With a pick-up in infrastructure development activities, demand is expected to remain firm in Star Cement’s core operating markets.
Star Cement, the largest manufacturer in the North East, reported tepid numbers for the March quarter. Better realisations drove the double-digit growth in topline, but volumes were largely stagnant and profitability was hit by higher expenses.
Despite the lackluster quarterly performance, Star stands to benefit from its strong presence in the North East and the industrial development in this region.
Rising costs weigh on the margins
Volumes for the quarter at 0.80 million tonnes were largely flat year-on-year. Demand in the North East was strong, but this was offset by low offtake in Eastern regions. Realisations for the quarter increased 11 percent as the company was able to increase prices.
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Operating profit for the March quarter declined 15 percent over the December quarter. Expenses rose, as freight subsidies expired in January, and due to higher fuel and raw material prices. Higher advertising spends and District Mining Foundation (DMF) provisions further dragged the margins lower. DMF was created for the benefit of persons and areas affected by mining-related operations, and companies have to contribute a certain sum to it.
Debottlenecking clinker capacity
The clinker utilisation rate for the quarter reached near full capacity (97-98 percent) during the March quarter. To meet the additional demand, Star Cement is planning to expand its clinker capacity from 2.6 million tonnes to 3.0 million tonnes by investing around Rs 15 crore.
The company plans to set up a 1.5-2.0 million tonnes grinding unit in Siliguri (West Bengal) at a cost of Rs 200-250 crore. This capacity is expected to become operational by the second half of FY20.
Demand environment to improve
The company has a dominant position in the North East and enjoys 23-25 percent market share. In 2017, the government initiated the North-East Industrial Development Scheme (NEIDS) for five years. This scheme, which replaces the North East Industrial and Investment Promotion Policy (NEIPP), has been designed to promote industrialisation in the states of the region. This bodes well for companies like Star Cement as does other government projects such as Bharat mala and housing for all. The management is hopeful of demand recovery in North East and expects 7-8 percent volume growth this financial year.
Outlook and Recommendation
With a pick-up in infrastructure development activities, demand is expected to remain firm in Star Cement’s core operating markets. While the demand picture looks robust, the company is facing a challenging cost environment with rising input costs and expiry of freight subsidy. Star Cement with its unique geographical positioning is well positioned to overcome near-term cost pressures. The company is trading at an FY20 Enterprise Value/EBITDA multiple of 11 times and should be considered in the ongoing market correction.