The most spectacular turnaround in Cement Industry

Rain Commodities Ltd. (Rs. 150/-):

Indian Cement Industry is the second largest market in the world after China. Cement being a basic building material, its output is directly related to the state of the construction business in general in the economy, essentially it tracks the overall economic situation.  Indian cement consumption has a strong positive correlation of 1.2 - 1.3x with the Indian GDP.  The per capita consumption of cement in India is 122 Kg. against the world average of around 320 Kg.

It has installed capacity of 160 mn TPA and total consumption of 135 mn TPA for FY2006.  It also exported around 9 mn TPA of cement and clinker for FY2006.  Cement demand is expected to remain buoyant due to government thrust on infrastructure investment (in road, ports and hydropower) and rising housing demand due to lower cost of finance, fiscal benefits on housing loans, favourable demography, rising disposable income and preferred nuclear family system.  On conservative basis industry is expected to grow at a CAGR of 9% over FY2006 - FY2008E taking total demand to 168 mn TPA by end of FY2008E.  With no major capacity addition coming for next 2 years, cement prices are expected to remain strong.  The recent Govt. intervention did not seem to have any impact on cement prices on the grounds which are determined by the current demand and supply scenarios.  Capacity utilization levels close to 96% and incremental capacities being absorbed by buoyant demand would boost earnings for cement companies despite rise in freight and raw material costs.

Southern Region Cement Snapshot

South India is the largest of the five regions in terms of both consumption and dispatches of cement in India.  The cement consumption of South India region was 29% of overall Indian cement consumption in FY2006. Capacities in the South now operate at 90% (80% in FY2005) with a sharp 24% growth in consumption in FY2006 to 41 mn TPA.  High growth in the region was due to the increased focus of Andhra Govt. in irrigation projects, the Tamil Nadu Govt. on rural roads, high construction activity in the all major metros (Bangalore, Chennai and Hyderabad), development activity in Tier-II cities like Mangalore, Cochin, Vizag and Coimbatore, stress on infrastructure development, minimal capacity additions in the next two years and relaxation in tax structure.  We expect 9.5% growth in consumption in FY2007 - 2008 in the region.  With little capacities slated to come on stream over the next 2 - 3 years in the region we expect demand - supply balance to continue driving up cement prices.  In view of same, we recommend to buy RCOL as the Best Buy.

History:  Earlier known as Priyadarshini Cement Ltd., it had come out with IPO in 1986.  RCOL has installed capacity to produce 1.40 mn ton cement at its 2 plants in A.P.  Company sells 60% of its production in A.P.  Rest is sold in Karnataka and T.N.  It started making losses in late 90's due to heavy debt burden and poor demand situation in South.  So, later, a scheme of arrangement was worked out under which cement business was hived off into a separate company called Rain Inds.  Rain Inds. issued shares for Rs. 76 crs. at a premium of Rs. 42/- per share.  With this, RCOL became holding for Rain Inds.  This scheme was worked out to avoid the reference to BIFR.  Still, company was making losses due to .low realization, higher interest costs and low capacity utilization.  Due to working capital crunch, company was unable to stock enough R/M and had to pay higher price for spot purchase.

Citigroup as strategic partner:

In April 2005, company allotted 5 mn Equity Warrants to Citigroup and 5 mn Warrants to promoters at Rs. 40/- for each Warrant with option to convert into Equity Shares within a period of 18 months.  Citigroup also invested Rs. 115 crs. in debentures issued by Rain Inds.  The proceeds were used to settle and restructure loans of certain banks, as a part of CDR scheme. CDR also approved reduction in interest rate from 13% to 9.5%.

Financial Performance:

For FY06, company reported Net Sales of 320 crs.  After providing nearly 15 crs. for depreciation, Net Loss was 4.96 crs.  However, company managed to report cash profit of 9.70 crs.  It may be noted that in Q4 alone, company made NP of 9.45 crs.  Many factors contributed to such sharp turnaround:

a)    Q4 interest cost was 5.44 crs. whereas, interest cost for 9M was 30 crs. which means, 10 cr. per quarter for earlier 3 quarters.

b)    Sales Realization improved by Rs. 15 - 17 per bag.

c)    Reduction in energy cost.

d)    Savings due to implementation of VAT.

Q4EPS was 4.27 which gave Annualized EPS of 17.

FUTURE SCENARIO:-

Huge Demand - Supply Gap

Cement demand in the country is growing at approx. 1.5 times GDP growth rate.

The cement inds. is expected to grow at a CAGR of 10% in the near term on account of housing demand and the increased thrust on infrastructure development and industrial projects.  The initiatives taken under the National Highway Programme for building highways and roads, the Pradhan Mantri Gram Sadak Yojana for constructing concrete roads in rural areas and Bharat Nirman for promoting irrigation, water supply, roads, housing are likely to be major drivers for cement demand.

I expect a cement deficit till atleast FY08, as incremental demand will exceed incremental supply.

The Govt. has decided to give a major thrust to highway and road development.  Among the major projects currently underway are:

*    The Golden Quadrilateral Project (5846 Km) expected completion Dec. 2006.

*    North - South - East - West Corridor (7300 Km) expected completion 2008.

*    48 new road projects (10,000 Kms) expected completion 2008.

All these projects are expended to lead to increased demand for cement.  It is estimated that the projects currently underway will require upto 3 MTPA of cement alone.

Housing Demand

India faces shortfall of around 20 mn dwelling units, but only 1.5 mn units are being built every year.  An average size unit of 400 sq. ft. requires 10 tons of cements and rise in per capita GDP levels will act as catalyst for housing demand.

Low per capita consumption

Though India is the second largest manufacturer of cement, per capita consumption is very low at 115 kg. p.a. which is well below international average of 260 Kg.  Hence, there exists tremendous scope for increasing consumption.

Infrastructure

Higher spending on infrastructure by the Govt. will also be a key driver in boosting demand.  The Govt. has opened the door for private player to participate in projects and is easing norms to facilitate entry of FDI into the sector.

Future Prospects of RCOL:

RCOL has rated capacity of 1.40 mn tons which can be utilized upto 1.50 mn tons. With increased acceptance of blended cement, RCOL has started using Fly Ash to produce blended cement which can take production level upto 1.7 mn tons.  At one time, A.P. had lowest cement prices in India.  However, now, prices have recovered sharply and average realization per bag from April 06 onwards is Rs. 130/- per bag which is highest ever in A.P.  RCOL is one of the biggest beneficiaries of this boom and has been performing extremely well, set to report bumper results in current year.

For Q1FY07 alone, RCOL reported NP of 28.20 crs. on net sales of 122 crs.  It gives Quarterly EPS of 12.76.  For Year Ended 31st March 2007, company may report NP of 98 crs.  However, Equity Warrants will be converted into Equity by Nov. 06, so, Equity will stand increased to 32.11 crs.  Even on increased Equity, EPS is likely to be 30.52.

Recently, company paid USD 123 mn to acquire 20.22% stake in Great Lake Carbon of U.S.A.  GLC is the biggest producer of CPC in the world with capacity of 24.50 lakh tons spread over 5 locations and having 23% of global CPC market.  Group Company (of RCOL) named Rain Calcining is already fifth biggest producer of CPC in the world.  At present, RCOL has nominated 2 Directors on the Board of GLC, U.S.A.  We feel that, in future, promoters may acquire another 20% of GLC which will enable them to get management control of GLC.  If it happens, Rain Group will command 28% of global CPC Market:

1)    First time, Citigroup has invested in a Indian Cement Company.  Its stake of nearly 14% will lead to excellent valuations for RCOL.

2)    Stock is trading at just 4.92 x FY07E EPS which is lowest in the cement industry.

3)    GLC stake holds great intrinsic value for the shareholders.

4)    It is not very far fetched, if, in near future, promoters decide to merge Rain Calcining with RCOL (due to GLC stake of RCOL) as combined entity will have synergy of operations, reduction in administrative costs and emergence of a consolidated financially strong entity with higher EPS.

New Trigger:

1)    Company is expanding its cement capacity to 3.10 mn tons at a cost of Rs. 340 crs.  Considering that ACC will spend 650 crs. for 1.50 mn ton plant in Eastern India for same capacity, capex of RCOL is extremely low.  Its being financed through internal accruals, debt and small equity dilution.  Expanded capacity should start production by Oct. 07. Again, project is being implemented extremely fast as normally, it takes 18 - 24 months to implement project of such size.

2)    Company is likely to make preferential offer of Equity Shares to Citigroup at Rs. 200 - 225 per share. We presume that Citigroup may pick up 50 mn shares at Rs. 100 crs. which will increase its Equity by 5 crs. in 07 - 08.

Valuations:

From the above Table, one can observe that Rain Commodities is still the cheapest cement scrip.  Its Quarterly EPS is the highest but share price is the lowest.  Companies in peer group are quoting at much higher P.E. Ratio.  Rain Commodities has the lowest P.E. Ratio.

Post expansion and post merger of Rain Calcining, RCOL will emerge as a big mid-sized company with diversified interests.  Based on our various assumptions, following may be the likely scenario:

We can sum up that RCOL is aggressively consolidating and charting new horizons.  Current market price has considered only its current fundamentals and future prospects are yet to be given any valuations in its share price.  RCOL is set for re-rating in near future and once buying by mutual funds/FI/FII starts, it share price will enter a new orbit.

We estimate that RCOL may touch Rs. 225/- by Nov. 06, Rs. 300/- by March '07.  If its plans (as projected by us) remain on course, this scrip can be Rs. 500/- in less than 24 months.

By – Hemant K. Gupta