Ambuja Cements: Potential for further upside seen limited

Ambuja Cements reported a healthy expansion in operating profitability during the June’10 quarter. Cost savings, on account of its strategy to use its own clinker facility, aided the big jump in margin despite rising input costs. The company is likely to see higher profitability on a year-on-year basis until the base effect comes into play after about three quarters. Also, given its negligible dependence on the markets in South India where demand is sluggish, Ambuja seems to be better placed than its peers.

Ambuja Cements, which is controlled by Swiss cement major Holcim, had recently brought two new kiln lines on stream. This reduced the clinker purchase cost by as much as one-tenth from the year-ago clinker costs, thereby offsetting the 9% jump in other key operational costs.

As a result, the company’s operating margin improved 320 basis points year-on-year to 30.8% in the second quarter (the company’s financial year ends in December). Net sales rose 10.6% to `2,088.4 crore. The company’s net profit also rose 20.5% y-o-y to `391.2 crore in the June quarter. When compared with its peer ACC, Ambuja’s June quarter performance looks superior. ACC’s consolidated operating margin plummeted 750 basis points year-on-year to 26.9% in the June quarter, coupled with 26% drop in its net profit.

Going forward, Ambuja Cements’ ability to keep a tight check on its operational costs would play a crucial role given the rising trend in per tonne cost for power & fuel, and freight and forwarding. The company may face demand pressure from the Western region of the country. Its impact, however, may remain muted since the Northern and Eastern markets, where Ambuja enjoys a wide presence, are witnessing a firm demand. Also, the sluggishness in demand from the South may not hit Ambuja as badly given its lower dependence on the region.

Given this, the company is expected to withstand the sluggish trend in cement prices in certain markets, over the next few quarters. At the Monday’s closing price of `116.6, Ambuja’s stock traded at 12.4 times its trailing four-quarter earnings.

The stock of its closest peer ACC traded at a P/E of 10.7. Other medium-sized cement makers attract a P/E in the range of 4-7. This makes Ambuja Cements, one of the costliest cement scrips on Indian bourses. As such, its valuations fully reflect future margin expansion and growth potential. This does not leave much potential for a further upside in its stock price.