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Company Background

Star Cement Ltd (SCL), promoted by Mr. Sajjan Bhajanka, Mr. Sanjay Agarwal (also promoters of Century Plyboards) and Mr. Rajendra Chamaria, is the largest cement player in India’s North East Region (NER) with ~24% market share selling under ‘Star Cement’ brand. It has fully integrated cement plants with installed capacity of 5.7 MTPA of cement; 3.0 MTPA of clinker and a 51 MW power plant spread across Sikkim, Meghalaya and Assam.

Investment Rationale

Logistic disruptions led to subdued performance

* During Q3FY21, SCL net sales de-grew by ~6.1% y-o-y to Rs 4.2 bn, on account of ~8% yo-y decrease in dispatches to ~0.66 million tons (mn tn) driven by logistic disruptions in Meghalaya which is likely to ease out by mid-February, 2021. Realization improved by mere ~2% y-o-y to Rs 6,396/tn, on account of higher sales in North East Region (NER) where the prices remained stable with an upward bias compared to muted prices in Eastern region. The core NER contributed ~81% (~75% in Q2FY21) and Eastern Region contributed ~19% (~25% in Q2FY21) of total dispatches in Q3FY21. The trade/nontrade mix stood at 87%/13% while premium product contributed ~3% to overall revenue.

* Cement prices in East India corrected by Rs 20-25/bag in Q3FY21 with a further drop of Rs 10-15/bag in Jan/Feb 2021 due to intense competition and supply glut. However, with low per capita consumption of cement in East India, Management is optimistic that with sustainable increase in demand on the back of housing and infrastructure activities the additional supply will get absorbed and price trend in East will likely see some reversal.

* Going forward, we expect SCL sales volume to grow by ~40% and ~16% to ~3.7 mn tn and ~4.3 mn tn in FY22E and FY23E respectively driven by (1) GoI’s thrust on infrastructure development with allocation of more funds in Budget 2021 (2) highway road expansion in East (3) premiumization coupled with robust distribution network and retail-centric business model resulting in better capacity utilization and higher sales volume.

Lower volumes & higher operational expenses acted as a deterrent

* EBITDA margin during Q3FY21 fell by 100 bps y-o-y to ~19.8% on account of lower volumes and higher power & fuel costs and other expenses which as a percentage of sales increased by 238 bps to ~52.4%. This was partially offset by reduction in raw material costs. Overall the cost/ton rose by ~3% in Q3FY21 vis-à-vis last year while EBITDA/tn fell by ~3% y-o-y to Rs 1,268/tn in Q3FY21.

* Discretionary costs like advertising and promotional expenses are normalising with recovery in demand. The ban on coal mining in the NER continues and the Company sources its coal requirement from Eastern Coalfields, subsidiary of Coal India which has also increased the coal costs by ~5-6%, in line with increase in imported coal prices.

* Going forward, the overall cost is expected to go up with further increase in power & fuel costs. However, with commissioning of ~2 mn tn grinding unit (GU) at Siliguri, rationalization would be seen in logistic costs. Therefore, we expect lower volumes and cost headwinds to weigh on FY21 EBITDA/tn. However, with buoyancy in demand, EBITDA margin is to stabilize at ~22.5% with EBITDA/tn nearing ~1,463/tn by FY23E.

* SCL charged ~Rs 645.7 mn in Q3FY21 on account of exceptional item as a result of reversal of its earlier claim of 50% excise refund made in 2012, entailing a cash outflow of ~322.85 mn. This has resulted in ~102% reduction in PAT y-o-y to negative ~17.5 mn.

Strong expansion plans in pipeline augurs well

* Recently, SCL commissioned its ~2 mn tn Siliguri GU with an aim to expand its footprint further in East India market and establish a decent market for its brand. They expect to increase the revenue share of East India to 40% (currently contributing ~25% to total revenue) in two years’ time on the back of expanded capacity.

* The Company is setting up a ~2 mn tn clinkerization unit which is likely to start commercial production by FY24E along with ~13-14 MW WHRS plant (expected to be commissioned by end FY23E) in Meghalaya for a total capex of ~Rs 9,500 mn to support its recent expansion at Siliguri. With an aim to increase its grinding capacity to ~12 mn tn and clinker capacity to ~8 mn tn in a span of 5 years, SCL is also planning to add cement GU in Guwahati with further plans to set up manufacturing units in Eastern and Central India. Accretion in cash flows with profitable NER operations will drive their expansion plans.

Valuation

With Government’s focus on infrastructure development, SCL’s leadership in NER with high entry barriers because of geographical location and challenging terrain, improved efficiency with lean balance sheet & excellent cash flows and undergoing geographical diversification benefits is likely to boost its profitability. We have valued the stock on the basis of EV/EBITDA of 8x of FY23E EBITDA – method of relative valuation, lowering it from 10x of FY22E EBITDA on the back of intensified competition in the East with new capacity addition in pipeline and recommend a ‘BUY’ on the stock with a target price of ~Rs 134 (~40% upside) in 18 months.

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