JK Lakshmi Cement
JK Lakshmi Cement (JKLC) is a part of the JK group (Hari Shankar Singhania) which is in to Tyres (JK Tyre), Paper (JK Paper), Sugar etc. The company mainly operates in the Western and Northern areas of India. JKLC commenced cement production in the year 1982 at Sirohi, Rajasthan & last year, it also started production from its second plant at Kalol, Gujarat. With the addition of this new plant, its total cement manufacturing capacity now stands at 4.75 MTPA. JKLC also produces Ready Mix Concrete (RMC) and Plaster of Paris (PoP). It has a captive power plant of 36 MW at Sirohi. JKLC has more than 2,000 dealers in its target markets.
Summary Financials
JKLC was a loss making company till FY 2004 but has turned around its performance backed by robust cement demand, increased volumes and improved efficiencies.
The last 4-5 years have been one of the best periods for the cement industry
due to buoyant demand fueled by the boom in housing and infrastructure sectors. To take advantage of this demand, JKLC has been steadily ramping
up its cement manufacturing capacity for the past few years. On the other
hand, it has also maintained a consistently high capacity utilization to cater to
this rising demand. The combination of these factors along with rising cement
prices have increased Revenues as well as Profitability of JKLC.
Reduction in Power Costs
Due to improved efficiencies and higher capacity utilization (fewer plant stoppages), JKLC has been able to bring down its power consumption on a
per ton basis. Additionally, JKLC has set up a 36MW captive power plant
which provides electricity at a considerably lower rate than what is available
from the state grid. Hence, the savings on overall power costs have been
significant in improving the bottom line of the company.
Better Blending Ratio (towards PPC) and Lower Fuel Costs
It is more economical to manufacture Blended Cement (PPC) compared to
Ordinary Cement (OPC) as less amount of clinker (raw material) is required to
produce the same quantity of cement, thereby reducing the fuel usage in the
firing process. Also with a higher blending ratio, cement production can be
partially increased by setting up additional grinding unit only (instead of
setting up both grinding and clinkering units), saving on capital expenditure.
Over the years, JK Lakshmi has been selling more of blended cement (PPC)
as compared to ordinary cement (OPC) and a higher blending ratio has
helped in reducing fuel costs and capital expenditure. Also, using cheaper
bio-fuels in addition to coal & coke has helped JKLC to bring down its overall
fuel costs.
Reduction in Interest Costs
In the past, high interest cost was one of the main contributors to the losses
made by the company. JKLC has consistently lowered its debt over the years
and maintained a healthy debt-equity ratio. As a result, its interest costs have
come down and the company has been able to post better net profit margins.
Better Working Capital Management
JKLC has tightened its working capital requirements over the years by
simultaneously increasing the creditor days and decreasing debtors days (by
focusing on 'Cash & Carry’ policy). Reduction in working capital requirements
has not only reduced interest costs on working capital loans, but also
increased the availability of cash for capital expenditures.
Greenfield Plant at Durg, Chhattisgarh
JKLC is setting up a new 2.75 MTPA greenfield plant at Durg, Chhattisgarh.
This plant is expected to complete by FY 2013 at a cost of Rs. 11,000 mn. The
Durg region has adequate limestone reserves and the new unit will allow
JKLC to tap the Central and Eastern markets of the country. Currently, the
company is in the process of acquiring land for the project and has already
acquired 40% of the required land.
Increasing Clinker Capacity at Sirohi
JKLC is planning to increase its clinker capacity from 3.63 MTPA to 3.96
MTPA at its existing plant at Sirohi, Rajasthan. It is also scouting for a split
grinding unit (at a different location) to service this enhanced clinker
production. This project is expected to complete by FY 2011 at a cost of
Rs. 700 mn. This enhanced capacity will be able to serve the rising demand till
the greenfield plant at Durg becomes operational in FY 2013.
Long Term PPA with V.S. Lignite
JKLC has entered into a long term power purchase agreement (PPA) with
V.S. Lignite, a KSK group company. Under this contract, JKLC will be able to
source 21MW of power annually at a cost of Rs. 3.3/unit for a period of 20
years. This contract will come into effect from October 2009. JKLC currently
sources power from the local grid at a cost of Rs. 4.4/unit. Hence, JKLC is
expected to benefit from this contract on a long term basis.
Augmenting Captive Power Plant & New Waste Heat Recovery Plant
The 36 MW captive power plant at Sirohi only suffices about 65% of the
current power requirements. To become fully self sufficient in power and cater
to the power requirements of future capacities, JKLC is planning to augment
its existing captive power plant at Sirohi by another 18MW at a cost of Rs.
800mn. This process is expected to complete by FY 2011. Also, a waste heat
recovery power plant of 12MW (at a cost of Rs. 1250mn) is being set up at the
same location. It is also expected to be completed by FY 2011. Even though
setting up a waste heat plant entails higher capital expenditure, the cost of
power obtained from this plant is as low as Rs.0.5/unit. Hence, the waste heat
plant would eventually result in cutting costs for the company.
Summary
Volume and Revenue Growth from Capacity Expansions
JKLC had increased its cement manufacturing capacity by 30% (from 3.65
MTPA to 4.75 MTPA) during the previous year (FY 2009). Additional volumes
and revenues from this increased capacity will be realized from the current
year. We expect the company's revenues to touch Rs. 15000 mn this year.
Also, the company expects to add another 0.4 MTPA capacity by FY 2011 and
complete its 2.75 MTPA greenfield plant at Durg by 2012-2013. Hence, by
2013, the company will increase its capacity by 67% of its current capacity.
This increased capacity will drive the revenues of JKLC.
Fuel :
JKLC uses pet-coke instead of coal as fuel in the firing stage to manufacture
cement clinkers. Even though pet-coke is costlier than coal, it has a higher
calorific value which reduces the quantity of fuel consumed. The company
mainly sources pet-coke from the nearby Reliance Industries Limited (RIL)
refinery at Jamnagar which helps in reducing transportation cost. JKLC had
entered into forward contracts with RIL for the supply of pet-coke at cheaper
rates in January 2009. At that time, prices of pet coke had corrected from a
peak of Rs.8,200/tonne in August 2008 to around Rs.3,800/tonne. Under
these contracts, JKLC will continue to get pet-coke from RIL till October 2009.
Last year, JKLC has started using Bio-fuels along with regular fuel. Going
ahead, this will further decrease the overall cost of fuel.
Power:
As mentioned earlier, JKLC will be able to reduce its power cost in the near
future by using power contracted from V.S. Lignite. (starting from October
2009). Additionally, both the new captive plants (thermal and waste heat
recovery), which are being constructed at the existing site at Sirohi, are
expected to be commissioned by March 2011. This will further reduce the cost
of power for JKLC.
Operating in High Growth Areas
JKLC mainly operates in Northern and Western markets of India where
demand is expected to be robust as compared to the Southern India.
Preparations for the Commonwealth Games (to be held in New Delhi) are far
behind schedule and construction activity is expected to pick up for timely
completion before the event. This would support volumes in the northern
region. Gujarat, its other major market is witnessing double digit GDP growth.
JKLC has installed a 0.6 MTPA cement grinding unit in Gujarat which will help
to make further inroads in this High Growth State.
Revenues from Sale of Excess Power
JKLC will have surplus power once the captive power plants are
commissioned (in FY 2011). This will allow JKLC to sell excess power from
the next year (FY 2012) onwards. Revenues from sale of excess power would
act as a hedge against the cyclical nature of cement business. The company
is also thinking about deploying its surplus cash to add further power
capacities.
Growing Thrust on RMC Business
Ready Mix Concrete (RMC) offers several advantages over on-site concrete
mixing like better quality control, elimination of storage space, elimination of
machinery required for mixing, reduction in waste etc. Although India is the
second largest cement producer in the world, the consumption of RMC by the
Indian construction industry is only 3-4% of total concrete used as against
over 60% in developed countries. Considering the growth potential of this
segment, JKLC has been pursuing this value-added business under the
brand name of “JK Lakshmi Power Mix”. It already has 11 RMC plants (total
capacity of 0.75mn cubic metre) all across the country in cities like Mumbai,
Pune, Delhi, etc. In FY09, the RMC business contributed Rs. 576m to the total
revenue (about 4% of the total revenues), which the company plans to
increase further.
Lower Tax Outflow
Due to the recent capital expenditures and higher depreciation, JKLC has
been paying taxes under the MAT regime for the past two years. Even though
the company expects to come out of the MAT regime in the current financial
year, high depreciation will lower down the proportion of current tax (v/s
deferred tax). Also, the company has built up a MAT credit reserve of Rs.
525Mn which can be used to pay taxes in lieu of cash.
Attractive Valuations
Above all, we believe that attractive valuation is the main reason to invest in
JKLC. Even though the company had been making losses earlier, it has performed consistently well in the past five years. JKLC has reduced its debtequity ratio significantly and its margin and return ratios are in line or better
than industry averages but the stock is currently trading at an EV of around
$50/ton which is at a 50% discount to its replacement cost of approximately
$100/ton. It is also trading at a significant discount to other large-cap and midcap cement companies which is discussed later.
Risks
Supply Overhang
The cement industry is likely to witness around 110 MTPA of new capacities to
come up between FY2009-FY2011. This new addition will be almost 50% of
the current capacity (~ 220 MTPA) whereas, historically, the demand has
grown around 9% pa (~ 1.3x GDP). These additional capacities may create
excessive supply pressure if the anticipated housing and infrastructure growth does not take off and can push the capacity utilization and prices downwards, hurting the profitability of the entire industry.
Smaller and Regional Player
JKLC is a small player as compared to other bigger players of the Birla and
Holcim group. Hence it may not have the pricing power like the bigger players.
Also, JKLC is a regional player and caters only to the northern and western
parts of the country. In case of a slow down in these areas, diversified (pan-
India) players would fare better than a regional player like JKLC.
Import Threat
JKLC's key markets (Gujarat, Rajasthan and North India) share their borders
with Pakistan. Pakistan has been a cement exporter to India and other west
Asian countries and lately cement companies in Pakistan have been ramping
up their capacities. Although cement imported from Pakistan may not be a big
threat now (due to low price differential between local and imported cement),
adverse government policies like abolishing import duties (customs duty,
countervailing duty (CVD), Special additional duty (SAD)) and hiking local
excise duty would increase this price differential and provide imported
cement an unfair price advantage over cement manufactured by local players
in the northern and western part of the country. The government has taken
such steps in the recent past to check runaway cement prices and in an
inflationary scenario, this regulatory risk cannot be totally ignored.
Increase in Fuel and Raw Material Costs
Fuel costs (coal & coke) make up for almost 40% - 45% of the total manufacturing expenses. JKLC has shown good profitability in the current year due to a decrease in prices of coal and coke which have fallen considerably from their peaks in August 2008. In January 2009, JKLC had entered into long term agreements for coke (till October 2009). This will ensure fuel availability at cheap rates for the major part of 2009 but going ahead, JKLC will have to purchase fuel and raw materials at a higher cost. On the freight front, JKLC has improved its rail-road ratio to 50:50. Even then, going ahead, freight costs will continue to depend on the cost of diesel. Packaging of cement is done in HDPE bags which are again sensitive to crude oil prices. Hence, increase in the price of energy commodities will push up the prices of coal & coke (fuel), diesel (transportation) and HDPE (packaging material). A recurrence of a surge in global energy commodities (like 2008) cannot be totally negated and can highly dent the profitability of JKLC.
Cap on Blending Ratio
Continuous increase in the blending ratio (PPC:OPC) over the years has been helpful in pushing up profits for JKLC. Currently, the blending ratio stands near 70% (70% PPC and 30% OPC for 100% cement produced). Going ahead, it will be difficult to increase the blending ratio by a significant percentage as demand growth is expected to be led by the infrastructure sector, where the acceptable blending ratio is less than housing sector (which has been a major contributor to cement demand in the previous years).
Funding for Capital Expenditures
To carry out its various expansions, JKLC has lined out a capex of Rs. 2500mn for FY10 and Rs. 4,500mn for FY11 (though we have assumed higher estimates). The company plans to finance these capital expenditures through a mix of debt and internal accruals. Currently, JKLC has cash and cash equivalents of approximately Rs. 5,000Mn and going ahead, it plans to maintain a debt-equity ratio of 1.1x – 1.2x while raising finances. Although this financing plan seems to be conservative, increase in project costs or decrease in revenues can strain the finances of the company. As JKLC has a higher percentage of fixed costs (interest and depreciation), its profit is more sensitive to price changes as compared to other unleveraged players.
Increase in Excise Duty
In Dec 2008, Government had reduced excise duty on cement from 12% to 8% as a part of the fiscal stimulus package to fight the overall slowdown in the economy. Since then, the cement industry has been amongst the first ones to
beat the economic slowdown and moreover, all cement companies have shown improved volumes and profitability. Hence, going ahead, looking at the overall healthy performance of the cement industry, the Government can revert back to higher excise duty on cement, which in turn could hurt the demand for the commodity.
Cement is a cyclical commodity and the earnings of cement companies tend
to be volatile. Hence it is difficult to accurately predict the earnings of cement
companies. We have analyzed the sensitivity of JK Lakshmi's earnings (EPS
for FY 2011) vis-a-vis the following factors:
- Gross Realization
- Excise Duty
- Price of Fuel (Pet-coke)
We believe that excess industry capacity will suppress cement prices to an
extent and marginally drive down realizations. Hence we have assumed a Gross Realization of Rs. 3,500/T (v/s Rs. 3,600-3,650/T currently). Government had reduced the excise duty on cement last year. With rising fiscal deficit, we believe that there could be rise in excise duty in FY 2011. Hence, we have assumed an excise duty of 10% in our estimates. Price of Pet-coke have increased considerably from their lows. At present, prices are hovering around Rs. 4,800/T. To be on the safer side, we have assumed a pet-coke price of Rs. 5,000/T in our estimates. Based on the above assumptions, we arrive at FY11E of Rs. 26.2.
Valuation
Cement is a cyclical commodity and the business is capital intensive. Cement
companies cannot be accurately valued using price/earnings ratio. Cyclicals
generally tend to have a low P/E ratio at the peak of the cycle and a high P/E
ratio at the bottom of the cycle. Hence, we use Replacement Cost as our
Valuation Metric (which is not volatile like earnings).
We believe that the fear of excess industry capacity in the near future is contributing to this depressed valuation. Even though excess capacity has been a concern for the industry in the past couple of years, delay in commissioning of new capacities and robust cement demand have helped cement prices to remain firm (contrary to market expectations). Apart from this part, we also believe that the cement industry is well placed to weather a slowdown as compared to the last cycle due to:
- Higher degree of consolidation in the industry (especially by the Holcim and Aditya Birla groups) which will obviate unnecessary price cuts and
- Higher proportion of variable costs (like raw material, power and fuel) compared to fixed costs (lower interests) will not force manufacturers to sell cement below their economic cost of production
Conclusion
Overall, we are optimistic about the future of J K Lakshmi Cement and conservatively value the company at $70/ton (a 30% discount to its replacement cost). At the target valuation, the stock would trade at Rs. 210 (8x FY11(E) EPS and 1.1x FY11(E) BVPS). We recommend a “BUY” on the stock.
Investmentguruindia.com provides expert advice, recommendations, broking firm tips, reports, technical analysis, news and many more things for stock market, mutual fund, commodities, IPO, currency derivatives, F&O, world market.
With Inputs From Parag Parikh
Imp Link: BSE, NSE, Sensex, Nifty, MCX, NCDEX
Keyword: Free Tips, Recommendation, News, Stock Market, Mutual Fund, Commodities, Currency Derivatives, World Market, IPO, Investment In India, Investment Guru India, Technical Analysis, NSE, BSE, MCX, NCDEX, Expert Advice, F&O, Nifty, Sensex, Indian Equity Market, Indian Mutual Fund, Indian Commodities , Indian Currency Derivatives, Indian IPO, Updates, stock market today, stock trading, online stock trading, money market, buy, sell, currency market, market forecast, share trading, online trading, options trading investment funds, stocks shares, stocks and shares, share price, insurance, financial services, morning star, day trade, currency options, futures brokers
Disclaimer: While we have made efforts to ensure the accuracy of our content (consisting of articles, views, advice and information), neither this website nor the author shall be held responsible for any losses/ incidents suffered by people accessing, using or is supplied with the content. The views and investment tips expressed by investment experts and authors on investmentguruindia.com are their own, and not that of the website or its management. Investmentguruindia.com advises users to check with certified experts before taking any investment decisions. Investment in mutual funds is subject to market risk so please read offer document before you invest. The Calls, views, advice made herein are for informational purpose and are not recommendations to any person to buy or sell any securities. The author does not accept any liability for the use of this column. Readers of this column those who buy or sell securities based on the information in this column are solely responsible for their actions. The author may have positions in any of the stocks mentioned in this column. The Recommendations made herein do not constitute an offer to sell or a solicitation to buy any of the securities mentioned. Readers using the information contained herein are solely responsible for their actions. The information and views contained herein are believed to be reliable but no responsibility or liability is accepted for errors of fact or opinion. Editors may or may not have trading or investment positions in the securities mentioned herein. Also Read Disclaimer