JK Lakshmi - Cementing Growth

Date: 10 June, 2010

BSE: 500380

Website: www.jklakshmi.com

CMP: Rs 45/Share; Value: Rs 83/Share

Must Buy: A growing mid-cap cement company available at 45% discount to its intrinsic value

Industry Prospects:

Cement industry growth practically mirrors GDP growth. And the simple reason is its end usage - housing for retail segment and construction for commercial segment. Indian Cement industry has been growing at a percentage or 2 higher than reported GDP numbers. Though, in our country GDP estimates have been found to be incorrect sometimes but cement output is tracked closely by CMA and is generally accurate. In the long-term, Cement will continue to grow at 7-8%. We are still far behind on per capita consumption compared to China leaving room for demand.

JK Lakshmi:

JK Lakshmi is owned by Lakshmipati Singhania group, one of the leading industrialists from India. JK Lakshmi has been in business for about 30 years. And has seen some tough times during downturn (early 2000s) largely because of imprudent financing decisions. Since then they have been prudent with their financing decisions. I had met the CFO once and he did acknowledge that because of financial imprudence they went through a rough patch and now have been prudent on that front.

In cement industry, the key to success are

• Economic capacity
• Proximity to market with regional presence
• Low energy cost and consumption norms

JK Lakshmi is quite a popular brand. They sell primarily in Rajasthan where they have their manufacturing facility. Slowly, they are expanding their regional footprint. They already have a split grinding unit in Gujarat and another one in Haryana and are now planning a greenfield capacity in Chattisgarh (good market to be in). JK Lakshmi has economic capacity units, in fact has one of the largest single location unit. Their specific consumption norms are in line (or slightly more) with other efficient players. Their per unit cost of energy is low as they have secured low rate contract for supply of electricity and have captive power plants totaling 66 MW.
They have also diversified into RMC (Ready Mix Concrete) business. RMC is very popular in US and other developed economies. But in India its in nascent stage. It is being used for commercial and residential constructions chiefly in urban settings. Its a good business with long-term prospects.
Historical:
Exhibit: Historical Financials

JK Lakshmi has been ploughing back a large share of capital to improve capacity and operating efficiency. They have made the investments wisely and have earned decent returns on capital employed. For instance, during 2006 to 2010, they ploughed back Rs 545 Cr. EBIDTA since then has gone up from Rs 128 Cr in 2006 to Rs 434 Cr in 2010. Even considering EBIDTA at historical long-term average of Rs 600 / T, Company has additionally earned Rs 150 Cr on Rs 545 Cr invested, more than 25% ROCE.
Projections:
Exhibit: Future Estimates

It is assumed that the proposed greenfield capacity of 2.7 Mn T will come in line during FY 13. Hence, FY 14 starting, the company will benefit from the new capacity. For Value Investment analysis, I have assumed the following:

• Future EBIDTA / T to be less than Rs 600/T (as against Rs 1300/T at peak and Rs 500/T at its most depressed)
• Depreciation for the new asset will continue at rates similar to existing assets. Given, a large part of JK Lakshmi's capacity has and will come in line recently, this is a conservative assumption
• I have assumed that beyond 8 Mn T total capacity (post Chattisgarh unit in FY 13), there will not be any further addition for the period under consideration. This also is a conservative one as the company will continue to improve capacities through equipment balancing.

Valuation:
Exhibit: Valuation

JK Lakshmi at current prices is available at $46/T as against replacement value of $100/T. Though, this is a huge discount but while using Value Investment technique, I rely on earnings rather than anything else. Above analysis indicates the following:

• Equity Value of JK Lakshmi: Rs 1000 Cr
• Or, Per Share basis: Rs 83/Share
• CMP: Rs 46
• Margin of Safety: 45% (much above recommended 25%)
• In 5 years, Rs 100 investment should grow to Rs 320

Strong Buy: Share Prices are down on concerns over over-capacity and that is why market provides an opportunity to buy a good company at a discount.