The Hindu Business Line : Birla Corp: Buy

Cement now accounts for about 90 per cent of revenues and Birla Corp is likely to be viewed as a pure-cement play though the jute business acts as a drag on earnings. However, the threat of higher input costs is the principal risk to the story of margin expansion.

AN INVESTMENT may be considered in the stock of Birla Corporation as the company consolidates the turnaround process started a couple of years ago.

The company is now well-placed to capitalise on the improvement in the cement industry dynamics in its key markets of the North and the East.

The controversy over the transfer of ownership stakes involving the Birla group and Mr R. S. Lodha, chairman of the company, is unlikely to be a major risk to the stock price.

Birla Corp appears set to close FY-05 with earnings growth of about 100 per cent; this is likely to taper off to more moderate levels over the next couple of years as the earnings stream stabilises at higher levels.

The stock appears attractively valued from a one/two-year perspective. The following factors are likely to rev profitability levels:

The emerging fine balance between demand and supply in the northern and eastern markets;

The enhanced level of consolidation — especially after the Gujarat Ambuja Cements-Holcim deal — is also likely to give producers the power to price;

The likely improvement in cement prices and stability at higher levels;

The likely reduction in power costs over a two-year period as captive facilities go on stream;

The continued reduction in the cost of debt that has been attained over the past couple of years;

The commissioning of a one-million tonne grinding unit by mid-2005, which is likely to enhance the revenue and profitability; and

The buoyancy in the housing sector and the thrust on toning up road infrastructure.

We have buy recommendations outstanding on the stock at price levels of about Rs 80 and remain bullish on the prospects.

As the industry structure becomes more favourable to the producers, there is likely to be enhanced investor interest in the sector and a re-rating of stocks.

The Birla Corp stock trades at a price-earnings multiple of about 10 times its expected FY-06 earnings and is likely to be among the preferred plays in the sector.

Its performance so far in FY-05 points to a qualitative improvement on several parameters. There has been a margin expansion by about 250 basis points despite the surge in the cost of fuel, power and transportation.

As the company still operates at operating margins of about 10 per cent, there is room for further expansion over the next few years. This augurs well for the earnings stream.

The spurt in earnings would be without the aid of a substantial `other income' component, which was the case in FY-04 and despite a sharp rise in losses from its jute business.

Cement now accounts for about 90 per cent of revenues and Birla Corp is likely to be viewed as a pure-cement play though the jute business acts as a drag on earnings.

Given the current controversy over ownership that is unlikely to be resolved quickly, the possibility of a decision to weed out the jute business is remote.

If and when this arrangement is put in place, it would be a positive for the stock. Even as the ownership issue drags on, the possibility of Birla Corp becoming a participant in the ongoing consolidation process in the cement industry cannot be ruled out.

A hostile bid for close to 40 per cent stake that is not held by promoters is in the realm of possibility; more so, as there are only a few cement companies that offer capacities of about five million tonnes. Our recommendation does not factor in any upside linked to any such developments.

The threat of higher input costs is the principal risk to the story of margin expansion and, by extension, to our sanguine view of the company's growth prospects.

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