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Published on 16/04/2018 1:14:35 PM | Source: Motilal Oswal Securities Ltd

Buy Shree Cements Ltd For Target Rs.18,867.00 - Motilal Oswal

Posted in Broking Firm Views - Long Term Report| #Shree Cements Ltd #Cement Sector #Broking Firm Views Report #Motilal Oswal

Capacity-led earnings growth on the cards

Valuations have moderated based on FY20E capacity

* Shree Cement (SRCM) is increasing its domestic capacity by ~32% over FY17-19 at an estimated capital cost of USD60/t. Acquisition of the asset in the UAE at USD76/t has also been at a significant discount and in line with the company’s long-term strategy.

* SRCM’s relatively low cost of production compared to peers has resulted in healthy margins and return ratios. As a result, it warrants premium valuations, in our view.

* We expect SRCM to deliver a better performance than industry due to 1) capacity ramp-up over FY17-19 and 2) a favorable market mix, with higher exposure to the north markets (>70%), where prices are expected to be the highest.

* Valuations have also moderated on account of ~18% correction in the stock price from its peak due to 1) market correction, 2) downward revision in its earnings estimate and 3) multiple de-rating due to capacity acquisition in the UAE.

* Valuations have moderated to USD174/t on FY20E capacity. This translates into ~25% premium to the replacement cost of USD140/t and ~14% premium to the revised bids for Binani Cements’ domestic assets.

* SRCM is likely to deliver EBITDA CAGR of 29% over FY18-20, led by healthy volume growth (driven by rapid capacity addition) and pricing improvement (driven by higher realizations in the underlying markets in the north). In our view, SRCM – with its superior return ratios and strong earnings growth – deserves to trade at premium valuations. We, thus, value the stock at 15.5x FY20E EV/EBITDA to arrive at a target price of INR18,867. Maintain Buy.

Aggressive capacity expansion at lower capex

SRCM is increasing its domestic capacity by ~32% over FY17-19, supported by capacity addition in the east, north and south markets at an estimated capital cost of USD60/t (significantly lower than market ascribed EV/tonne of USD 170-200/t). Additionally, the company has acquired an integrated asset in the UAE at USD76/t, helping it maintain lower cost of capacity addition – in line with the company’s long-term strategy.

Cost leadership ensures healthy return ratios and warrants premium valuations

SRCM has been able to generate superior RoEs/RoCEs than peers owing to a healthy cost curve – a differentiating factor in a commodity-led market. SRCM’s cost of production has been ~19% lower than its peers, which has resulted in healthy margins and strong earnings growth. As a result, SRCM valuations have always commanded a significant premium to peers.

Expect SRCM to deliver healthy performance than industry

We expect SRCM to deliver a healthier performance than industry due to 1) capacity ramp-up over FY17-19 and 2) a favourable market mix, with higher exposure to the north markets ( >70%), where prices are expected to be the highest. We note that SRCM’s valuations have moderated due to ~18% correction in the stock price from its peak due to 1) market correction 2) a downward revision in its earnings estimates and 3) the acquisition of an asset in the UAE.

Valuations have moderated on FY20E capacity

SRCM’s valuation on EV/tonne on FY20E adjusted capacity is ~35% lower than that on FY17 capacity due to low-cost capacity addition. SRCM trades at USD174/t on FY20E capacity. This translates into ~25% premium to the replacement cost of USD140/t and ~14% premium to the revised bids for Binani Cements’ assets.

Deserves premium valuations; reiterate Buy

We believe that the key trigger for SRCM over the next 12-15 months would be domestic profitability, especially because it is adding ~13mt of capacity domestically (~3x of acquired capacity) and also diversifying into newer markets. Given SRCM’s low cost curve and capex cost, it should be able to generate healthy return ratios from domestic operations, in our view. Moreover, any improvement in profitability from the acquired capacity in the UAE would be an added benefit. SRCM is likely to deliver EBITDA CAGR of 29% over FY18-20, led by healthy volume growth (driven by rapid capacity addition) and pricing improvement (driven by higher realizations in the underlying markets in the north). In our view, SRCM – with its superior return ratios and strong earnings growth – deserves to trade at premium valuations. We, thus, value the stock at 15.5x FY20E EV/EBITDA to arrive at a target price of INR18,867. Maintain Buy.

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