Madras Cements: Sell, especially on further uptrend

Recommendation: Sell, especially on further uptrend

S. Vaidya Nathan

The Madras Cements stock has seen a steady upswing in the last month with gains of around 36 per cent.

However, the stock is still below the levels prevailing at the turn of 2000. The recent uptrend appears to be linked to the general revival in market interest in cement industry stocks. Madras Cements has been a major beneficiary.

As one of the few companies to manage good profitability even in difficult times, due mainly to its operational efficiencies, the Madras Cements stock has attracted institutional interest whenever the cement sector is viewed favourably.

There has been a spurt in cement prices across country, with the Tamil Nadu and Kerala markets in lead. Through carefully calibrated production levels and tight supply-side management, the industry has managed to effect sizeable price hikes over the last four months.

The benefits of higher prices would be magnified in an efficient player such as Madras Cements. But there is the possibility of lower volumes cutting into the benefits the present cement price levels would have delivered.

This was evident even in the July-September quarter when the company reported lower profits. Then there are also questions about the sustainability of supply-side-managed high price levels. A breakdown in discipline or government action could weaken prices.

The present show could also slow the consolidation pace with an adverse long-term impact. On company-specific factors, the expansion plans of Madras Cements may also weigh on its earnings through heavy interest costs and depreciation charges. Thus, it may be better to use the present uptrend to book profits now and contemplate re-entry later.

The stock appears to be a sell candidate only due to the spurt in prices which may not be sustainable. Otherwise, Madras Cements continues to be one of top exposures in the sector -- a good reason why even shareholders who book profit should track it for accumulation later.

On the volume front, the story may not be good, especially if the industry returns to the normal operating mode. Capacity constraints ensured that Madras Cements trailed the industry even in 1999-2000 when industry-level growth rates were around 15 per cent. Over the next two years, the company may be better placed on this front as it has lined up capacities of six million tonnes. Towards this exercise, the company is slated to add a million tonne unit this fiscal.

As a focussed regional player in the South, Madras Cements would be a big player though its capacities may lag those of Grasim, ACC, Larsen and Toubro and Gujarat Ambuja. The cost-efficiencies may also stand the company in good stead. Its operating profit margins have consistently been more than 25 per cent.

As for expansion plans, the company is well placed to put them through without expanding its equity base. Madras Cements' relies on internal cash accruals and debt which is good for shareholders.

Though the revenue stream may improve as capacity constraints are removed, the company's profitability may remain under pressure unless prices are sustained at the present high levels. In this context, the present valuation levels could also come under strain. It is in this backdrop that shareholders could use the present bullish phase to pare exposures in the stock and review the position later.