Shree Cement Limited is the largest single location cement producer in North India with a total capacity of 12mtpa (as on date). The company has also foray into power venture from Q2FY’09. Going ahead, it is planning a big ticket entry into power business.

INVESTMENT RATIONALE:

Timely execution of expansion plan: SCL has already commissioned 1.8mtpa unit in Suratgarh, Rajasthan and 1mtpa unit in Roorkee, UTk taking total cement capacity to 12mtpa. Even, the company’s 1mtpa Jaipur unit is likely to commission by Dec’2010. Capacity expansion is likely to boost the volume growth of the company.

Profitable power business: SCL’s current power generating capacity of 260MW enough to meet the 100% power requirement of cement business (even on expanded capacities). It is selling excess power on merchant basis since Q2FY’09. The company has already completed 1st phase of power expansion plan (140mw) by June’10 where as 2nd phase of 300MW merchant power expansion plan at Beawar, Rajasthan is likely to be completed by Dec’11 taking total capacity to 560MW. Power venture is likely to cushion the operating margins in the depressing cement realization scenario.

Buy with target price of `2,328: At current market price of `1,900 stock is trading at a PE of 13.5x discounting trailing four quarters EPS, EV/EBIDTA of 5.5x and EV/tonne of $177 discounting FY’10 earnings and capacity 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. At our target price, stock would be trading at a PE of 9.9x, EV/EBIDTA of 5.9x and EV/tonne of $141 discounting FY’12E EPS, EBIDTA and capacity respectively.

Company background

Shree Cement (SCL) is a leading cement manufacturing player in Northern Region. Its manufacturing units are located in Beawar and Ras, Rajasthan. It has three products under its Brand namely ‘Shree Ultra Jung Rodhak Cement’, ‘Bangur Cement’ and ‘Tuff Cemento’. SCL enjoys logistic advantage of being closer to attractive Haryana and NCR market. It is the first Indian cement company to join Cement Sustainability Initiative (CSI), World Business Council for Sustainable development (WBCSD).

Highly efficient cement player

SCL fares well as compared to peers on account of constant cost saving measures and meeting 100% power requirement captively. In FY’10, the company was able to maintain operating margins of 41% as compared to 30% of peers. Going ahead also, due to its profitable power venture, the company is likely to enjoy high margins as compared to peer group.

SCL has already commissioned 1.8mtpa grinding unit in Suratgarh, Rajasthan and 1mtpa grinding unit in Roorkee, UTK, taking total cement capacity to 12mtpa. Even, the company’s Jaipur unit with 1mtpa capacity is likely to be commissioned by Dec’2010. Post this expansion, SCL would be 13mtpa entity. Recently, the company has announced `2,000cr investment in Karnataka to commission 3mtpa grinding unit with 100mw CPP. This would help the company to increase its foothold in other region of India and make it less vulnerable to regional D-S dynamics.

We are expecting the company to record CAGR volume growth of 8.2% over FY’10?12E on account of capacity expansion.

Lucrative Power venture

SCL is increasing its power generation capacity in two phases to 560mw by FY’12. The company has already completed its first phase of power expansion of 140mw taking total capacity to 260mw. In the second phase, it is expanding its capacity by 300mw (150mw*2) by Q3FY’12 purely for merchant sell. Out of the total 560mw power capacity, around 60% of the capacity would be available for sale in open market, generating additional revenues for the company and would provide cushion against any unexpected fall in cement margins.

We are expecting the company to sell 724mn units in FY’11E and 1,429mn units in FY’12E as compared to 264mn units sold in FY’10. Even, the contribution of power revenues in the total income of the company is likely to increase to 15% in FY’12E from 5% in FY’10.

De-leverage Balance?sheet

As on Mar 31’2010, SCL has an overall gearing ratio of 1.15x. The overall gearing ratio is comparatively higher than other peers due to debt taken for the expansions. However, the company has generated free cash flow worth `1,113cr at the end of FY’10 and is likely to generate positive free cash flow in coming years even though it is in expansion phase. Free cash flow would be useful for the company to de-leverage its balance-sheet and for inorganic growth.

Financial Performance in Q1FY’11

Top-line increased by just 2%: SCL’s Total income increased by 2% to `944cr as compared to `922cr in Q1FY’10. The company’s cement revenues declined by 8% y/y to `814cr mainly on account of 11% y/y decline in cement realizations. Its power revenues grew by more than 3times to `130cr compared to `36cr in same quarter last year.

Operating profit dragged down by higher input cost: The operating profit of the company was down by 32% y/y to `289cr due to higher input costs. Even the company’s operating margin also come down by 15% to 30.7% in Q1FY’11 against 46.2% in Q1FY’10.

Net profit declined by 63%: Net profit of the company de-grew by 63% y/y to `105cr on account of decline in profit at operating levels and higher depreciation and interest cost on account of commissioning of power plant. Net profit margin also came down by 20% to 11.2% as compared to 31.6% in Q1FY’11.

Valuation

At current market price of `1,900 stock is trading at a PE of 13.5x discounting trailing four quarters EPS, EV/EBIDTA of 5.5x and EV/tonne of $177 discounting FY’10 earnings and capacity 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.

We have valued cement business of the company on EV/tonne basis. We have assigned EV/tonne of $100 for FY’12E year end capacity of the company. We have valued merchant power business of the company of DCF basis. In power model, we have assumed merchant power rate of `5/unit for the first 6 years (FY’11-16E) and marginal decline thereafter.

At our target price, stock would be trading at a PE of 9.9x, EV/EBIDTA of 5.9x and EV/tonne of $141 discounting FY’12E EPS, EBIDTA and capacity respectively.