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Strong Foundations

JK Cement will be a beneficiary of the booming cement industry with its aggressive plans for the future

We have seen that quite often de-mergers tell the rags to riches story. The same holds true for the company we analyse here. In November 2004, after having incurred heavy losses and net worth erosion, JK Synthetics Limited decided to de-merge its two main business areas. The company was involved in the manufacturing of man-made fibres and cement. Its cement division was de-merged to form a new company - JK Cement, which is today one of the leading grey cement manufacturers of northern India.

JK Cement has two state-of-the-art operational plants in Rajasthan - in Nimbahera with three kilns and 2.8 million tonnes per annum (mtpa) capacity and in Mangrol with a capacity of 0.75 mtpa. The company recently underwent capacity expansion, increasing its grey cement manufacturing capacity by 0.5 mtpa, taking the installed capacity to a total of 4.05 mtpa.

JK Cement holds an important position in the white cement segment as well. It is the second largest white cement manufacturer in the country with an installed capacity of 0.3 mtpa, after having been expanded recently by 0.5 lakh tpa. All of JK Cement's plants are located close to its mining reserves, which are estimated to have a lifespan of 40 years. The company boasts of a strong and dedicated marketing network as well.

Investment Rationale
Focussed Cement Player
JK Cement acquired the cement business of JK Synthetics following the de-merger and focused concentration on the cement business has enabled the company to grow from being a 'going concern' to a major player of the segment. The company recorded a Profit Before Tax of Rs 52.21 crore on a turnover of Rs 1108.68 crore in FY06, resulting EPS at Rs 6.37. Furthermore, its net worth increased from Rs 54.59 crore in March 2005 to Rs 354.0 crore a year later. These figures show that JK Cement is a focused cement player with no baggage of accumulated losses.

Earning Boost From Captive Power
Power is the key cost component for cement plants and JK Cement has addressed this key issue by setting up its own captive power unit. Currently, the company sources its power requirements from the Rajasthan State Electricity Board and a small part from captive diesel generating sets. However, after the captive power plant is commissioned, the company is expected to save approximately Rs 240 per tonne. Savings from the captive power plant are expected to be around Rs 76 crore from FY08E onwards.

Expansion plans to Double Capacity
JK Cement plans to set up a green-field plant of 2.5 to 3 million tonnes in northern Karnataka. The project will be funded through debt and internal accruals in a 50:50 proportion. There are not many cement plants in this region and hence from its plant, the company will be able to cater to Karnataka, Goa and parts of Maharashtra. The location will also shield it from region-specific downturns apart from giving it a presence in the southern region. It will also enhance the company's stature from a regional player to a national player.

Cement/Clinker Production to Improve
JK Cement's cement/clinker conversion ratio is 1.14. The company is targeting 75-80 per cent of blended cement and overall ration of about 1.22, which will help reduce cost and increase profitability.

Risks & Concerns
Prices In Northern India Under Pressure
North India reported a growth of 8.6 per cent, which is over and above the all-India average of 6.2 per cent in Q1FY09 and the same is expected in the coming years. However, the region also witnessed massive capacity addition, resulting in the decline of capacity utilisation rates, which went down to 80 per cent in Q1FY09 from 105 per cent in Q1FY08. Due to this, cement prices have remained subdued in the northern region. And with further capacities of a few cement companies expected to come on stream, cement prices are likely to remain under pressure.

Inflationary Pet Coke Prices
JK Cement has ambitious plans to run its plants on 90 per cent pet coke. Hence, any significant change in the pet coke price will impact the company's profitability.

Change in Government Policy
Cement is a low-value, bulky commodity, hence transportation costs are a significant expenditure to the industry. Furthermore, most transportation regulations (railways and roadways) are governed by government policies and so any increase in cost resulting from a change in government policy can have an adverse effect on the company's profitability.

Valuations
JK Cement is expected to post an EPS of Rs 25.4 and Rs 32.5 in FY09 and FY10 respectively. The company's earnings are likely to decline in FY09 due to a surge in input costs and pressure on realisations. However, with new capacities coming on stream, volumes are likely to drive the company's earnings in FY10. At the current market price of Rs 130, the stock is trading at 5.1x FY09E and 4x FY10E earning. It is trading at EV per tonne of US$103.4 and US$55.3 for FY09E and FY10E capacity respectively. Taking into consideration that JK Cement is trading at a premium to larger and more efficient north-based cement players, the stock is good to be held at the reduced target price of Rs 143.



Financials
  FY 06  FY 07  FY 08
Net Sales (Rs cr) 871.94 1230.18 1457.11
PAT (Rs cr)* 33.16 174.37 265.46
EPS (Rs) 6.37 25.54 37.92
RONW (%) 16.23 40.19 41.68
ROCE (%) 14.97 34.5 36.79
FY ending March 31 each year
*Net of non-recurring transactions

Source: ICICI Direct