Madras Cements: Hold

Recommendation: Hold

S. Vaidya Nathan

DESPITE a not-so-good performance in the first quarter of fiscal 2000-2001, Madras Cements shareholders can stay invested for the present.

The performance in the second quarter may be better on account of higher price levels. Based on the performance in this period, the exposures can be reviewed. From a long-term perspective, along with Gujarat Ambuja Cements, Madras Cements continues to be an attractive option.

The industry level growth rates in this fiscal may not match up to last year's level of around 15 per cent, when Madras Cements trailed the industry. This trend may continue as capacity constraints and the slowdown in the first quarter of 2000-01 may act as dampening factors on volume growth.

But, given the expansion plans of the company, it could get over this problem to a large extent in the next two years. In a phased manner, capacity is expected to touch six million tonnes over the next couple of years. The company is slated to add a one-million tonne unit this fiscal as part of this exercise.

Even when the complete expansion plan is complete with a capacity of around six million tonnes, Madras Cements would be way behind producers such as Grasim Industries, Larsen and Toubro, ACC and India Cements. But, as a focussed regional player in the southern markets, Madras Cements would have a capacity that should place it on a fairly string footing. What may work to the company's favour is its cost-efficiencies.

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The company has managed to achieve high levels of efficiency at its Alathiyur unit (in Tamil Nadu) where the next one-million tonne capacity unit is also due to go on-stream. Even before this unit was commissioned, the company had high levels of profitability with operating profit margins in excess of 25 per cent consistently.

The high operating efficiencies have helped neutralise increase the prices of inputs such as power and coal to some extent. It has also ensured good cash flows which have enabled the company to grow without expanding on its equity base. This has been the trend through the 1990s as well.

Madras Cements' has traditionally relied on internal cash accruals and debt to bankroll capacity expansion and modernisation programmes. Despite a difficult period for the industry, the company has managed to report healthy levels of profitability after sizeable financial charges (on account of interest and depreciation) in the last three years. This aspect of its financing also leaves the company with flexibility on the equity front, which has not been used for a long time now.

As capacity constraints get removed, the company is bound to manage higher scales of revenues in the next two to three years. But the bottomline could be under stress on account of financial charges. This may be a good price to pay as the expansion would strengthen the company from a long-term perspective. More so, since the industry is headed for a time when less than 10 players would control close to 80-85 per cent of the capacity. While Madras Cements' is unlikely to be a major player across all markets, it may figure in the shortlist of 10 as the best-placed regional major.

Tamil Nadu and Kerala markets would continue to see intense competition as producers from elsewhere chase better price levels. In this context, the low distribution cost from the Tamil Nadu unit and the brand equity may provide an edge in pushing through higher volumes. The kind of price levels enjoyed in the 1990s may become a thing of the past.

But even at lower average price levels, the cost-efficiencies combined with volumes may enable Madras Cements' to show healthy earnings. While any flare-up in price in the near term appears unlikely, existing shareholders with a medium-to-long-term perspective can stay invested. Investors looking to cut exposures could wait out for the second quarter earnings announcement. Since significant profit growth may be weighed by high financial charges, fresh exposures can be avoided for the present.