of Delhi and is a fellow of the Institute of Chartered Accountants of India. He was co-opted as a director and later elevated to the post of managing director of the company in February 2011. He holds about 39 years of experience in the cement industry. Mr. Dalmia has served as president of the Cement Manufacturers Association.

Mr. N. Gopalaswamy Non-executive director

He holds a B.Sc. degree in chemistry from Madras University and a B.E. degree in chemical engineering from Annamalai University. He is a member of the Institute of Industrial Engineers, USA, Indian Institution of Industrial Engineering, Indian Institute of Chemical Engineering, and the Institution of Engineers (India). He is a council member of the Tiruchirapalli Productivity Council and has over 44 years of experience in the cement industry.

Mr. Gautam Dalmia Non-executive director

He has 19 years of experience in cement and sugar industries. Mr. Dalmia was co-opted as a director of the company in February 2011. As managing director of group companies, Dalmia Cement (Bharat) and Dalmia Bharat Sugar and Industries, he is directly responsible for managing the operations of the cement and sugar businesses and leads execution of projects. He also provides leadership to the commercial functions of the group.

Mr. V. S. Jain Non-executive director

He is a fellow of the Institute of Chartered Accountants of India and Institute of Cost and Works Accountant of India. He graduated from Shri Ram College of Commerce, University of Delhi. Mr. Jain began his professional career with Indian Oil Corporation and was engaged over 26 years in various capacities. He was responsible for financial strategies and implementation and financial appraisal of projects. As executive director, his responsibilities include international negotiations for procurement of crude oil and petroleum products. He later served as the chairman of Steel Authority of India until July 2006.

Mr. Jayesh Doshi Executive director Mr Doshi is a fellow of the Institute of Chartered Accountants of India. He holds the position of Group CFO,

Mrs. Sudha Pillai Non-executive, non-independent director

-



37 Dalmia Bharat

Exhibit 21: Plant locations


Exhibit 22: 10-year capacity growth chart


0

5

10

15

20

25

30

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

2.5 mnmt

commissioned at Kadapa, AP

2.5 mnmt added at

Ariyalur, TN

Expansion at Belgaum

& Bokaro


38 Dalmia Bharat

Financials

Exhibit 23: Income statement

Y/E March (Rsmn) FY15 FY16 FY17E FY18E FY19E

Net Sales 35,141 64,380 73,140 82,829 92,052

Raw Material Costs 5,365 11,165 12,022 13,378 14,609

Employee Costs 2,774 5,065 5,903 6,632 7,311

Freight costs 8,101 13,100 14,250 15,705 16,985

Power and Fuel 7,087 8,829 9,016 10,226 11,059

Other Exp 4,757 8,998 10,861 11,614 12,489

Total Exp 29,143 48,607 53,629 59,310 64,370

Operating profit 5,999 15,773 19,511 23,519 27,682

OPM (%) 17 25 27 28 30

Other Income 960 1,655 1,076 1,130 1,186

Interest 4,344 7,256 8,710 7,640 6,857

Depreciation 2,716 4,528 5,191 5,362 5,524

PBT (101) 5,644 6,686 11,646 16,487

Tax 469 2,991 2,006 3,494 4,946

Tax rate - 53% 30% 30% 30%

Adjusted Profit 30 1,908 3,800 7,141 10,327

EPS (Rs) 0 21 43 80 116


Exhibit 25: Balance sheet


Equity Capital 169 185 185 185 185

Reserves and Surplus 30,800 39,521 42,653 48,959 58,243

Networth 30,982 39,739 42,871 49,177 58,461

Minority interest 7,470 3,569 3,747 3,747 3,747

Total Debt 84,797 88,925 83,925 76,925 67,425

Deferred tax liability 4,006 5,674 5,674 5,674 5,674

Total liabilities 129,918 140,870 139,418 138,980 139,040

GB 84,124 106,420 110,013 112,585 115,587

Acc. Depr. 25,891 30,303 35,494 40,856 46,380

NB 58,233 76,117 74,518 71,729 69,207

CWIP 19,142 2,702 1,750 1,750 1,750

Investment 16,870 25,752 25,752 25,752 25,752

NWC-Cash 5,595 (401) (57) 303 706

Cash 5,281 2,483 1,527 1,722 2,014

Total Assets 129,918 140,870 139,418 138,980 139,040


Exhibit 24: Cash flow


Profit after tax 30 1,908 3,800 7,141 10,327

Add : Depreciation 2,716 4,528 5,191 5,362 5,524

Net change in WC (2,875) 4,115 (695) (729) (792)

Net cash from operations (128) 10,551 8,296 11,774 15,060

Capital expenditure (40,072) (13,509) (4,000) (4,000) (4,500)

Sale of investments (4,534) (8,883) - - -

Net cash from investing (44,605) (22,392) (4,000) (4,000) (4,500)

Issue of shares 13 36 - - -

Increase in debt 42,063 4,129 (5,000) (7,000) (9,500)

change in DTL 2,334 9,016 - - -

Dividends paid incl. tax (209) (534) (668) (835) (1,044)

Net cash from financing 49,170 9,044 (5,252) (7,579) (10,267)

Net Cash 4,437 (2,798) (956) 195 293

Opening Cash 844 5,281 2,483 1,527 1,722

Closing Cash 5,281 2,483 1,527 1,722 2,014


Exhibit 26: Key ratios


Growth (%)

Sales 17 83 14 13 11

Operating profit 14 67 10 11 9

Net profit (136) - 99 88 45

Leverage (x)

Debt:equity 2.74 2.24 1.96 1.56 1.15

Net debt:equity 2.06 1.55 1.35 1.03 0.70

Profitability (%)

OPM 17 25 27 28 30

NPM 0 3 5 9 11

RoE 0 5 9 15 18

RoCE 7 15 18 21 25

Valuation (x)

P/E - 57.4 56.2 29.9 20.7

P/BV 1.7 2.8 5.0 4.3 3.7

EV/EBITDA 19.3 10.9 13.9 11.2 9.2

EV/mt (US$) 73.9 105.3 167.0 162.5 156.5



Initi

atin

g C

over

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Reuters: SGRC.NS; Bloomberg: SGC IN

Sagar Cements

Beneficiary Of Demand Recovery In Southern Region We initiate coverage on Sagar Cements (SCL) with a Buy rating and a target price of Rs951 up 18% from the current market price. SCL is an Andhra Pradesh-based cement player with current capacity of 4.3mnmt which is slated to increase to 5.5mnmt by FY19. Despite its small size, SCL is a relevant and significant player in the market following the various initiatives taken by the company in the past like building a strong brand, control over variable costs, judicious capital allocation, upcoming waste heat recovery (WHR) project, introduction of sulfate-resistant cement and its overall understanding of the market. We believe SCL is in a sweet spot as its recent inorganic growth is likely to help in achieving higher volume growth and cement prices in its key markets are also at a high level which helps improve profitability. Recent acquisitions by the company will lead to a substantial reduction in operating costs as we expect the move to reduce lead distance as well as improve the blending ratios. We have not fully factored in the cost reduction on account of acquisitions and expansion in our estimates as we await more clarity on the same. Once the cost reduction benefits are visible, earnings growth will be superior. We have factored in 22%/25%/36% CAGR in sales, EBITDA and net profit for SCL over FY16-FY19E. We have valued SCL stock based on the average of earnings and asset-based valuation methodologies. We have assigned target multiples of 7.0xFY19E EV/EBITDA and US$80 FY19E EV/mt which are in line with the multiples that we assigned to regional cement players. Our target price on SCL as a result is Rs951, up 18% from the current market price. Key risks to our rating are government intervention on cement pricing, lower-than-expected demand in southern region on account of drought in Tamil Nadu, lower government spending and delay in expansion of Bayyavaram grinding unit.

Beneficiary of demand recovery in southern region: All of SCL’s 4.3mnmt capacity and future expansion is based in Andhra Pradesh. The company sells close to 78% of its total production in southern region. We expect cement demand in the region to be better than the all India average on account of higher government spending on low-cost housing, irrigation, roads and urban infrastructure. SCL, with a very high exposure to southern region, especially Andhra Pradesh and Telangana, stands to benefit from the same. Higher volume coupled with sustained higher cement prices in the region are likely to result in improved profitability and growth for SCL.

Acquisition to not only bring volume growth, but also help reduce costs: SCL has acquired BMM Cement with a capacity of 1mnmt and a grinding unit at Bayyavaram in Andhra Pradesh. Both acquisitions provide geographic advantage which will result in much lower lead distance for the company. We expect the lead distance to come down from 500km to less than 400km in the medium term. Moreover, post expansion of Bayyavaram unit, blending ratio of the company is expected to improve from 30% in FY16 to almost 70% by FY20, further improving the cost structure.

Healthy pricing in key markets: SCL’s key markets are Andhra Pradesh, Telangana, Tamil Nadu and Karnataka which have witnessed sharp cement price rise in April 2017. We believe the higher prices are likely to sustain at least till the monsoon season, resulting in better profitability.

BUY

Sector: Cement

CMP: Rs806

Target Price: Rs951

Upside: 18%


Key Data


Mkt Cap (Rsbn/US$mn) 16.5/254.6

52 Wk H / L (Rs) 870/512



Promoter 56.9 56.7 50.0

DII+FII 7.8 7.5 18.9

Others 35.3 35.8 31.0



1 M 6 M 1 Yr

Sagar Cements 2.8 26.8 38.4


Source: Bloomberg

Y/E March (Rsmn) FY14 FY15 FY16 FY17E FY18E FY19E

Revenues 4,889 5,756 8,028 9,792 12,041 14,539

YoY (%) 20.0 0.2 12.2 22.0 23.0 20.8

EBITDA 13 567 1,217 1,237 1,729 2,372

EBITDA (%) 20.8 14.7 15.1 12.6 14.4 16.3

Adj. PAT (256) 2,968 462 364 709 1,149

YoY (%) 61.7 (47.1) 2.7 (21.2) 95.0 62.0

RoE (%) (10.1) 77.8 8.6 5.4 8.6 12.5

EV/EBITDA 392.9 14.5 10.0 18.1 13.6 10.8

EV/mt (US$) 27.9 43.9 45.6 77.7 81.8 69.8

P/E (x) (11.2) 1.8 14.5 45.2 23.2 14.3


80

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120

130

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150

May-16 Jul-16 Sep-16 Nov-16 Jan-17 Mar-17 May-17

SAGAR CEMENTS Nifty 50

10 May 2017


40 Sagar Cements

SCL is a small but significant player in southern region

SCL is a small cement player with a capacity of 4.3mnmt located in Andhra Pradesh and Telangana. Despite its size, SCL is a relevant and significant player in the market following the various initiatives taken by the company in the past like building a strong brand despite its size, control over variable costs, upcoming waste heat recovery (WHR) project, introduction of sulfate-resistant cement and overall understanding of the market. Out of the total eight large limestone clusters present in India, two clusters are in Andhra Pradesh viz. Nalgonda and Yerraguntla. With the presence of a large quantity of limestone, several cement companies have established their plants in this region. As a result, Andhra Pradesh is a highly fragmented cement market with over 50 cement plants and over 30 players. Despite this high fragmentation, SCL- through its operating efficiency and with the help of relatively better prices has been able to deliver better earnings growth and managed to grow its capacity as well.

Exhibit 1: Consistent addition of technology and capacities over three decades of operations

Source: Company presentation

Beneficiary of demand recovery in Andhra Pradesh and Telangana

SCL currently has 4.3mnmt of capacity situated entirely in Andhra Pradesh and Telangana. The demand growth in these two states has on the uptrend recently after at least four to five years of slowdown. Key demand drivers of cement in these states have been increased spending on low-cost housing, irrigation and urban infrastructure. We believe this momentum of higher cement demand is likely to continue for some more time as both incumbent state governments are relatively stable. Andhra Pradesh posted a growth of 12% in FY17 compared to a decline in the entire country. We believe that FY18 will witness much higher growth as various government schemes will lead to high demand for cement. We expect demand growth of 15% in Andhra Pradesh in FY18. SCL, with almost 100% of its capacity situated in Andhra Pradesh (AP), is likely to benefit from this high demand. Currently, SCL is selling close to 45% of its total production in AP market. With higher demand growth, we expect the sales in AP to increase, thereby reducing the lead distance and freight costs


41 Sagar Cements

Exhibit 2: Cement demand in AP has started picking up

Source: Industry,Company,Nirmal Bang Institutional Equities Research

Acquisitions and expansion to ensure higher volume growth

SCL has increased its capacity substantially over the past few years. After the expansion in FY08-09, the company did not add capacity as the weak markets did not support expansion. Now that the greenshoots of better demand are in place, SCL is all geared up to benefit from this demand uptick. The company first acquired BMM cements with a capacity of 1mnmt in FY16. Later the company bought a smaller grinding unit at Bayyavaram with capacity of 0.2mnmt and further enhanced to 0.3 mnmt. The company has then raised QIP to increase the capacity of Bayyavaram unit to 1.5mnmt. The addition of grinding capacities will be ably supported by SCL’s clinker capacity at its mother unit in Mattampally. The acquisition took total cement capacity of the company from 3 mnmt to 4.3 mnmt which will eventually go up to 5.5mnmt post expansion at Bayyavaram. As a result, we are estimating 14% volume CAGR for the company over FY16-19.

Exhibit 3: Expect 15% volume CAGR for SCL over FY16-FY19E


Acquisitions to reduce operating costs through lower lead distance and higher blending

SCL has acquired two units which are situated almost equidistant from its existing facility in opposite directions. This will ensure significant reduction in lead distance as the distant markets of Tamil Nadu, Kerala and Karnataka will now be serviced through BMM Cement whereas markets in Odisha and coastal Andhra Pradesh will be serviced through Bayyavaram grinding unit. The existing facility at Nalgonda will now service nearby markets like AP,Telangana and Maharashtra. The current lead distance of SCL is close to 500km. We believe these acquisitions will help SCL to achieve lower lead distance of less than 400km in the medium term and less than 350km over a slightly longer period. Moreover, additional grinding units will also increase the blending ratio of SCL as the Bayyavaram unit will produce only slag cement. We expect the blending ratio of SCL to move up from 30% in FY16 to 70% over the next three to four years which will help reduce operating costs for the company significantly. We have not factored in the benefits of higher blending as well as lower lead distance in our estimates fully as we await some confirmation of the same.

12%13%

17%

-3% -3%-2%

-5%

-12%

-7%

2%

12%

15%

-15%

-10%

-5%

0%

5%

10%

15%

20%

FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18E

Cement demand growth in

AP and Telangana recovering after years of

slowdown

1.58

1.41 1.56

1.89

2.15

2.50

2.87

(15)

(10)

(5)

0

5

10

15

20

25

1.00

1.20

1.40

1.60

1.80

2.00

2.20

2.40

2.60

2.80

3.00

FY13 FY14 FY15 FY16 FY17E FY18E FY19E

Volumes (mnmt) Growth (% YoY)

(mnmt) (%)


42 Sagar Cements

Exhibit 4: Acquisitions will help reduce lead distance

Source: Company’s QIP document

Exhibit 5: Significant change in blending ratios to drive costs lower

Source: Company,Nirmal Bang Institutional Equities Research

Gaining further control on costs through new waste heat recovery plant and captive power plant

SCL is on the verge of commissioning the 6MW waste heat recovery plant at its unit in Matampally. Secondly, the company plans to use the funds from the QIP to build a 18MW coal-based captive power plant at the same unit. This will ensure greater control over power and fuel costs for SCL as it currenty sources more than 70% of its electricity requirement from the grid and 10% from an energy exchange. The BMM plant already has a 25MW power unit. As the utilisation of BMM plant is on lower side, SCL is currently selling power from this plant through the energy exchange.

Exhibit 6: Moderate growth in operating costs likely


OPC, 70%

PPC, 30%

PSC, 0%

FY2016

OPC, 30%

PPC, 25%

PSC, 45%

FY2020E

3,448

3,326

3,604

3,971

4,126

4,233

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

3,000

3,200

3,400

3,600

3,800

4,000

4,200

4,400

FY14 FY15 FY16 FY17E FY18E FY19E

Operating costs/mt (Rs) Growth (YoY)


43 Sagar Cements

The past several quarters have witnessed the share of AP-Telangana in SCL’s total cement sales drop to as low as 29%. This was because of weak demand in these states following political uncertainty, bad monsoon and a muted real estate market. This has affected the lead distance as well, thereby leading to overall cost escalation. A break-up of the total tonnage through roads and rakes is given in the chart below. With rake rates slashed in the previous quarter, there could be substantial cost savings in the coming quarters. In addition to this, as demand stages a comeback in AP and Telangana, SCL will enjoy a huge advantage in its selling and distribution costs as the lead distance reduces. As cement is a bulky commodity, reduction in lead distance will translate into huge savings in total expenses. We expect cement demand from AP and Telangana to be higher than southern region’s overall demand.

Exhibit 7: Road transportation continues to dominate freight costs Exhibit 8: Share of AP and Telangana in total cement sales expected to pick up


Pricing in key markets in a sweet spot

We believe the cement business of SCL is in a sweet spot with strategic locations, better demand growth and strong prices. SCL is currently operating at 53% of its cement capacity, offering huge operating leverage. Despite lower capacity utilisation, the industry in southern region has survived because of better prices. We believe cement prices in AP will remain stable which will result in significantly better return ratios for SCL. Over the past few weeks, cement prices in southern region have risen sharply and we expect this price rise to sustain till the monsoon. This will ensure better profitability going forward. Exhibit 9: Cement prices in southern region have moved up recently and are likely to remain stable

Source: Crisil, Company data, Nirmal Bang Institutional Equities Research

(5,000)

0

5,000

10,000

15,000

20,000

25,000

0

100

200

300

400

500

600

700

1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17

By road (thousand tonnes)- LHS By rake (tonnes)- RHS

(000's tonnes) ( tonnes)

5142 43

54 53

36 3729 33 36

4552

4537

44

4958 57

46 47

64 6371 67 64

5548

5563

56

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1QF

Y14

2QF

Y14

3QF

Y14

4QF

Y14

1QF

Y15

2QF

Y15

3QF

Y15

4QF

Y15

1QF

Y16

2QF

Y16

3QF

Y16

4QF

Y16

1QF

Y17

2QF

Y17

3QF

Y17

Within AP & Telangana Outside AP & Telangana

200

250

300

350

400

Ma

r-1

4

Ma

y-1

4

Jul-1

4

Se

p-1

4

No

v-1

4

Jan

-15

Ma

r-1

5

Ma

y-1

5

Jul-1

5

Se

p-1

5

No

v-1

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Jan

-16

Ma

r-1

6

Ma

y-1

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Jul-1

6

Se

p-1

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No

v-1

6

Jan

-17

Ma

r-1

7

Bangalore Chennai Hyderabad

(Rs/50 Kg bag)


44 Sagar Cements

Judicious usage of fuel

SCL’s plant is located within 150km of coal mines. SCL typically sources close to 70%-75% of its coal requirement from Singareni coal mine. However, the plants of SCL have flexibility to use either pet coke or coal. Depending on firing cost of fuels such as domestic coal, imported coal and pet coke, SCL uses the fuel in its kiln. As a result of this coal mix, SCL has been able to optimise its fuel costs. Prices of imported and indigenous coal have witnessed flattish growth since the first quarter of FY17. As usage of pet coke is not very economical for SCL based on its plant location, power and fuel costs for the company remained steady unlike other companies which witnessed a huge decline in such costs last year.

Exhibit 10: Domestic coal accounts for a small percentage of total coal usage

Exhibit 11: Coal prices have been fairly stable for the past four quarters


0

20

40

60

80

100

120

1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17

Domestic coal (%) International coal (%)

(%)

0

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2,000

3,000

4,000

5,000

6,000

7,000

1QF

Y15

2QF

Y15

3QF

Y15

4QF

Y15

1QF

Y16

2QF

Y16

3QF

Y16

4QF

Y16

1QF

Y17

2QF

Y17

3QF

Y17

Indigenous Imported

(Rs/tonne)


45 Sagar Cements

Financials - Expect 25% EBITDA CAGR over FY16-FY19E

We expect 22% sales CAGR over FY16-FY19E. This is a result of sales volume assumed to have a conservative growth of 15% over three years and realisation growing at 6% CAGR over the same period. Our pricing growth assumption is only slightly higher than our cost assumption, which means we expect SCL to just pass on the increased cost burden and maintain or marginally improve its EBITDA/mt. During the same period, we have factored in cost escalation of 21% CAGR on absolute basis and 5.5% CAGR on per mt basis. We expect the RoE of SCL to improve to 12.5% by FY19E.

Exhibit 12: Operating profit to post a CAGR of 25% Exhibit 13: PAT to go up 2.5x times to Rs1,149mn


Assign Buy rating to SCL with a target price of Rs951

We have assigned Buy rating to SCL with a target price of Rs951. We have valued the stock based on our usual method of the average of earnings (EV/EBITDA) and asset-based valuation (EV/mt). We have used target multiples of 7.0x FY19E EV/EBITDA and US$80 EV/mt to value SCL’s business. The target multiples are in line with our assigned multiples for mid-sized regional cement companies, and are at a reasonable discount to our target multiple for UltraTech Cement.


Particulars (Rsmn)

FY19E EBITDA 2,372

Multiple 7.0

EV 16,605

Net debt 3,633

Equity value 12,972



Particulars (Rsmn)




Net debt 3,633

Equity value 25,847





Particulars (Rs)




Target price 951

CMP (Rs) 806

Upside (%) 18%


1,217 1,237

1,729

2,372

0%

20%

40%

60%

80%

100%

120%

140%

-

500

1,000

1,500

2,000

2,500

FY16 FY17E FY18E FY19E

EBITDA (Rsmn) YoY growth (%)

(Rsmn)

462 364

709

1,149

-100%

-80%

-60%

-40%

-20%

0%

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60%

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100%

120%

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FY16 FY17E FY18E FY19E

PAT (Rsmn) YoY growth (%)

(Rsmn)


46 Sagar Cements

Exhibit 17: Forward EV/mt of SCL(US$)


Company background and recent developments

SCL is a prominent cement player in southern region with a track record of over three decades. The company manufactures a wide variety of cement like OPC - grade 53, OPC - grade 43, PPC and sulphate-resistant cement (SRC). In addition to maintaining high standards of quality and pollution control, SCL has well known certifications like ISO 9001:2008, ISO 14001:2004 and OHSAS 18001:2007. At the current level, SCL has grinding capacity of 4.30mtpa and clinker capacity of 3.62mtpa. SCL has two clinker units –one each in AP and Telangana and three grinding units – one each in Mattampally, Gudipadu and most recently Bayyavaram.


Source: Company data, Nirmal Bang Institutional Equities Research

0

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100

Jan-

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Jul-0

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Jan-

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Jul-0

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Fwd EV/Ton (US$) Average +1 Std Dev


47 Sagar Cements

Acquisition of BMM Cements completed in 3QFY16

SCL has signed a share purchase agreement to acquire 1mt cement plant and captive 25MW power plant in Gudipadu from BMM Cements. The acquisition took place at an enterprise value of Rs 5.4bn or US$87/tn. BMM Cements has limestone reserves of about 155mt. The acquisition of BMM Cements came at an opportune time wherein the demand environment and pricing in the region of its operations look encouraging. Post acquisition, SCL is likely to benefit from freight and power cost savings because of shorter lead distance and captive power plant, respectively.

Vicat joint venture

In 2008, SCL had formed a joint venture or JV with a French cement company, Vicat, to set up 5.5mtpa capacity in Karnataka along with 50MW captive power plant. While SCL had 47% stake in the JV, Vicat had the remaining 53%. Out of total investment of Rs5 bn, SCL’s contribution was Rs900mn while Vicat invested around Rs4.1bn.The lower equity infusion by SCL was because of the local expertise it brought to the table and the premium paid by Vicat to make its entry into India, one of the biggest cement markets in the world. In July 2014, SCL sold its entire 47% stake to Vicat for Rs4.5bn. This deal helped SCL to curtail debt and further fund its capex.

Recent fund raising through the QIP route

SCL recently raised close to Rs2bn by way of QIP and preferential allotment of shares to promoters. While the QIP happened at Rs720/share, the preferential allotment to promoters happened at Rs800/share. The proceeds of the QIP will be used to fund the expansion of Bayyavaram unit and set up a18MW power plant at Matampally unit. The QIP resulted in 17% dilution in pre-money equity base.

Exhibit 19: Recent developments in SCL


Exhibit 20: Progress in clinker capacity over the past 10 years (mtma)

Source: Company data, Nirmal Bang Institutional Equities Research

0

0.5

1

1.5

2

2.5

3

3.5

FY

06

FY

07

FY

08

FY

09

FY

10

FY

11

FY

12

FY

13

FY

14

FY

15

FY

16

FY

17E

FY

18E

FY

19E

Addition of line 2 at Nalgonda

Post acquisition of BMM


48 Sagar Cements

Exhibit 21: Top shareholders (as on March 2017) Exhibit 22: Shareholding pattern

Key shareholders Holding %

Promoter 56.7

AVH Resources India Pvt. Ltd. 17.6

SBI Fund Management 4.6

HDFC Asset Management 4.5

ICICI Prudential Asset management 2.8

Kotak Mahindra Asset Management 1.8

AP Industrial Development Corporation 1.5

IDFC Mutual Fund 1.4 Source: Company data, Nirmal Bang Institutional Equities Research Source: Company data, Nirmal Bang Institutional Equities Research

Exhibit 23: Board of directors


Mr. O.Swaminatha Reddy Chairman Chartered accountant by qualification. Financial and management consultant by profession and is known for his acumen in corporate finance - associated with SCL since 1983 as its chairman,

Mr. S.Veera Reddy Managing director An agriculturist turned industrialist - promoter, he is the managing director since 1991 looking after overall management of SCL. Played a key role in bringing the company up to its current status.

Dr.S.Anand Reddy Joint managing director

He holds a MBBS degree. He is also a director in other companies like Sagar Power, Amareswari Cements, Satwik Drugs, and Sagar Priya Housing and Industrial Enterprises.

Mr. S.Sreekanth Reddy Executive director He holds BE degree and post graduate diploma in cement technology. He joined Sagar cements as a technical consultant in 2002 and then inducted into the board of directors subsequently.

Mr. K.Thanu Pillai Director He holds MBA. and CAIIB qualification. He has experience in banking and finance. He is also a director in State Bank of Travancore, BSCPL Infrastructure, LVS Power, Sathvahana Ispat., Bollineni Castings & Steel, and Amar Biotech.

Mr. K.Rajendra Prasad Nominee director - APIDC

He is non-executive director - APIDC nominee since 18 July 2012. He also serves as deputy general manager (EPM) of APIDC, Hyderabad.

Mr. John-Eric Fernand Pascal Cesar Bertrand

Director Partner at AVH Resources. Before joining AVH, he worked as a senior consultant at Ronald Berger Strategy. He is a commercial engineer and an MBA.

Mrs.S.Rachana Director She is the non executive director of Sagar cements. Currently, serves as the executive director at Panchavati polyfibre limited. She holds a degree in Bachelor of science.

Mr. V.H.Ramakrishnan Director Independent, non-executive director of SCL. Has extensive experience for more than 35 years in both domestic and international banking during his career in Bank of India.

Source: Company presentation

56.7

2.15.4

35.8



49 Sagar Cements

Financial summary Exhibit 24: Income statement


Net Sales 5,756 8,028 9,792 12,041 14,539

Raw material costs 678 1,685 1,882 2,271 2,768

Employee costs 334 410 500 615 750

Freight costs 1,541 1,899 2,555 3,052 3,370

Power and fuel expenses 2,102 2,204 2,814 3,395 4,099

Other expenses 358 613 783 953 1,151

Total expenses 5,189 6,811 8,555 10,311 12,167

Operating profit 567 1,217 1,237 1,729 2,372

OPM 9.8 15.2 12.6 14.4 16.3

Other income 3,661 65 300 300 300

Interest costs 231 418 566 530 475

Depreciation 215 336 451 486 556

PBT before extraordinary items

3,782 528 520 1,013 1,641

PBT 3,782 528 520 1,013 1,641

Tax 814 66 156 304 492

Tax rate 21.5 12.5 30.0 30.0 30.0

PAT 2,968 462 364 709 1,149

EPS (Rs) 171 27 18 35 56



Y/E March (Rsmn) FY13 FY14 FY15 FY16E FY17E

Equity capital 174 174 204 204 204

Reserves and surplus 5,046 5,403 8,181 9,286 10,657

Net worth 5,220 5,577 8,385 9,490 10,861

Total debt 2,454 4,370 5,070 4,570 4,070

Deferred tax liability 475 263 263 263 263


Gross block 5,548 12,030 12,882 13,882 15,882

Acc. Depr. 2,210 2,546 2,997 3,483 4,039

Net block 3,338 9,485 9,886 10,400 11,844

CWIP 1,122 152 300 300 300

Investment 572 227 300 300 300

NWC-cash 1,347 281 783 963 1,163

Cash 2,193 65 2,017 1,483 437

Total assets 8,572 10,210 13,286 13,446 14,044




PAT 2,968 462 364 709 1,149

Add: Depreciation 215 336 451 486 556

Less:

Chg. in NWC (996) 1,066 (502) (180) (200)

Cash flow from operations 2,187 1,864 312 1,015 1,505

Capex (923) (5,512) (1,000) (1,000) (2,000)

Chg in Investment 288 345 (73) - -

Cash flow from inv. (635) (5,168) (1,073) (1,000) (2,000)

Issue of shares - - 2,118 - -

Inc in debt 176 1,916 700 (500) (500)

inc in DTL 153 (212) - - -

Dividend paid (157) (105) (105) (50) (50)

Cash flow from financing 172 1,599 2,713 (550) (550)

Net cash flow 1,724 (1,705) 1,952 (535) (1,045)

Opening cash balance 46 1,770 65 2,017 1,483

Closing cash balance 1,770 65 2,017 1,483 437




Growth (%)

Sales 17.7 39.5 22.0 23.0 20.8

Operating profit - 114.8 1.6 39.8 37.2

Net profit NA (84.4) (21.2) 95.0 62.0

Leverage (x)

Debt:equity 0.5 0.8 0.6 0.5 0.4

Net debt:equity 0.1 0.8 0.4 0.4 0.4

Profitability (%)

OPM 9.8 15.2 12.6 14.4 16.3

NPM 51.6 5.8 3.7 5.9 7.9

RoE 77.8 8.6 5.4 8.6 12.5

RoCE 4.3 8.6 5.9 9.2 12.9

Valuation (x)

P/E 1.8 14.5 45.2 23.2 14.3

P/B 1.0 1.2 2.1 1.9 1.7

EV/EBITDA 14.5 10.0 18.1 13.6 10.8

EV/MT ($) 43.9 45.6 77.7 81.8 69.8



50 Sagar Cements



Initi

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over

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Reuters: TRCE.BO; Bloomberg: TRCL IN

The Ramco Cements

Best In Class Profitability Awaits Operating Leverage We like The Ramco Cements (TRCL) in the cement sector as it has several advantages in the southern region like: (1) Cost efficiency (100% captive power plant and lower operating costs) and premium product pricing, resulting in superior profitability. (2) Beneficiary of demand uptick in the southern region (strong brand image, large market share in Tamil Nadu and Kerala). (3) Completion of major capex, and robust operating cash flow expected to deleverage the balance sheet and improve return ratios. TRCL is highly efficient in its operations, as despite lower capacity utilisation the company has been able to control its costs well. TRCL has been reporting higher EBITDA/mt compared to most other cement companies in India for the past few quarters. This best-in-class profitability awaits operating leverage to open up as the current capacity utilisation of the company is only 50%, leaving ample scope for further volume growth. We have factored in sales/EBITDA/PAT CAGR of 11%/15%/17.5%, respectively, over FY16-FY19E. Revenue growth will be driven by 9.6% volume CAGR and a mere 2% pricing CAGR. Lower growth in prices in our estimates corresponds to already higher prices in key regions. After declining in 9MFY17, we expect operating costs to increase ~4% in FY18 and FY19. This will translate to higher EBITDA/mt for TRCL compared to other companies. We have valued TRCL based on the average of 12.0x FY19E EV/EBITDA and FY19E EV/mt of US$160 to arrive at our target price of Rs775. We have assigned Accumulate rating to the stock as the upside is only around 10% from the current market price. Key downside risks to our call include government intervention in cement pricing, severe drought in Tamil Nadu impacting volume and increase in input costs. Myriad factors supporting best-in-class profitability: Multiple factors have supported higher profitability of TRCL over the years including lower costs and premium pricing. Operating costs of TRCL have posted only a 1% CAGR over the past five years (FY12-FY17E). In fact, over the past two years, operating costs actually declined by 7% CAGR. A large part of this decline can be attributed to the fall in fuel costs (coal and pet coke) while measures to reduce costs and improve efficiency have also played their part in reducing overall operating costs. Demand uptick in the southern region is positive for TRCL: We expect cement demand in the southern region to be higher than the all-India level on account of increased state government spending on various infrastructure projects such as irrigation, ports, roads and low-cost housing. TRCL, with ~90% exposure to the southern region, is well placed to capture this growth. We have factored in 7%-8% demand CAGR for the southern region and for TRCL we expect 9.6% volume CAGR over FY16-FY19E. Financials and valuation: We have factored in 15% EBITDA CAGR for TRCL on top of its already high base. EBITDA growth will largely be driven by higher volume as cement prices in the region are already high. However, if the recent price hikes undertaken in most states in the southern region sustain, there may be upside risk to our estimates. We have valued TRCL based on the average of earnings and asset-based valuations to arrive at our target price of Rs775, up 10% from the current market price.

ACCUMULATE

Sector: Cement

CMP: Rs706

Target Price: Rs775

Upside: 10%


Key Data


Mkt Cap (Rsbn/US$bn) 167.9/2.6

52 Wk H / L (Rs) 728/473



Promoter 42.3 42.3 42.3

DII+FII 43.5 43.1 36.8

Others 14.2 14.6 20.9



1 M 6 M 1 Yr

The Ramco Cements 4.2 14.4 40.9


Source: Bloomberg

Y/E March (Rsmn) FY14 FY15 FY16E FY17E FY18E FY19E

Revenues 36,835 36,449 35,958 40,524 45,517 50,178

YoY (%) (3.8) (1.0) (1.3) 12.7 12.3 10.2

EBITDA 5,630 7,133 10,590 13,105 15,045 16,090

EBITDA (%) 15.3 19.6 29.5 32.3 33.1 32.1

Adj. PAT 1,377 2,424 5,583 6,557 8,045 9,064

YoY (%) (65.9) 76.0 130.3 17.5 22.7 12.7

FDEPS (Rs) 6 10 23 28 34 38

RoE (%) 5.5 9.2 18.1 17.0 17.0 17.0

EV/EBITDA 8.4 14.2 14.0 11.0 13.4 11.3

EV/mt (US$) 83.1 79.2 93.4 108.6 163.7 159.0

P/E (x) 14.3 37.2 30.4 17.1 24.3 19.8


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Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15

JK LAKSHMI CEMENT NSE CNX NIFTY INDEX

10 May 2017


52 The Ramco Cements

Myriad factors support best-in-class profitability

We like TRCL for its best-in-class profitability supported by high efficiency, positive free cash flow leading to faster deleveraging and significant operating leverage. Multiple factors have supported higher profitability of TRCL over the years including lower costs and premium pricing. TRCL’s plants have operated at lower capacity, given the weak demand and overcapacity scenario in the southern region. Despite this, TRCL has been able to control its operating costs quite well. The company focused on improving its trade sales, resulting in higher sales of blended products. The company was one of the firsts to enjoy 100% captive power in the southern region. The availability of power in the southern region was erratic till FY15 during which the company benefitted from captive power. TRCL boasts of significantly lower operating costs/mt at Rs3,100 for companies having more than 10mnmt capacity and plants at several locations. As a result, TRCL has been able to report higher EBITDA/mt compared to its regional as well as pan-India peers.

Exhibit 1: TRCL posts highest EBITDA/mt among its peers Exhibit 2: Operating costs much lower compared with large companies


Operating costs of TRCL posted only 1% CAGR for the past five years (FY12-FY17E). In fact, over the past two years, operating costs actually declined by 7% CAGR. A large part of this decline can be attributed to the fall in fuel costs (coal and pet coke) whereas measures to reduce costs and improve efficiency also played their part in reducing overall operating costs.

Exhibit 3: Operating costs moderate substantially on account of lower fuel prices and improved operating efficiency


1,545

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Operating cost/mt (Rs)

(Rs)



Exhibit 4: Steady decline in fuel usage Exhibit 5: Power consumption also below standard


Higher market share in key regions and premium brands help achieve higher realisation

TRCL has a higher market share in Tamil Nadu and Kerala and a relatively good presence in Andhra, Karnataka and West Bengal. The company sells close to 70% of its total production inTamil Nadu and Kerala alone. The grinding units in Vizag (Andhra Pradesh) and Kolaghat (West Bengal) help the company to register up to 10% sales in the eastern region. The Ramco Supergrade is a renowned cement brand in the southern region and helps TRCL to achieve premium realisation compared to peers. The company produces different types of cement including Portland pozzolona, ordinary Portland, sulphate-resistant, and sleeper-grade (for Indian Railways) so as to cater to various types of customers.

Exhibit 6: Geographic distribution reach of TRCL


Demand uptick in the southern region is positive for TRCL

As stated above, TRCL is among the largest cement producers in the southern region suffering from an oversupply situation since the past four years following large capacity expansion and muted demand growth. The likely traction in the region’s demand will provide higher delta to the sales volume of TRCL which has a strong brand image and also available capacity. We expect cement demand in the southern region to be higher than the all India level on account of increased state government spending on various infrastructure projects like irrigation, ports, roads and low-cost housing. We are factoring in 7%-8% demand CAGR for the southern region and for TRCL we expect 9.6% volume CAGR over FY16-FY19E. We have assumed only moderate demand growth for TRCL as we believe that the drought in Tamil Nadu coupled with unstable political scenario in that state may impact cement demand negatively in the medium term. However, despite the so-called political turbulence, the state has been on the forefront when it comes to implementation of the government housing scheme in urban areas. The company is currently operating at ~50% of its capacity which leaves ample room for further growth if demand uptick is higher than expected.

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Fuel (% of clinker)

(Rs)

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Electricity consumption (Kwh/mt) Average

(Rs)

Tamil Nadu, 45%

Kerala, 23%

Andhra Pradesh, 13%

Karnataka, 9%

Others, 10%



Exhibit 7: Demand drivers in key states

State Snapshot Demand drivers

Tamil Nadu

1. Installed capacity of ~40mt (~11% of total installed capacity) and 20mt of consumption (~8% of total consumption).

2. Major urban demand from Chennai, Madurai, Coimbatore and Trichy.

1. Recently the state government started announcing infrastructure projects and improved policy framework.

2. Good monsoon and low base of the previous year to drive agriculture-based economy.

3. Low-budget housing programme. 4. Ban on sand mining impacts demand, but a solution

expected soon.

Karnataka & Kerala

1. Installed capacity of ~27mt (~7% of total installed capacity).

2. Major urban demand from Bengaluru, Mysore, Kochi and Trivandrum.

1. Focus on state roads.

2. Strong housing and commercial markets in Bengaluru.

Andhra Pradesh

1. Huge demand because of state-sponsored housing schemes.

2. New state creation-related construction activities.

1. Telangana statehood and new capital creation.

2. Strong monsoon to create further rural demand

3. Cyclone-related construction work.

4. Traction in low-cost housing.

5. Irrigation projects.


Exhibit 8: Volume growth expected to be higher


Exhibit 9: Lower capacity utilisation leaves ample room for volume growth


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Volumes (mnmt) Growth (% YoY)

(mnmt) (%)

64.5%

57.1%

59.5% 59.6%

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Capacity utilisation



Robust operating cash flow to deleverage balance sheet

TRCL has completed major capex in the past five years (integrated capacity at 12.5mt, satellite grinding capacity of 4mt) which led to a rise in its debt from Rs7.0bn in FY07 to Rs 26.6bn in FY13. The company has no major capex plan for the near future and is expected to generate free cash flow (post capex) of Rs5bn-Rs7bn which will be used to repay debt. The deleveraging has already started and the company has repaid debt of Rs5bn in FY16 and about Rs5.3bn in FY17.

We are factoring in sales/EBITDA/PAT CAGR of 11%/15%/17.5%, respectively, over FY16-FY19E. Revenue growth will be driven by 9.6% volume CAGR and a mere 2% pricing CAGR. Lower pricing growth in our assumption corresponds to already higher prices in key regions. As with any other company, higher-than-expected price hikes poses a key upside risk to our estimates. After declining in 9MFY17, we expect operating costs to increase by ~4% each in FY18 and FY19.

Exhibit 10: FCF growth to remain high in the absence of capex


Exhibit 11: Debt-equity ratio to fall substantially


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Total debt to equity (x)

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Assign Accumulate rating to TRCL with a target price of Rs775

We have assigned Accumulate rating to TRCL with a target price of Rs775. We have valued the stock based on our usual method of the average of earnings-based valuation (EV/EBITDA) and asset-based valuation (EV/mt). We have used target multiples of 12.0x FY19E EV/EBITDA and US$160 EV/mt to value the business. The target multiples are slightly higher than our assigned multiples for mid-sized cement companies on account of better return profile and huge operating leverage. We believe TRCL is a must-have stock in one’s portfolio on account of credible management and best-in-class profitability.


Particulars (Rsmn)

FY19E EBITDA 16,090

Multiple 12.0

EV 1,93,078

Net debt 2,312




Particulars (Rsmn)




Net debt 2,312






Particulars (Rs)


Value based on asset valuation 749


Target price 775

CMP (Rs) 706

Upside 10%


Exhibit 15: 12-month forward rolling EV/mt (US$) Exhibit 16: 12-month forward rolling EV/EBITDA

Source: Bloomberg, Company, Nirmal Bang Institutional Equities Research Source: Bloomberg, Company, Nirmal Bang Institutional Equities Research

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Company background

TRCL is a South India-based cement company headquartered in Chennai and is the flagship company of the Ramco Group. The company is the fifth largest cement producer in India with a total production capacity of 16.45mtpa. TRCL also produces ready-mix concrete and dry mortar products, and operates one of the largest wind farms in India.

Exhibit 17: Shareholding pattern (%)


Exhibit 18: Major shareholders (%)

Promoter 42.3

Government of Tamil Nadu 3.4

SBI Funds Management 3.3

Aberdeen Asset Management 3.0

Kotak Mahindra Asset Management 2.3

Reliance capital Asset Management 1.8

Sundaram Asset management 1.8


Exhibit 19: Board members and the management team


Mr. P.R.Ramasubrahmaneya Rajha

Chairman & Managing Director

Mr. Rajha is the patriarch of the Ramco Group and has been responsible for sustainable growth and profits.

Mr. P.R.Venketrama Raja

Non-Executive Director

He has a bachelor’s degree in chemical engineering from University of Madras and masters in business administration from University of Michigan, USA. He has been on the board of TRCL since 1985.

Mr. R.S.Agarwal Non-Executive Independent Director

He started his career in 1965 and after serving in various capacities with a paper mill in North India for 9 years and with Industrial Development Bank of India (IDBI) for 28 years. Retired as executive director of IDBI.

Mr. M.B.N.Rao Non-Executive Independent Director

A graduate in agriculture, he holds a diploma in computer studies from University of Cambridge and National Computing Centre, London, and a certificate in industrial finance.

Mr. M.M.Venkatachalam Non-Executive Independent Director

Justice Mrs. Chitra Venkataraman (Retd.)

Additional Independent Director

She serves as additional independent director of TRCL. She is a graduate in economics from Ethiraj College, Chennai, and a graduate from Law College, Chennai. She started her practice at Madras High Court specialising in direct and indirect tax laws.


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14.5

22.3

20.9




Financials

Exhibit 21: Income statement


Net sales 36,449 35,958 40,524 45,517 50,178

Raw material costs 5,160 4,571 4,942 5,497 6,176

Employee costs 2,287 2,592 3,041 3,415 3,801

Freight costs 11,203 9,381 10,033 10,619 11,932

Power and fuel exp. 7,040 5,270 5,636 6,391 7,181

Other expenses 3,595 3,454 3,892 4,414 4,854

Total expenses 29,317 25,368 27,419 30,471 34,088

Operating profit 7,133 10,590 13,105 15,045 16,090

OPM (%) 19.6 29.5 32.3 33.1 32.1

Other income 869 913 407 324 533

Interest costs 1,938 1,802 1,378 984 639

Depreciation 2,499 2,670 2,766 2,892 3,036

PBT 3,564 7,030 9,367 11,494 12,948

Tax 1,141 1,448 2,810 3,448 3,884

Tax rate (%) 32.0 20.6 30.0 30.0 30.0

Adjusted profit 2,424 5,583 6,557 8,045 9,064

EPS (Rs) 10 23 28 34 38




Equity capital 238 238 238 238 238

Reserves & surplus 26,214 30,688 36,099 42,712 50,056

Net worth 26,452 30,926 36,337 42,950 50,294

Total debt 27,119 22,056 16,756 11,756 6,756

Deferred tax liability 8,271 8,521 9,202 9,939 10,734


Gross block 72,005 75,340 78,340 82,340 86,340

Accumulated depreciation 23,250 26,291 29,057 31,949 34,985

Net block 48,755 49,049 49,283 50,391 51,354

Capital work in Progress 2,627 1,468 1,468 1,468 1,468

Total Investments 3,558 3,654 4,654 4,654 5,654

NWC - Cash 6,145 8,511 8,832 10,637 11,726

Cash 619 908 616 607 1,349

Total assets 65,617 66,650 68,215 71,452 75,612




Profit after tax 2,424 5,583 6,557 8,045 9,064

Add : Depreciation 2,499 2,670 2,766 2,892 3,036

Net change in WC 2,108 (2,366) (321) (1,805) (1,089)

Net cash from operations 7,031 5,887 9,003 9,133 11,011

Capital expenditure (3,928) (1,806) (3,000) (4,000) (4,000)

Sale of investments (724) (95) (1,000) - (1,000)

Net cash from investing (5,162) (1,048) (4,302) (4,333) (5,366)

Issue of shares 0.1 - - - -

Increase in debt (2,169) (5,063) (5,300) (5,000) (5,000)

change in DTL 897 250 682 736 795

Dividends paid incl. tax (430) (861) (1,146) (1,433) (1,719)

Change in other LT liab. 368 1,372 772 888 1,021

Misc (362) (248) - - -

Net cash from financing (1,697) (4,549) (4,992) (4,809) (4,903)

Net cash 172 289 (292) (9) 742

Opening cash balance 446 619 908 616 607

Closing cash balance 619 908 616 607 1,349




Growth (%)

Sales (1) (1) 13 12 10

Operating profit 27 48 24 15 7

Net profit 76 130 17 23 13

Leverage (x)

Debt:equity 1.0 0.7 0.5 0.3 0.1

Net debt:equity 0.9 0.6 0.3 0.2 0.0

Profitability (%)

OPM 20 29 32 33 32

NPM 7 16 16 18 18

RoE 9 18 18 19 18

RoCE 13 20 25 28 28

Valuation (x)

P/E 30.4 17.1 24.3 19.8 17.6

P/BV 2.8 3.1 4.4 3.7 3.2

EV/EBITDA 14.0 11.0 13.4 11.3 10.2

EV/mt (US$) 93.4 108.6 163.7 159.0 153.7



60

Disclaimer

Stock Ratings Absolute Returns

BUY > 15%

ACCUMULATE -5% to15%

SELL < -5%

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Cement Sector- Initiating Coverage-10 May 2017.pdf

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