Will midcap cement stocks shine post Budget 2022?

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Midcap IT stocks have significantly outperformed their largecap peers over the last 12-15 months. Is a similar trend likely to play out in midcap cement stocks over the next 12-15 months?

If you observe carefully, the valuation differential between some frontline names and smaller cement companies is considerably high. And if smaller companies manage their operations efficiently and grow faster in future, they might become interesting to track.

But what could be the potential triggers for the cement sector?

You see, some crucial events that can potentially decide the pace of reforms in the country are around the corner—Budget 2022 and the assembly elections in 5 states. They might decide the pace of reforms and infrastructure development in the country.

First advance estimates of NSO (National Statistical Office) suggest that the real GDP growth in FY22 is likely to be 9.2%—which isn’t bad. Tax buoyancy is likely to offer more leeway to the government to spend on the developmental agenda.

In a developing country like India, government spending heavily on infrastructure acts as a fiscal stimulus. The cement sector is a good play on infrastructure, isn’t it?

The key here is to focus on companies that are:

  1. Adding capacities to capture future growth opportunities
  2. Moving closer either to markets or sources of raw material (Please read it as an extension of point 1)
  3. Attentive to their ESG scores
  4. Mindful of their profitability matrix

Take an example of The Ramco Cements. It is the 6th largest cement company in India and has a capacity of 19.4 MTPA. Ramco has a market share of 4%.

Expanding capacities and geographical presence

Majority of Ramco Cement’s operations are focused in the southern states, which contribute 70%-75% to its top line. That said, the company has been diversifying across geographies.

Of late, Ramco is growing its presence in the eastern parts of India and also eyeing large markets such as Maharashtra.

In FY20, Ramco Cements guided for a multi-year capex of Rs 3,500 crore. In FY21 the company invested Rs 1,766 crore towards capacity expansion. It is focusing on offering the right products for the right applications and hopes to benefit from product premiumization. Currently, it owns 12 brands.

In H1FY22, the company has already incurred a capex of Rs 902 crore of which Rs 160 crore has been towards expanding the capacity of dry mix products.

On the completion of ongoing capex, the company’s clinker capacity is expected to expand from 11.4 MTPA to 14 MPTA, cement capacity from 19.4 MTPA to 20.4 MTPA and dry mortar capacity from 0.96 lakh tonnes to 9 lakh tonnes.

All these capacities are scheduled to come on stream over the next 1-2 years.

The capacity additions in the dry mix products are expected to help the company expand its product portfolio to high value offerings. They include water proofing, repair products and flooring screeds, amongst others.  Nearly 1/5th of its revenue comes from premium products as of now.

Despite being capex-bound, Ramco’s net debt/EBITDA ratio is 1.9 times.

Focus on ESG compliance

The company has set some aggressive ESG (Environmental Social and Governance) goals for the foreseeable future. By 2025, it aims to achieve zero waste to landfill across operations. Ramco Cements is also investing in innovative technologies to ensure that it minimizes its water and carbon footprint.

The benefits of investments in green energy initiatives and in Waste Heat Recovery Systems (WHRS) might be more visible in FY23.

Ramco Cements: one of the most efficient cement manufacturers

The rising operating costs have been putting some pressure on the company’s profitability of late.  Nonetheless, Ramco’s EBITDA per tonne of Rs 1,484 in Q2FY22 has been better than Rs 1,427 of Shree Cements. ACC and  Ultra Tech reported EBITDA/tonne of Rs 1,084 and 1,254 respectively in Q2FY22.

Here’s an interesting observation

Rajapalaym Mills, a textile company of the Ramco Group, holds a 13.99% stake in Ramco Cements. At Rs 1,019/share (the closing price of Ramco Cements as on January 11, 2022), the value of Rajapalaym’s 3,30,65,000 shares of Ramco Cements works out Rs 3,369 crore. The market capitalization of Rajapalaym Mills as on January 11, 2022 was Rs 1,130 crore.

Now let’s look at another mid-sized company which is focused on northern and western markets predominantly, JK Lakshmi Cement. Proximity of its manufacturing plants to raw material sources makes JK Lakshmi one of the lowest cost cement manufacturers.

Over the last 5 years, the company has ramped up its capacity from 8.6 MTPA to 14 MTPA. As the large capacities have already come on stream and started contributing to the company’s revenue pie, the net debt/EBITDA ratio of JK Lakshmi has fallen from 5.14 in FY16 to 0.46 in FY22.

Between FY19 and FY21, JK Lakshmi’s profitability, as denoted by EBIDTA/tonne, has improved from Rs 413 per tonne to Rs 900/tonne.

Udaipur Cement, a subsidiary of JK Lakshmi, has undertaken a brownfield expansion at an approximate cost of Rs 1,400 crore of which Rs 1,000 crore will be in the form of debt. However, it is unlikely to disturb the financial metrics of JK Lakshmi at a consolidated level since a similar amount of debt is expected to be repaid.

Endnote

It’s noteworthy that Crisil expects the profitability of cement companies measured by EBITDA/tonne to decline ~12% in FY22 due to high power, fuel and freight costs. Nonetheless, it’s also forecasted an 11%-13% rise in cement sales volumes in FY22.

You see, efficiently run companies enjoying high profitability might be able to tackle cost escalations more effectively. If such companies enjoy lower valuations, they may suddenly attract the spotlight, more so if they can achieve higher volume growth in the times to come.

All eyes on Budget 2022 now!

Do you think Budget 2022 will affect the outlook of the cement sector positively? Do let us know in the comments.

You may also like to read: Which companies might be the beneficiaries of 11th round of CGD?

 

Disclaimer:

 The blog is for information purposes only and anything mentioned herein shouldn’t be construed as a fundamental reason to buy/hold/sell any stock. Furthermore, the information provided in the blog and observations made therefrom shouldn’t be treated as the extension of recommendations made on the other properties of Ventura Securities. If you follow any research recommendations made by our fundamental or technical experts, you should also read associated risk factors and disclaimers.

We strongly suggest you to consult your financial advisor before taking any decision pertaining to your finances. Asset allocation becomes extremely relevant.

We, Ventura Securities Ltd, (SEBI Registration Number INH000001634) its Analysts & Associates with regard to blog article hereby solemnly declare & disclose that:

We do not have any financial interest of any nature in the company. We do not individually or collectively hold 1% or more of the securities of the company. We do not have any other material conflict of interest in the company. We do not act as a market maker in securities of the company. We do not have any directorships or other material relationships with the company. We do not have any personal interests in the securities of the company. We do not have any past significant relationships with the company such as Investment Banking or other advisory assignments or intermediary relationships. We are not responsible for the risk associated with the investment/disinvestment decision made on the basis of this blog article.

 

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