Is India Cements a good pick at current valuations?

India Cements, among the seriously underperforming cement stocks on the BSE, is current available at very low valuations as compared to those of other cement players. Can this be a good opportunity for one to enter the counter, or should one stay away in the current weak economic scenario?

With a capacity of 15.5 MT, India Cements is among the leading cement producing companies in the southern region of the country. The company added 1.5 MTPA capacity in CY2011, and is currently in the process of developing a coal mine in Indonesia that will help it to integrate the supply chain, as more than 50% of its coal requirement is met through imports. Further, the coal mine will help reduce its exposure to the fluctuating coal prices.

The company is also in the process of setting up a 50 MW power plant near Tirunelveli (Tamil Nadu), which is expected to be completed by Dec 2011. This will help it to reduce power and fuel costs.

In the last one year, India Cements has faced serious problems such as subdued demand in the region, surplus capacity due to faster expansion, and the Telangana issues that impacted the company’s performance in the last 2 quarters. The stock price of India Cements in particular, and all the other cement players in the South has fallen sharply as compared to those of other players in the country.

Apart from subdued demand and surplus capacity, the companies in the South were also faced high input costs, which created greater pressure on their margins. Input costs, especially those of power and fuel went up significantly due to an increase in coal prices, mainly on account of limited supply. Other costs such as freight charges also went up significantly due to a continuous hike in diesel prices by the Central govt. Power & fuel costs and freight charges costs constitute 50% of the total cost of the company. Also, during Sept 2011, the company witnessed an upset in the availability of coal in Andhra Pradesh on account of the Telangana agitations, which lead to the purchase of high-cost imported coal for the plants.

In fact, in order to offset the increase in input costs, the companies resorted to keeping the cement prices firm by cutting down their production during the quarter. This has helped the southern players to maintain some of the margins in turbulent times.

The coal price in the last one month has come down by 5% to USD 115/tonne, which will provide some cushion on the margins front. However, freight charges will continue to remain high. However, due to higher cement prices and some pickup in demand, the margins may remain flat or will see some improvement in the Dec quarter. The only thing to watch out for is the higher interest expense, which could drag down the net profits in the Dec quarter.

At the current market price of Rs 69, the scrip is available at a PE (TTM) of 8.2x at an EPS of 8.09. With the industry PE at 12x,  the scrip, which has fallen the most by 38% in the last one year, looks attractive at this level. However, a huge debt and higher interest expenses may remain a dampener for the stock's performance in the coming months. Therefore, we recommend that investors should stay away from the scrip.