ICICI Direct: Buy JK Cement

JK Cement, a part of the JK group, was incorporated by acquiring the assets of the cement division of JK Synthetics in November 2004. Currently, JK Cement has grey cement capacity of 4.4 million tonne (MT) and white cement capacity of 0.4 MT. The company is the second largest manufacturer of white cement in India. JK Cement sells cement under brand names Sarvashaktiman (43 grade OPC), JK Super (blended cement) JK White Cement and JK Wall Putty. The JK Cement Works (Fujairah, UAE) FZC, a subsidiary of JK Cement, has signed an MoU with the Municipality of Fujairah. The company has been allotted limestone mines with reserves estimated at 150 MT.

Investment rationale

To increase cement capacity by 68% JK Cement’s 3 MT greenfield plant at Karnataka is likely to be commissioned in H1FY10. The new plant will increase grey cement capacity by 68% from 4.4 MT at present to 7.4 MT at the end of H1FY10. On account of capacity additions, we expect JK Cement’s grey cement volumes to grow at a CAGR of 23.2% between FY09 and FY11. Decline in pet coke prices, entering into high priced South Indian market to boost margins JK Cement meets 90% of its fuel requirement through petcoke and rest 10% from linkage coal and open market. With crude oil and coal correcting from its peak, petcoke prices have also declined by 25% from its peak. Thus, we expect JK Cement’s power & fuel cost to decline to Rs 785 per tonne in FY10 from Rs 972 per tonne in FY09. Apart from this, JK Cement’s entry into the high-priced South India market will have a favourable impact on blended realisations. Thus, we expect the EBITDA margin of JK Cement to improve from 21.6% in FY10 from 22.6% in FY09. Presence in high growth market

JK Cement’s sales contribution is 33% from Haryana, 27% from Delhi and UP, 21% from Rajasthan and 19% from Punjab, MP and Gujarat. Most states where JK Cement has a presence are growing faster than the all-India average. As against all-India consumption growth of 11% in April-May 2009, consumption has grown by 27% YoY in UP, 16% in Gujarat & Haryana, 11% in MP and 9% in Gujarat. Going ahead, we expect the northern region (key market of JK Cement) to continue to grow above the all-India average due to incremental demand that will come from the Commonwealth Games and the hydropower projects coming up in the region. In addition, the upcoming US$90- billion Delhi-Mumbai Industrial Corridor project and the 1,483-km high-speed dedicated freight corridor project will also boost cement demand in North India. Q1 results expected to be encouraging With 14% YoY growth in blended sales volume and 5.8% increase in blended realisation, we expect net sales to grow by 20.6% YoY to Rs 414.4 crore. We expect the EBITDA margin to increase by 570 bps to 27.9% due to decline in power & fuel cost and improvement in realisation. We expect the adjusted PAT to grow by 69.8% YoY to Rs 61.3 crore. On a QoQ basis, we expect the PAT to grow 2.6%.

Risks & concerns

Delay in ramping up of greenfield plant, Delay in ramping up of greenfield plant of 3 MT at Karnataka may lead to lower volumes, Increase in fuel prices, Petcoke prices are highly correlated with crude oil and coal price, which are highly volatile. Increase in petcoke pricesmay adversely impact the margins, Capacity additions to put pressure on cement prices, CMA has estimated capacity additions of 60 MT at an all-India level in FY10. Out of this 22 MT has been estimated in the southern region.

Valuations

At the CMP of Rs 100 per share, the stock is trading at 4.8x its FY10 earnings and 0.7x its FY10 book value. On an EV/EBITDA basis, the stock is trading at 4x while on an EV/tonne basis, it is trading at $44.5 of its FY10 capacity. Since JK Cement is trading at less than half of its replacement cost, volume growth from capacity additions, reduction in fuel prices and expected encouraging Q1, we expect 10% upside from the stock in 3-6 months.

Technical Outlook

The stock is forming rising peaks and troughs on the weekly charts, which define an up trend. It has been in consolidation mode for the past five weeks. Sustained trading above 95 would trigger further upsides for the stock. We are placing a short-term target of 108 and 113, with stop loss at 91. Earlier, the stock had corrected from its December 2007 highs of 253 and made a good base around 40 levels. Then from early April 2009 it started its uptrend accompanied by rising volumes.

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