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S. Vaidya Nathan

INVESTORS can consider exposure in Shree Cement, as it appears well-placed to deliver earnings growth that could lead to a further re-rating of the stock. Buy the stock with a one/two-year perspective, especially on any weakness in the near term linked to broad market trends or its earnings announcement.

Such an investment horizon may be needed to capitalise on the benefits from the new capacity that is to be commissioned in the second quarter of FY-06.

The company is set to unveil its earnings numbers for the January-March quarter on Monday. As demand in February was affected by the colder-than-usual weather conditions, its performance may show the effects of sluggish trends in the quarter.

Yet, the higher average cement prices are likely to ensure that earnings remain at impressive levels.

If there is any weakness following the earnings announcement, it would be an opportunity to accumulate the stock.

We have multiple `buy' recommendations outstanding on the stock over the past couple of years with the latest at about Rs 225 last November. The stock has risen seven-fold from our first call in 2003.

Despite the run-up in prices, we believe that the higher price-earnings multiple that the stock now enjoys is likely to endure and expand.

As Shree Cement has over the past year adopted a policy of charging depreciation on an accelerated basis, the per share earnings is understated compared to its peers.

Also, given its high operating efficiencies and the balance-sheet strength, Shree Cements' presence in a geography where the demand-supply situation is now in favour of producers, and its ability to post healthy margins even in difficult years for the industry, we expect the stock to a command a premium to its peers.

On an enterprise value basis, it is now bunched with other cement stocks with inferior fundamentals; the exception is Gujarat Ambuja, which enjoys a significant premium over the rest. As the expanded capacities start contributing to revenues and earnings, Shree Cement could break away from the pack. As the industry dynamics continue to improve in favour of the cement producers, institutional investors have begun taking a fancy for the sector.

This trend is likely to sustain and could lead to a higher degree of institutional investor interest in such stocks as Shree Cement over the next couple of years.

As a pure-cement play with top-of-the-charts efficiency numbers, Shree Cement offers a superior exposure to the sector.

The commissioning of a 1.2-million tonne capacity is likely to ensure that volume growth remains robust. Capacity constraints capped volume growth in recent years as Shree Cement has consistently operated in excess of 100 per cent. The steep rise in earnings is largely attributed to higher cement prices and, to a lesser extent, the benefits from its new captive power plant.

Over the next couple of years, the combination of an increase in volumes and a firm undertone in cement prices are likely to drive earnings growth.

There is the possibility of the demand-supply equation being threatened by capacities that are to be commissioned by ACC and Gujarat Ambuja in the northern region over the next couple of years. This is, however, not likely to dent pricing power in a significant manner.

Producers have an interest in ensuring price stability at higher levels that now prevail, especially in the wake of a rise in energy costs.

Collectively, the new capacities, which are on the anvil, are not likely to be large enough to impact prices for a prolonged period. Even if there is a brief period of price weakness, it is likely to be only in the second half of FY-07.

Shree Cement also enjoys the advantage of proximity to high-growth markets of the north compared to its competitors. This aspect, too, could profitability against pricing pressures.

We would, however, recommend close tracking of any announcements of additions to capacities through new units and/or de-bottlenecking, as it could emerge as a significant risk to our recommendation. In the near term, higher energy cost represents the major risk to profitability.

But if Shree Cement's performance in the last quarter of 2004 is an indication, it appears well-placed to cope with this threat.

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