Mark to market | Digvijay: rags to riches story

Mark to market | Digvijay: rags to riches story

Sale of its majority stake in Shree Digvijay Cement Co. Ltd by Grasim Industries Ltd marks a stark turnaround in the fortunes of Grasim’s 10-year-old investment.

Less than three years ago, in fiscal 2004-05, Grasim had written off its entire equity investment in Digvijay Cement. The firm also provided for a permanent diminution in the value of loans to Digvijay Cement worth 37.1 crore. Digvijay had been declared a sick industrial company, and Grasim had stated in its annual report that one reason for the provision, was its outlook for cash earnings for the next few years.

In the six-month period between October 2004 and March 2005, Digvijay Cement’s cash flow from operations was a dismal Rs55.83 crore. But, things turned around in FY06 when cement prices started rising, and Digvijay reported a profit (excluding other income) for the first time since Grasim took over.

In FY06 and FY07, the company generated cash worth Rs54 crore. Last fiscal, Grasim even reversed its loan write-off worth Rs37 crore and infused Rs72 crore in the company through a rights issue.

Including its original investment in 1998, Grasim’s total equity investment in Digvijay was Rs117.7 crore.

The Cimpor group of Portugal has agreed to purchase this for 322 crore, resulting in a return of 174% for Grasim. That’s a fantastic return, since the majority of the investment was made just over a year ago, through the rights issue.

The enterprise value/tonne works out to $160, which is a rich valuation for an asset that’s insignificant as far as size goes, and operates on low profit margins.

Digvijay is expected to sell one million tonnes of cement this year, which is less than 1% of the country’s consumption. Even at the current cement prices, which are high by historical standards, the company makes an operating profit of only around $15 per tonne. This is roughly half what cement majors in the country make.

Cimpor seems to have paid a premium to gain an entry into the world’s second largest cement market.

From a Grasim shareholder’s point of view, the sale is a bonanza since Digvijay was seen as a dead investmenttill recently.

S&P on Asia’s markets

It all boils down to the price of oil. While making his presentation at Standard and Poor’s conference on the 2008 outlook for Asia-Pacific’s Financial Markets, Subir Gokarn, S&P’s chief economist, Asia Pacific, outlined his reasons why the region would be relatively insulated from the slowdown in the US. One of them is that housing’s import-intensity is relatively low, which means that if the US slowdown is largely confined to housing and doesn’t spill over into other sectors, then Asian exports may not be hit too badly. Moreover, interest rates in the region are close to their cyclical peaks, implying they can cut rates if the slowdown in exports becomes too much. That’s where the price of oil becomes important. Gokarn believes that a hike in domestic fuel prices would push inflation to around 4%, well within the Reserve Bank of India’s short-term target.

But, if oil prices rise, that would inhibit the ability of the region’s central banks to reduce interest rates. As a matter of fact, S&P’s interest rate forecast for India predicts a long-term interest rate of 8.5% as at end-July 2008. Gokarn also says that both China’s and India’s domestic growth drivers would be affected by oil prices remaining at current levels.

What does all this mean for investors? S&P estimates that the compounded annual growth rate of earnings per share for Indian corporates will be 24.2% over 2007-2009. The CAGR for China H-shares over the same period is lower, at 22.9%. That makes the price-earnings to growth ratio for India below one, making it comfortably priced.

In contrast, while the P-E multiple of the US market is low, S&P expects earnings growth for the S&P 500 to slip into negative territory.

That would make the US market unattractive on a PEG basis. In short, if the credit crunch does not kill risk appetite completely, money should still flow to theIndian markets.

Lorraine Tan, director of research, Asia, at S&P says investors are sitting on cash, which is a good thing because they will be able to redeploy their capital quickly once there’s more clarity on the extent of the credit crunch. Until then, Tan says the markets will remain range-bound.

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