FY15 was a challenging year for the cement industry, which grew by just 3.5%, but this challenging period saw a wave of consolidation sweeping through the industry, with UltraTech and Holcim reinforcing their first and second spots, and with the 24 million tonne (mt) Dalmia Bharat Enterprises (DBEL) grabbing the third place. It’s pertinent to note that Dalmia Bharat has managed to enhance its presence in the south by emerging as one of the top five cement producers in the Andhra Pradesh and Tamil Nadu markets and now has a ready plant in Karnataka that will start commercial production by next month. Thus, Dalmia’s total capacity in the south stands at 11.5 mt, with a market share of 8%. Among the different states in the south, it has a 13% share in Tamil Nadu, 13% in Kerala and 5% each in Andhra Pradesh and Karnataka. In the south, it competes with local players such as India Cements and Ramco Cements and national players such as Holcim and UltraTech.
We expect DBEL’s cement volume in the south to clock double-digit growth over the next two years. While demand in Tamil Nadu and Kerala is stable, Andhra Pradesh will see a sharp increase due to the creation of the new state of Telangana last year. Andhra Pradesh has aggressive plans to build its capital city and several infrastructure projects. The housing market is also looking up in Telangana. Besides, incremental volume will come from the company’s new unit in Karnataka, which will also allow sales into Maharashtra. The strategic location of the plant gives it a lead distance of less than 500 km to half of Maharashtra’s market.
My strong conviction in DBEL, however, stems from the strategic choices made by the company to power its growth engine. After establishing a presence in the south, DBEL chose to focus on the east and northeast regions. These regions are just beginning to taste the fruits of development and they present a potential long-term growth opportunity as successive governments focus on bringing these regions on par with mainstream growth. Competition in these regions is low, which engenders a buoyant pricing scenario. DBEL has a presence in the eastern market through Orissa Cement (OCL), promoted by the Dalmia family. OCL has an overall capacity of 6.7 mt. Apart from this, DBEL has acquired two plants in the northeast: Adhunik Cement in September 2012 and Calcom in November 2012. These plants are still young and they will take some time to register major improvement. In March ’15, DBEL increased its stake in OCL to 74.6% from 48%. OCL’s Konark brand is the market leader in Odisha given its long-standing presence of four decades. In the eastern markets, DBEL has a market share of 22% in Orissa, 6% in West Bengal, 5% in Bihar, 8% in Jharkhand and 18% in the northeast.
We forecast DBEL’s cement sales in the east to rise 20% every year due to an under-penetrated market (18% of national demand against 14% of capacity) and the onset of state elections (Bengal and Assam) over the next one year. Good demand in the east coupled with less intense competition engenders a better selling price and will enhance OCL’s profitability. A key change to note is that in the accounting of OCL’s revenue and profit from the fourth quarter of FY15, with DBEL’s stake crossing 51% in OCL, resulting in consolidation of financials. Earlier, the profit share of OCL was shown as profit from associates, which will now flow through Ebitda.
Strong cost efficiency
The hallmark of DBEL lies in its operational efficiency, which reflects in the fact that it is one of the lowest-cost producers of cement. The company has achieved this feat by continuously focusing on reducing costs. A shift in fuel mix to economical fuels such as petcoke (70-75% vs 30% a year ago) and increasing road-rail mix have helped the company achieve excellent per-tonne profitability, on par with the best in the industry. For the first half of the current fiscal, DBEL reported Ebitda per tonne of ₹1,243. We expect the company to clock Ebitda per tonne of ₹1,200 in the current fiscal and close to ₹1,268 for FY17, aided by reduced power and coal consumption and increased use of petcoke. Besides, benign fuel prices should help moderate freight costs.
Further, DBEL’s peak capex is over, which should allow it to strengthen its balance sheet. For the past four years, DBEL spent ₹5,100 crore on capital expenditure. This increased its net debt-to-equity ratio to 1.9x from 0.6x in FY12. However, finally, DBEL’s peak capex intensity is over and its focus is now on increasing utilisation. We forecast DBEL’s net debt-to-Ebitda to reduce to 2.6x in FY17 from 6.3x in FY15.
Riding the recovery
Dalmia Bharat should outperform the sector growth due to its high operating leverage and strong presence in the south (48% of volume) and the east (52% of volume). I expect the company to increase its market share to 9% in the south and 15% in the east and the northeast by the end of FY16, while utilisation levels rise and demand improves. Despite a strong run-up this year, the stock is still cheap at Ebitda multiple of 6x FY17 against its five-year average of 12.1x. The stock’s multiple of 15.4x estimated FY17 earnings compares favourably with peers. We believe DBEL’s valuation discount will narrow with a reduction in its debt as the Street recognises its superior performance metrics. Sustainability of its first-half earnings (4x jump Y-o-Y) will provide a catalyst for re-rating of the stock.
In fact, the company is in a strong position to report its best-ever profit in the current fiscal, following negligible profits over the past two years. We expect a major positive swing in earnings underpinned by substantial cost savings at its plants in the south, a higher stake in the highly profitable Odisha Cement, and increase in overall utilisation to 60% in FY16 from 57% in FY15, translating into volumes of close to 13 mt against 11 mt in FY15. Also note that the company’s enterprise value per tonne of $100 is below its replacement cost and at a discount to its peers. Hence, I believe the stock should re-rate, considering the sharp improvement in profitability, strong operating leverage and reducing capex intensity. At a multiple of 7.5x estimated FY17 Ebitda, the stock should touch ₹973.
The author does not hold the stock in his personal capacity, but has recommended it to clients of Kim Eng Securities India