Star Cement's volume growth is likely to be led by capacity expansion, but gains in operation margin is the key. (Sarvesh Kumar Sharma/Mint)
Star Cement's volume growth is likely to be led by capacity expansion, but gains in operation margin is the key. (Sarvesh Kumar Sharma/Mint)

Star Cement’s lower valuations reflect concerns on operating margins

  • Govt subsidy will aid deleveraging, making Star Cement debt-free eventually, but further upside largely depends on operatiing performance
  • Supreme Court’s recent ban on coal mining in Meghalaya is likely to remain an overhang on Star Cement, whose operations are based in North-East India

With the government clearing freight subsidy claims of around 50 crore, the Star Cement Ltd stock is in the spotlight. Shares of the North-East-based cement producer jumped nearly 10% intraday on NSE on Thursday. However, it has given up most of those gains and is up only about 2% since the development.

The government incentivizes, in the form of subsidies, cement producers operating in hilly and backward states. Other companies are also entitled to it. No wonder then that the euphoria didn’t last and the stock gave up the gains.

This , say analysts.

The company’s December quarter results were a mixed bag. Margins took a hit after it stopped receiving a transport subsidy.

“In Q3FY19, the company witnessed a dip in margins from 37.8% to 29.5%, mainly led by end of transport subsidy from January 2018. We believe margins of 25-26% will be the new normal for the company in the coming years," ICICI Direct Research said in a report on 6 February.

The Supreme Court’s recent ban on coal mining in Meghalaya is also likely to remain an overhang on the stock.

Star Cement is procuring coal for fuel from the local market at 6,000 per tonne and has an inventory of two months, say analysts. However, an extended ban by the apex court could force it to procure imported or spot coal from Coal India Ltd at 8,000 per tonne, they add.

The company, like its regional counterparts, can use price hikes to offset this impact. However, in the current scenario, the sustainability of price hikes is questionable. This means margins could remain under pressure.

Meanwhile, the outlook on volume growth is improving because of government spending on infrastructure projects in the North-East.

The Siliguri grinding project is on track for commissioning by December this year, the management said in a post-earning conference call with analysts. The company also proposes to set up a clinker unit in Meghalaya.

Investors seem to have concluded that the concerns outweigh the promises. At a one-year forward EV/Ebitda of 8.52 times, Star Cement trades at a discount to other mid-cap peers. EV is short for enterprise value and Ebitda is earnings before interest, tax, depreciation and amortization.

For valuations to improve, margins need to grow as well.

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