It is one thing to be part of an economic upcycle and another to benefit from it. Concerns about India Cements Ltd came to the fore after the company reported a sharp fall in earnings for the September quarter. Profit fell to a paltry 1.4 crore from 23.7 crore a year ago, triggering a sell-off in the stock on Monday.

Profit slumped even as sales volumes grew 14%, reflecting improving demand conditions. According to the company, even the southern region, which has been under pressure, registered a healthy double-digit growth in cement production due to infrastructure demand from the Andhra Pradesh and Telangana governments. The continuing thrust on infrastructure spending should help maintain positive momentum in volumes. “The pick-up in cement demand witnessed after sluggish or nil growth for several years is expected to continue," India Cements said in a statement.

But the seemingly improving demand is not helping much. Excess supply means cement prices continue to remain under pressure in south India. Add to this the increase in input costs (imported coal and petcoke), and the company’s earnings came under pressure. As demand gathers pace, India Cements expects the market to achieve equilibrium leading to better prices in the coming months. “Management expects significant improvement in cement prices in Q4FY19, considering the strong demand momentum," said Emkay Global Financial Services Ltd in a note.

Many analysts share the volume recovery thesis. But not everybody is convinced it will result in earnings accretion.

India Cements plans to invest around 1,000 crore to expand capacities in central India. The investment is expected to be funded from internal accruals. With profitability under pressure, the company may be forced to borrow, deteriorating its leverage and returns ratios. “While we concur with the industry positive view, we are concerned about: 1) high net debt/ EBITDA of ~4.5x FY19E; 2) lack of visibility on debt reduction and rather potential spurt in debt (to fund capex); 3) increase in working capital; and 4) low return on equity," said Edelweiss Securities Ltd.

Of course, one cannot find fault with the strategy to expand into central and northern India. The investments will help it diversify. However, for investors, the investment will prove remunerative in the short term only if the southern market sees a timely recovery in prices. The incremental earnings can help fund capex and keep debt in check.

Unfortunately, the September quarter results show no signs of this. Rather debt increased and profitability came under pressure, amplifying earnings challenges. “With subdued current profitability despite robust volume growth and risk of earnings downgrade in case of further delay in price hikes in South, we cut India Cement’s valuation multiple to 6.5x FY20E EV/ EBITDA (from 7.0x)," adds Edelweiss.

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