Shree Cement outpaces rivals with contrarian capex strategy

Shree Cement is one of the few companies in the cement industry which have managed costs well even in tough times. In the past three years, when the cement demand dropped and the industry faced oversupply, Shree Cement emerged as the most cost-efficient company with its three-year average total expenditure, as a percentage of sales, hovering around 73 per cent, while for most large cement companies, it has been in the range of 75-85 per cent.

As a result, Shree Cement’s stock has also done well in comparison with its peers. In the past three years, it has given returns of 96 per cent against 9.7 per cent of the ET Cement Index, a composition of large cement companies.

Hari Mohan Bangur, managing director, Shree Cement, says, “It’s not just about cost-efficiency.

Cost-efficiency involves growth which, in turn, leads to free cash flows that can be used for further expansion. In the last 10 years, when most cement players were circumspect about expanding capacities due to oversupply, we have expanded without sacrificing growth.”

Financials corroborate his views. In 2004-2008, Shree Cement which, has a strong presence in the North, boosted its cement capacity to 10 MT from 3.5 MT at a time when demand was tepid. This was also a time when India’s per capita consumption was in the range of $850-900.

“We bet on the low business cycle and were confident that demand would pick up — our strategy worked,” says Bangur.

The company’s strategy to augment capacity when demand is low and benefit when it picks up worked well, especially during the slowdown.

In the past three years, when revenues of most large cement companies registered a compounded annual growth rate in the range of 3-24 per cent, Shree Cement’s sales grew at a compounded annual growth rate of 26 per cent, indicating the benefit of timely expansion.

Also, the company’s operating profit grew at a CAGR of 36 per cent to Rs 1,559 crore in the past three years when most large cement companies clocked growth of less than 33 per cent. Today, the company is again expanding. In addition to having a strong presence in the high-growth northern region, where it has close to 20 per cent of the market share, it is also expanding in the east.

In the next two and a half years, Shree Cement is likely to enhance its cement capacity to 25MT from the current 13.5MT.

This growth in capacity, analysts reckon, is likely to come from internal accruals (Rs 3,200 crore in operating cash flow in FY14-15) and net cash on books (Rs 1,280 crore as of FY13). With a utilisation level of close to 80 per cent, the company hopes to cash in once the demand picks up.

“We want to maintain cost-efficiency as our distinguishing factor from other cement companies, and want to maintain high productivity so that the cost of production of cement comes down,” Bangur adds.

Ankur Kulshrestha, a cement analyst with HDFC Securities, points out that Shree Cement's average production cost in the past 12 months was around Rs 2,600 a tonne, compared with Rs 3,300-3,600 for others. This cost advantage has given an edge to the company’s operations.

On the valuation front, on FY15 estimated earnings, the company is trading at an EV/tonne of $97, which is far better than its larger counterparts Ultratech Cement and Ambuja Cements, which are trading at an EV/tonne of $137 and $114, respectively.