India Cements: Hold

Recommendation:Hold

S. Vaidya Nathan

THE BURDEN of acquisitions financed largely by debt and soft price trends has had an adverse effect on India Cements' profitability in the first quarter of 2000-01.

But with the possibility of a better showing in the second quarter, shareholders may remain invested for now. On a performance evaluation in the second quarter, or in the homestretch to this announcement, exposures in the stock can be pared. The company has a long way to go before it can offer shareholders the kind of earnings commensurate with the risks and capital employed.

It is more than two years since India Cements completed its acquisition of Raasi Cements; a unit of Cement Corporation of India, and sold its shipping business, and a year since it took control of Sri Vishnu Cements.

While these acquisitions have pushed India Cements' to the top in terms of capacity, alongside ACC, Grasim Industries and Larsen & Toubro, its profitability has come under considerable strain. This trend appears set to continue though price levels may be better than in the April-June 2000 quarter.

Acquisitions yet to pay: Raasi Cements' acquisition has no doubt helped scale up the capacity and the revenue stream of India Cements. But there is little evidence of the benefits reflecting in the bottomline or reaching the shareholders.

What the earnings numbers show is that the company is yet to get the kind of returns for the price (Rs. 300 per share and close to Rs. 400 crores) paid for Raasi Cements. And this after more than two years of initiating and completing the process. This also implies that the company is yet to make money on other acquisitions in the industry.

It also continues to be weighed down by a sizeable debt burden as is evident from the interest outgo which continues to be at last year's levels despite the recent soft trends in interest rates. What the acquisitions have ensured is make India Cements a big player in terms of capacity. But unless this is translated into sustainable benefits for the earnings stream, the stock valuation may not improve significantly.

Prices, a problem: What has acted as a damper on the company's performance, apart from high financial costs, is the cement price trends. In 1999-2000, despite a 15 per cent growth in volumes, prices were flat with periodic moves in either direction.

The price trends in Tamil Nadu even assumed political overtones. In the first quarter, lower prices impacted on the profitability. With Larsen & Toubro, Grasim Industries and Madras Cements increasing volumes, the price trends that would have been required to justify what it paid for acquisitions has not materialised.

It is unlikely to do so in a sustainable way given the consolidation and the scramble for market share bound to come about from time to time. Major companies have tried out supply-side management. But so far it has worked only for short periods and with more capacities from Grasim and Madras Cements likely in the Tamil Nadu markets, prices may come under pressure often. For instance, in the first quarter, the sales realisation for India Cements declined from Rs. 2,306 per tonne to Rs. 2,346.

In this backdrop, the level of shareholder earnings may improve only if and when India Cements gets its act together on reducing financial charges on the bottomline. Given the performance trends, this may not only take time but also prove difficult.

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An insipid show: That these costs have taken a toll is evident even in the performance of the first quarter (April-January). Sales rose 7.94 per cent to Rs. 331.10 crores (Rs. 306.75 crores in the previous corresponding quarter). The operating profit margin declined by 1.5 percentage points on account of the higher expenses and lower sales realisation. The improvement in operational efficiencies, in areas such as power and coal, pegged the decline to lower levels.

But with financial charges remaining rather high, at Rs. 66.43 crores (Rs. 63.55 crores), there has been a decline in the post-tax earnings. Earnings dipped by around 24 per cent to Rs. 5.67 crores (Rs. 7.44 crores). This is more or less in line with the performances of major cement companies.

What may be of concern is the low level of cash flows that do not point to a comforting picture given the high debt burden on the balance-sheet. For 1999-2000, the company reported sales of Rs. 1,194 crores, operating profit margin of Rs. 23.29 per cent and post-tax earnings of Rs. 45.31 crores.

The outlook would hinge on the sustainability of a recent uptrend in prices. If it is held for much of the remaining seven months of the current fiscal, the overall level of earnings may improve. The earnings in the next quarter could be better on the back of higher prices. Existing shareholders can stay invested and use any uptrend linked to cement price trends to pare exposures in the stock. Fresh exposures can be avoided at this point.