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Margin declines, rich valuation warrants a rating downgrade

Higher cost negates the benefits from volume growth

* JKCE was impacted by higher costs (OPEX/t rose 10% YoY, 4% higher than our estimate), which led to margin pressure (OPM decline of 7.1pp YoY and 5.1pp QoQ). Grey Cement sales volume was up 20% YoY as the company benefitted from capacity expansion.

* We keep our estimates broadly unchanged for FY22-24E. Though we continue to like the company and its growth strategy, a sharp run up in the stock price in the last three months (up 13%) leads us to downgrade our rating to Neutral. The 15.2x FY23E EV/EBITDA (v/s an average one-year forward EV/EBITDA of 10.8x for the last seven years) would restrict nearterm upside in the stock price. We await a better entry point.

OPM and EBITDA/t below our estimate

* Standalone revenue/adjusted EBITDA/adjusted PAT stood at INR18.4b/ INR3.6b/INR1.9b (+18%/-14%/-13% YoY and +5%/-5%/nil v/s our estimate). We have adjusted EBITDA and profit for an impairment expense of INR260m related to the Nimbahera Line III kiln.

* Volumes were up 19% YoY to 3.33mt. Grey Cement/White Cement volumes were up 20%/8% YoY to 2.94mt/0.39mt (est. 2.89mt/0.35mt).

* Blended realization remained flat YoY at INR5,510/t (+2% QoQ) v/s our estimate of INR5,421/t. Grey Cement realization rose 2% YoY, whereas White Cement realization declined by 2% YoY.

* Blended cost/t was up 10% YoY and 9% QoQ (4% higher than our estimate) due to fuel and freight cost inflation as well as higher branding expenses and a rise in packaging cost.

* Higher costs led to a 7.1pp YoY contraction in OPM to 19.3% (est. 21.2%). Blended EBITDA/t stood at INR1,066 (est. INR1,149) v/s INR1,461/ INR1,323 in 2QFY21/1QFY22.

* Standalone revenue/EBITDA/adjusted PAT was up 38%/21%/34% YoY to INR34.7b/INR7.5b/INR4b in 1HFY22, led by a 39% YoY growth in volumes. However, EBITDA margin fell 3.1pp YoY to 21.8%.

* OCF/capex/FCF stood at INR3.9b/INR2.6b/INR1.3b in 1HFY22 v/s INR7.1b/ INR3b/INR4.1b in 1HFY21.

Highlights from the management commentary

* JKCE raised prices by INR25/INR40 per bag in North/South India in Oct’21. The management expects another price hike of INR10-15/bag in North India once demand recovers.

* It believes that the INR40-50/bag QoQ hike will offset cost inflation, assuming fuel prices remain stable at current levels.

* Commissioning of the integrated plant in Panna, Madhya Pradesh and grinding unit in Hamirpur, Uttar Pradesh, with a combined grinding capacity of 4mtpa, are expected by 4QFY23 and 1QFY24, respectively.

* Capex guidance: In FY22/FY23, INR3.5b/INR2b will be incurred on routine capex and INR9b/INR13b will be spent on Panna capacity.

Valuation and view

* JKCE is in the process of increasing its Cement grinding capacity by 4mtpa in Central India by 1QFY24. Higher limestone reserves in Panna, Madhya Pradesh (518mt) could help the company increase its capacities to 12mtpa (assuming a plant life of 30 years).

* The stock trades at 15.2x/13.4x FY23E/FY24E EV/EBITDA. It has traded at an average one-year forward EV/EBITDA of 10.8x for the last seven years. We believe the stock deserves to trade at higher multiples considering: a) its capacity expansion plans, b) improvement in Grey Cement’s profitability in the last two years, and c) 20.3% expansion in RoE over FY21-24E v/s an average of 9.5% over FY11-19.

* The run-up in the stock price in the last three months (up 13%) led us to downgrade our rating to Neutral as we believe that the upside would be restricted in the near-term. Our TP of INR3,725/share (upside of 6% from CMP) is based on 15x Sep’23E EV/EBITDA. We would await a better entry price.

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