A relook – mangalam cement

I analysed mangalam briefly here and here and recently started analyzing the company again as I was looking at some other cement stocks. This is what I found -

The good
The company has a 2MT plant and supplies to the northern markets of Rajasthan, MP, Haryana and parts of western UP.

The company was a BIFR case till 2002-2003, but has been able to turn around the performance. The company has been able to maintain an ROE in excess of 20%. The topline has grown at around 10% and the net profits have gone up by a factor of 7 in the span of the last 7 years.

The company has been able to bring power cost as % of sales (power is a big component in cement) from 35% to around 24% levels. In addition the company has captive power plants and windmills, so it is not be exposed to fluctuations in power costs and cutbacks in the supply. The company now has a net profit margin in the range of 15-18% which is comparable to the other companies in the industry.

The company has excess cash of around 90 Crs on the books and is now planning a 1.75 MT brownfield project at the cost of around 800 crs. The total capacity should be around 3.75 MT by 2012, when the plant goes into production. In addition to the plant, the company is also setting up a 17.5 Mw captive power plant which should go onstream by the end of the current year.

The bad
The industry – cement – is a very cyclical industry and a pure commodity play. I really doubt consumers would pay too much premium for a brand. Pricing in this industry is driven by local/ regional demand and supply situation.

The upside is that the demand is growing rapidly, but at the same time there is quite a bit of supply coming online too. As a result pricing is unlikely to get too firm, with occasional dips on the way.

The ugly
The company board recently announced a merger with Mangalam timber (see here) in the ratio of 1:10. It may appear that the mangalam timber shareholder is getting hurt, but I would say they are not the only ones hurt by this transaction.

Unless you believe that the true value of mangalam cement is the current price, it is not difficult to see that the management is giving out quite some value to the Mangalam timber shareholders. The merger is in the ratio of 1:10 and if one assumes a fair value at around 400 rs per share (difficult to explain this valuation in single line, so just play along with me even if you don’t agree), the management is giving out 40 Crs in value for the sister firm.

One can debate whether the merger ratio is fair or not, but I find cannot understand the logic of the merger. Please don’t suggest that the management is building a construction company – that way a steel company should buy a car company and imply that they are integrating forward.

The management is allocating 40 Crs on behalf of the shareholders and should be doing so in the best possible opportunity which adds value. Is mangalam timber the best value??

Anyway, inspite of this merger the company will still not lose too much of its value though it definitely does not give confidence to a minority shareholder.

Conclusion
I still think the company is fairly undervalued and is selling at 40-50% below fair value. I do not have a position in the stock and will continue digging further before I make up my mind

As always, please do your own research before you make a decision.