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S. Vaidya Nathan

AN INVESTMENT can be considered in the stock of Shree Cement. A pure cement company catering to the northern market, it is well-placed to benefit from the emerging balance between demand and supply.

The stock trades at a valuation of less than 10 times its likely per share earnings over the next two years.

The stock has the potential to deliver attractive returns over a one/two year period. Along with Grasim, Gujarat Ambuja and Madras Cements, Shree Cement is likely to emerge as a preferred play in the sector. Our recommendation represents continuity in the bullish view we have had on the stock over the past 18 months; we have buy recommendations outstanding on the stock at Rs 90, made last September.

There has been a re-rating of the stock subsequently. Despite the three-fold rise in price, it offers an opportunity to participate in the growth prospects of the cement industry.

The risks to our recommendation are the decline in cement consumption level over the past month and half, which may get accentuated if the monsoon turns out to be indifferent, a second consecutive year of modest growth in volumes and the possibility of prices coming under stress due to lower demand. Even if the industry performance tends towards moderate growth rate, Shree Cement may operate in excess of its capacity and maintain market share. Over the years, the company has exhibited resilience in performing well — in terms of volumes and margins — even in difficult years for the industry.

As Shree Cement operates at levels higher than its capacity, it would depend on price increases to sustain its profitability levels in the two years.

In the northern market, a fine balance has emerged in the demand-supply equation. This is likely to ensure stability of prices at higher levels than in the past, and, also bestow producers with better pricing power.

As its capacity expansion plans are completed by the end of next year, there is likely be an impetus to revenues and earnings from higher volumes; the effect may kick in a prominent manner from FY 07.

The replacement of a sizeable proportion of its high-cost debt by funds sourced at fine rates and prepayment of a part of its loans last year are positive indicators. This has resulted in a sharp decline in interest cost.

The improvement in price levels, the reliance on captive power, and the higher efficiency levels on key parameters, have led to operating profit margins of about 30 per cent.

This scaling up of margin levels provides a cushion on the downside in a difficult year for the industry.

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