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MOSL: SHREE CEMENT (Buy)-Low-cost acquisition in the UAE aligns well with long-term strategy

Shree Cement: Low-cost acquisition in the UAE aligns well with long-term strategy

(SRCM IN, Mkt Cap USD10.2b, CMP INR19,512, TP INR22,424, 15% Upside, Buy)

• In-line results: SRCM reported healthy volume growth of 8% YoY, led by a favourable base (3QFY17 was impacted by demonetization). Cement realization fell 1% QoQ to INR4,120/t due to lower prices in its focus markets. Unitary cost increased 14% YoY (3% QoQ) due to higher freight cost/t and P&F cost/t (higher petcoke prices and ban on usage of petcoke). Cement EBITDA/t declined 11% QoQ (+3% YoY) to INR1,003 due to cost push and weaker realizations. Hence, EBITDA increased 13% YoY to INR5.3b in 3QFY18. Depreciation fell 34% YoY to INR2.1b, resulting in PBT of INR3.8b (+57% YoY). Tax rate stood at 22% v/s 3.4% in 3QFY17, resulting in adj. PAT of INR2.9b (+23% YoY). Reported PAT rose 42% YoY to INR3.33b due to reversal of DMF provision for earlier years.
• Establishing footprint in UAE: SRCM has approved acquisition of Union Cement Company in the UAE, which has capacity of 4mt, at an EV of ~INR19.5b, translating into EV/tonne of USD76 (~41% discount to replacement cost in India) and EV/EBITDA of ~8.8x on CY17 annualized earnings. The move is in line with SRCM’s strategy of setting up/acquiring plants at lower costs and achieving higher return ratios. The acquisition at first glance appears positive (given its discounted cost), but SCRM’s execution capabilities in new geography are yet to be tested. We have not incorporated the financials of the acquired company in our estimates.
• Strong capacity addition in domestic market: While it would be critical for SRCM to generate healthy return ratios from the acquisition, we believe the key trigger for SRCM over the next 12-15 months would be domestic profitability. SRCM is adding ~13mt of capacity in the domestic market (~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, and any improvement in profitability from the acquired capacity could only act as a potential trigger for the stock. We remain positive and value SRCM at ~16x EV/EBITDA (15% premium to peers due to superior return ratios) on FY20 earnings and arrive at a TP of INR22,424/share, implying upside of 15% from present levels. Maintain Buy.