December 6, 2009

Analysis – some cement companies

I have written about the cement industry in the past (see here, here and here). You can download a detailed analysis of the industry from here (see file - Business analysis_working_aug 2007.xls, column for cement industry).

I had the following in an earlier
post

Considering the level of undervaluation in some sectors such as pharma, IT etc and the better economics enjoyed by those industries compared to Cement, I am personally not too keen on investing in the cement sector. If I had to pick up one cement company to put my money in for the long term, I would prefer ambuja cement.

When I wrote this comment, I did not realize that it would turn out to be this accurate. IT and pharma stocks (the don’t touch sectors of 2007-2008) have done much better than the cement industry stocks. Note the word stocks and not the industry. As I have said in the past, a good and well performing company or industry is not necessarily a good stock and vice versa.

I have been running various filters to come up with new ideas and it has been slim pickings. The filters recently threw up some cement companies, so I decided to an analysis of these companies again . A short review follows

Mangalam cement
This is a birla group company with a capacity of around 2MT and caters to the northern market. The company currently has a net margin of around 15% and an ROE of around 30%. The company also has surplus cash on its books
The company however has been a BIFR case in the past (2002-2003). The company has since then been able to turn around its performance by restructuring its debt, reducing its cost structure (by generating power internally) and was also aided by the rise in the demand and pricing for cement in the last 5 years.
The company now plans to expand capacity by around 1.5 MT at the cost of 750 crs. The company sells at around 300 crs, net of cash and at a PE of 2-3. In addition, the company is also selling at 25% of replacement cost.

Ambuja cement
This is one of the top companies in the industry with an installed capacity of around 22 MT.The company has generally maintained an ROE in excess of 20%, net margins in excess of 10% and fairly low debt equity ratios.
The company has one of the lowest cost of production in the industry and is a well managed company. The company sells at around 11-12 times PE and around 610 Crs/MT of capacity.

Additional thoughts
The cement industry is a commodity industry where the profitability of the players is driven by the demand supply situation and the resulting cement pricing. The demand growth is now at around 8-9% and picking up due to revival of the economy. However at the same time, a lot of additional capacity is scheduled to come online which may add to the pricing pressure.

To look at the same dynamics in a different way, the current profits per MT of cement is around 70 Crs. The average profitability is generally around 40-50 Crs per MT of sale. As a result the current profits are around 30-40% higher than average. Any increase in capacity or slowing down of demand could impact the margins and net profit for the industry.

The second tier companies such as mangalam, JK cement etc look attractive at current valuation. However such companies typically sport low PE ratios at the peaks of business cycles or peak pricing. As a result, I have yet to make up my mind if the above companies are truly undervalued. Maybe a good time to buy cement stocks was a year back, but then one could have bought almost anything then and made money by now.

Disclosure: no current holding, only extensive reading. As always if you buy based on my analysis, blame yourself :)

8 comments:

ravi said...

Hi Rohit,

Great post as always. I have a question on the replacement cost comment of yours. You had mentioned that managalam is selling at 25% of replacement cost. Can you elaborate on how you calculated this?
I am already invested in mangalam. The way I look at it is yes the profit right now is high. If we go by 40 cr average profit per MT then mangalam would make 80cr (current capacity of 2 MT) on average. At current market cap of 300 cr net of cash, it means we get around 26% return on our investment which is a very decent return compared to other businesses that we have. Offcourse the capex is something which is a dampener right now.

Regards
Ravi

Rathin Shah said...

Hi Rohit,

If possible, it would be great if you can throw some light on the concept of replacement cost and how does one calculate it?

Another question is about low cost producer. How does one go about analyzing which company is the lowest cost producer in the industry (Do we take cost of mat / sales or SG&A / sales or total cost / sales which can be reflected in the margins as well or is there any other way?). Should we focus more on operating margins here or is the gross margins which determine cost advantage. Everything else being equal (even the net margins), which company is better; one which has higher gross margins or one with higher operating margins?

In anticipation,

Warm Regards
Rathin

Rohit Chauhan said...

Hi ravi
mangalam cement plans to put up a new 1.5 MT plant for 750 crs. the same seems to be a the cost of a new project for other companies too. this works out to around 500 crs/ MT. mangalam sells for around 250 crs excluding excess cash for an installed capacity of 2MT. so per MT, it is selling for 125 crs and hence 25% of replacement cost
rgds
rohit

Rohit Chauhan said...

Hi rathin
for lowest cost producer, i would not look at the margin as that may depend on a premium selling price too (less so in case of cement) which may vary by region.
for cost of production it makes sense to analyse the Raw material cost/ MT of production, overheads/MT of prod, power and distribution cost/ MT produced and total cost of production/MT of production. these numbers will give you a decent idea on the lowest cost producer.
ofcourse you could come up with something similar by looking at margins, but sometime a better selling price may mask higher cost of production

karthik said...

Hi Rohit,
Sorry for a off the topic comment..
Iam planning to take a health insurance but worried about taking the private insurance.
Do you have any experience in this?.. Can we trust the private players.. PSU insurances dont ahve much information on thier website and its really difficult to gauge them too. Have you taken a health insurance?..Hope you would be able to help me.

Rohit Chauhan said...

Hi karthik
i am sorry, i dont have much experience on this. i checked for some health insurance for my parents and found it to be way overpriced. almost 10k+ for 1.5 lacs coverage


rgds
rohit

KD said...

Hi Rohit, Its always good to read your analysis, as they throw some different angle at which I have not looked at yet..Pls also see Birla Corp..similar story as Mangalam, however stock has already catch up some fancy..

karthik said...

Thanks Rohit. I agree.. That too only couple of insurance companies are ready to insure 65 ++ senior citizens.. But I think I will go ahead as there are very few options.