Shree Cement - Lower than expected; margins under pressure; maintain Reduce - BRICS

Shree Cement Limited's (SCL) recurring PAT was lower than we expected at Rs801mn vs. our estimate of Rs894mn. Topline growth was aided by impressive cement volumes and power revenues. However, only a modest growth in realistions coupled with increase in power trading led to pressure on margins-fell 241bps to 25.2%. We expect prices to soften in the coming quarter, given oversupply clubbed with onset of monsoon. SCL's implied cement valuations come to US$130/tonne, which we believe is expensive. Maintain Reduce.

Turnover driven by cement volumes and power revenues: SCL's cement and clinker volumes grew by 21%. However, average cement realisations rose only 3.8% yoy and fell Rs373/tonne qoq as it chose to credit Rs650mn of government grants/subsidies for FY12 to the capital reserve in Q4. Power revenues were up 141% with own-generation volume seeing a 67% jump owing to power sale agreements with SEBs in the North. However, average merchant realisations were down 10% given downtrend in merchant rates. Overall, revenues grew 38% yoy.

Margins under pressure: SCL's freight costs/tonne was up 12% yoy, but fuel costs showed a strong decline of 24% as clinker inventory in Q3 resulted in much lower clinker production requirement in Q4 despite strong cement production growth. Despite this, SCL's margins fell by 241bps to25.2% (we saw 27.3%) due to sharp increases in power trading and muted cement realisation growth. SCL also reported a lumpy other income of Rs772mn consisting of Rs369mn of provisions no longer needed and adjusted as non-recurring. Its effective tax rate also shot up in Q4 to 34% (we saw 22%) probably due to adjustment on government grant/subsidy following which recurring PAT fell 20% yoy.

Power uncertainty: SCL has firm contracts for sale of power for 255MW till June 2012 at an average realisation ofRs4.2/unit, but for the periodafter this, it is still working on entering into short-term PPA's.

Outlook and valuation: SCL trades at a residual cement EV/tonne of US$130-a slight premium to replacement cost. Cement business fundamentals are likely to remain weak till FY14 and given the oversupply scenario, we see prices weakening in monsoons. In this season, SCL may also find it difficult to get customers for merchant power. We believe such premium valuations are not justified.

Source : Equity Bulls

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