Is Shree Cement’s rich valuation warranted?
Shree Cement’s December quarter earnings were marred by the performance of its power segment, which incurred a loss at the operating level, thus impacting overall profitability. In the cement segment, volumes improved 4.5% year-on-year (y-o-y) to 4.91 million tonnes (mt) due to capacity additions in east India, but realizations declined sequentially as prices corrected sharply in both eastern and northern markets post demonetization.
On a y-o-y basis, net profit increased by a mere 0.72% to Rs235.45 crore and net sales rose 3.24% to Rs2,091.17 crore, aided by higher other income. Last but not the least, freight costs surged, pushing cement operating cost/tonne higher.
Going by these factors, there’s nothing much to cheer about, but the stock’s valuations show a different picture. Shares of Shree Cement, trading at a one-year forward price-to-earnings multiple of 33.92 times, compare well with ACC Ltd and Ambuja Cements Ltd. Shree Cement is expected to have an edge over peers in the long run given positives like a less stressed balance sheet, better operating efficiency and geographical diversification. But the question to ask is, whether such rich valuations are justified? The answer probably is that current valuations already reflect the aforementioned factors.
More importantly, there are concerns which cannot be ignored. Cement volumes would remain sluggish in the states of Uttar Pradesh and Punjab due to elections thus impacting cement realizations. Brokerages Reliance Securities Ltd and Karvy Stock Broking have trimmed their Ebitda estimates for FY17, FY18 and FY19 to factor subdued realizations in key markets. Ebitda stands for earnings before interest, tax depreciation and amortization.
Secondly, freight and energy costs would weigh on margins as they are expected to harden. Also, how soon volumes in the power segment revive is key. Shree Cement is on a capacity addition spree and aims to become a 40mt capacity company by FY19. It will incur a cost of Rs1,800 crore to add clinker capacity of 2.80 mtpa and cement capacity of 3 mtpa in Karnataka. This integrated project will be funded through internal accruals and is expected to be completed by December 2018. Though the company has been adding capacity without leverage, some analysts don’t favour this move simply because south India already has excess capacity. Meanwhile, it has announced a one-time special dividend of Rs100 for every equity share held.
Since the company has been expanding its footprint in various regions, a slew of brokerage houses are gung-ho on the stock citing it to be a beneficiary of cement demand recovery. When this anticipated revival will finally happen is anybody’s guess, but for now valuations need to correct.