Piling on limestone

Prashant Jain-managed HDFC MF bumps up its holding in Orient Cement  

Just when one thought that a major overhang on cement stocks has been lifted as the Supreme Court allowed use of petcoke by cement players, the industry was hit by the government diktat to increase import duty on petcoke to 10% from 2.5%. The hike is expected to bring down the operating margins of cement manufacturers by 1% if the increased cost burden is not passed on to the end users. Notwithstanding the adverse impact, HDFC AMC is adding to its holding in Delhi-based Orient Cement. On December 7, 2017, exchange disclosures show that HDFC AMC bought stock worth Rs. 77.18 crore, raising its stake in the company to 7.27% from 5.03%.

Year-to-date, Orient Cement has gained 34%, while the benchmark Sensex has gained 27% during the same period. And the stock seems to be on a firm footing currently bolstered by growth visibility. Recently, Orient Cement acquired a 74% stake in Bhilai Jaypee Cement (2.2m tpa), and Nigrie Cement's grinding unit (2m tpa) in Madhya Pradesh at an EV of Rs.1,450 crore and Rs.500 crore respectively. This deal would take its capacity from 8 million to 12.2 million tonne.

Analysts reckon that the acquisitions would open up markets in the east and central regions for Orient Cement. This would lead to higher growth as at present 84% of its sales come from southern and western territories. Post the deal, analysts expect Orient Cement to see its volume grow at 16% CAGR over FY18-20.

Funded through a combination of debt and equity, analysts expect the acquisitions to lead to an additional debt burden of Rs.150 crore-Rs.200 crore. At present, Orient Cement has debt of Rs.1,337 crore and free cash flow of Rs.54 crore. While the move will help Orient Cement scale up, diversify into new markets and also save on freight costs, the deal will take more than two years to become EPS accretive. 

Orient Cement itself has some inherent competitive advantages due to its strategically-located assets and lower costs. It benefits from being in the same vicinity as the limestone mines which keep its freight cost low. The company’s power and fuel costs are amongst the lowest in the industry and it has also successfully implemented the use of alternative bio-fuels for producing energy, resulting in improved efficiencies and higher cost savings. With power, fuel and freight costs of Rs.1.759/tonne, Orient Cement is one of the lowest cost cement producers. 

In FY17, Orient Cement reported net sales of Rs.2,010 crore and an operating margin of 8.26%. At net level, the company reported losses of Rs.32 crore due to lower utilisation of assets amid sluggish demand in its key markets — Maharashtra, Telangana and Seemandhra — due to back-to-back poor monsoon.  

At a combined valuation of $89/tonne (i.e. Orient’s current + proposed asset valuation) analysts believe the stock is attractive. It trades at an EV of 9.4x FY19E ebitda and $85 per tonne on standalone calculation. 

Given this optimism, it is not a surprise that marquee fund houses like ICICI AMC (5.04%), HDFC AMC (4%), Reliance AMC (3.45%) and Franklin Templeton AMC (2.4%) have a sizeable position. Market legend Rakesh Jhunjhunwala also has a 1.3% stake. Among insurance companies, HDFC Standard Life Insurance Company (1.05%), ICICI Prudential Life Insurance Company (1.47%) and Life Insurance of India (2.06%) comprise the other major institutional holders.