JK Lakshmi Cement Ltd. Long Term Buy Call

JK Lakshmi Cement LtdCement stocks are trading in a narrow range over the last few quarters mainly on account of concerns over Demand – Supply mismatch. However in this report, we focus on the three stocks that offer potential upside in terms of their valuations despite current concerns over the negative industrial scenario.

As on today, these companies are in better financial state as compared to the previous down cycle. Even though having same profitability and return ratios, these companies are trading at almost 50-60% discount to peers making them attractive in current industrial scenario.

Going ahead, we sense that robust demand scenario would narrow down D-S gap and would provide platform to these companies to catch up with major players in terms of valuation parameters.

Valuation on our Mid?cap Universe:

JK Lakshmi Cement: At current market price of `60, stock is trading at a PE of 11x and 5.7x discounting FY’11?12E EPS respectively. We initiate our coverage on the stock with target price of `80. We have valued the stock at $62 EV/tonne and 5x EV/EBIDTA discounting FY’12E capacity and EBIDTA respectively.

Mangalam Cement: At current market price of `164, stock is trading at a PE of 8.9x and 4.7x discounting FY’11?12E EPS respectively. We are initiating our coverage on the company with ‘HOLD’’ rating. We have arrived at a target price of `174 for the company by valuing it at EV/EBIDTA of 5x and PE multiple of 5x discounting FY’12E EBIDTA and EPS respectively.

Shree Cement: At current market price of `1,900, stock is trading at a PE of 14x and 8.1x discounting FY’11?12E EPS respectively. We are initiating our coverage on the company with ‘Buy’’ rating. We have arrived at a target price of `2,328 for the company on SOTP basis.

5.5% growth in cement demand during Apr-July’10: On YTD basis, Cement sector grew by 5.5% y/y to 69.4mt. The growth has been subtle on account of higher base and onset of monsoon. Nonetheless, post monsoon, we believe that sector will continue to record healthy despatches due to pickup in construction activities.

We continue to expect our 10% y/y growth for the sector on account of heavy offtake of cement by government’s infrastructure projects and due to revival in rural and urban housing segments.

Depressed realizations: Stabilization of the capacities commissioned in past 1 year has resulted in depressed cement realizations. Currently, on an average cement prices (which has started coming down from 2nd half of May’10) are hovering around `235/bag, down by `25/bag from Apr’10 levels. The fall in cement prices were mainly witnessed in Southern India due to supply over passing demand.

We have assumed 5% q/q decline in cement prices in our valuation model in July?Sep’10 quarter. However, Post Sep’2010, we feel that cement prices will stabilize on account of completion of monsoon and starting of peak cement season for the industry. (as we have stated in our sector report dated June 04, 2010)

JK Lakshmi Cement Ltd. is a JK Group company engaged in the business of manufacturing and marketing of cement, Ready Mix Concrete and Plaster of Paris in North India. It is the leading player in Rajasthan and Gujarat.

INVESTMENT RATIONALE:

Expanding capacities to be beneficial: The company is planning to increase its capacity to 8mtpa by FY’13 from current 4.8mtpa by setting up 0.55mtpa plant at Haryana and 2.7mtpa plant at Chattisgarh. Capacity augmentation would drive the volume growth of the company in long term.

Efficiency with captive power plants and Long term PPA: JKLC is setting up 12mw waste heat recovery plant and 18mw of Thermal power plant. Post both these expansions, total power generating capacity of the company is likely to reach 66MW. Alongwith, the company has entered into a long term contract with VS Lignite to source 21MW of power annually for 20 years at a fix cost of `3.3/unit. Due to these CPPs and long term PPA, the company’s EBIDTA margin is expected to be cushioned by 90bps.

Buy with target price of Rs. 80: At current market price of `60, stock is trading at a PE of 11x and 5.7x discounting FY’11-12E EPS respectively. On EV/tonne basis, stock is trading at $49 and $56 on FY’11-12E capacity and EV/EBIDTA of 5.6x and 4.2x discounting FY’11-12E EBIDTA.

We sense that stock is greatly undervalued at current level as compared to its previous down cycle and trading at almost 60% discount to its peer. We initiate our coverage on the stock with target price of `80. We have valued the stock at $62 EV/tonne and 5x EV/EBIDTA discounting FY’12E capacity and EBIDTA respectively.

JK Lakshmi Cement, promoted by the HS Singhania group, is a north based cement player, having total cement capacity of 4.8mtpa. The company has its integrated plant at Sirohi, Rajasthan with a capacity of 4.2mtpa and one grinding unit of 0.6 MT at Kalol, Gujarat. The company also has 36 mw CPP at Sirohi, Rajasthan and 11 RMC units of capacity 0.75 mn cubic meters. JKLC is planning to increase capacity of its existing plant through debottlenecking and setting up a Greenfield plant of 2.7 MT plant at Durg, Chhattisgarh.

The major selling markets of the company include Rajasthan, Gujarat, Maharashtra and other North Indian states (viz: J&K, Himachal Pradesh, Punjab, Haryana, Delhi and west UP). Rajasthan, other North Indian states (excluding Rajasthan) and Gujarat contribute around 30% each to the total sales while Maharashtra contributes the remaining 10% of total sales.

North market dominance to be advantageous

As stated earlier, Northern region contributes around 60% of total sales of the company. Furthermore, DMRC related works, other road projects etc are likely to provide boost to cement demand in the region despite slow down in common?wealth related activities.

Even, the company is increasing its capacity to 8mtpa by FY’13 from current 4.8mtpa. The expanded capacities are likely to drive the volumes of the company. We are expecting the company’s volume to grow at a CAGR of 3.6% during FY’10?13E.

The company is expanding its power generating capacity by 30mw to 66mw by FY’11 by setting up 12mw waste heat recovery plant and 18mw of Thermal power plant.

The company has also entered into a long term agreement with VS Lignite, a KSK group company. Under this contract, JKLC would be able to source 21mw of power annually at a fix cost of `3.3/unit for a period of 20 years. This contract would come into effect from April, 2010.

JKLC currently sources power from the local grid at a cost of `4.4/unit. The company is likely to consume the power purchased from VS Lignite and sell power from its captive power plants on merchant basis.

We are expecting the company to garner an income of `92cr and `80cr in FY’12-13E respectively on account of selling power on merchant basis.

Apart from this, we are expecting the company to save operating profit margin by 90bps due to increasing power generating capacity and long term PPA.

Top?line plunged by 8%: JK Lakshmi’s Top?line declined by 8% y/y (26% q/q) to `323.7cr mainly on account of flat volume growth and 8.7% Y/Y de?growth in realizations to `3,169/tonne. However sequentially, the company was able to maintain its realizations due to major dominance in Northern region.

Operating profit dragged down by higher input cost: The operating profit of the company halved to `56cr in current quarter against `119cr in Q1FY’10 due to 15% increase in total costs. Even the company’s operating margin also come down by 16% to 17.4% in Q1FY’11.

Net profit declined by 75%: Due to lower operating profit and higher interest cost, the company’s Net profit declined by 75% y/y and 66% q/q to `24cr. Net profit margin also came down in single digit to 5% against 22% in same quarter last year.

At current market price of `60, stock is trading at a PE of 11x and 5.7x discounting FY’11?12E EPS respectively. On EV/tonne basis, stock is trading at $49 and $56 on FY’11?12E capacity and EV/EBIDTA of 5.6x and 4.2x discounting FY’11?12E EBIDTA.

We sense that stock is greatly undervalued at current level as compared to its previous down cycle and trading at almost 60% discount to its peer. We initiate our coverage on the stock with target price of `80. We have valued the stock at $62 EV/tonne and 5x EV/EBIDTA discounting FY’12E capacity and EBIDTA respectively.