Prism - Cement, Tiles and RMC

17 July, 2011
BSE 500338
website: www.prismcement.com
CMP: Rs 49/Share; Value: Rs 65/Share

Buy: Its a decent business but likely to get under stress because of aggressive growth pursuits. Currently sitting at just about the right discount to its value but who knows it could be available at even cheaper valuations.

Company
Prism Cement earlier had three companies which they now have merged into one. Its a Rajan Raheja promoted company and has been around for xx years. Prism Cement is into Cement, TBK (Tiles, Bath and Kitchen) and Ready Mix Concrete businesses.
Their cement business is one of the finest in India. Prism Cement is, I think, the most efficient cement manufacturer in the country. Their specific consumption for power and coal are the lowest, or one of the lowest in the country. They do not have captive power plant so buy from power producers. Purchased power is costlier compared to captive power but lower specific norms keeps the power costs down. It has a good brand recall and primarily sells in under-developed markets of Bihar, Jharkhand, Madhya Pradesh and West Bengal. Another advantage they have is their ability to sell in markets closer to manufacturing location (Satna, Madhya Pradesh). This has helped them keep their lead distance low, 275 km, and consequently freight expenses, a very heavy contributor to cost structure.
They have been doing quite well in the TBK business as well. They have grown their business at very high rates (+25%) over the last 5 years. Their tiles are the most recognized in the country and sell under the brand name of Johnson Tiles. Their tiles are recognized by international quality rating agencies and they are the only Indian company to have that distinction. They have a very strong distribution network of 2,000 dealers and sub-dealers.
Ready Mix Concrete (RMC) business is a growing business for Prism contributing 25% to their net revenues. They are the third largest in the country in this segment. They have 80 RMC units and cover about 30 cities at present. This business does not require a lot of cash and return on investment is around 15-16%.
Management
Prism is promoted by Rajan Raheja. Back in 2008, I was researching cement companies and had met analysts from brokerage firms. There was this analyst I really liked who also happened to work with Rajan Raheja at Prism. His view was that he is a very very patient and long-term guy. For cement business, its really a bonus where one has to go through good and bad times to make money. Raheja has a fairly competent team managing these business units. But again, not much is published information on the management. Rajan Raheja has been talking about becoming a 10 Mn T cement company for about 3 years now so growth is certainly in his plans.
Historical
The three business segments got amalgamated into one only last year hence consolidated financials are available for FY10 and FY11 only.
Exhibit: Historical

Following emerges from historical financials (I am also adding bits from earlier annual reports from Prism Cement) - (a) Cash reserves have been exhausted for funding capacity additions; (b) Company has taken new Debts to fund the same and growth capex in other businesses. It is likely that Company will continue to add Debt to fund other planned expansions like they did recently.

Outlook and Estimates
Long term outlook for cement in terms of demand is quite positive. Long term it'll continue to grow at 9-10% on a national average basis. In the markets Prism is present, given current levels of penetration future demand may even be higher than national average. In anticipation of future demand, companies have recently added capacities and consequently margins will be depressed in the near term. Margins in cement industry follow cyclical patterns and bounce back after lows. What is worrying me most is that the company has started work on a new greenfield project of 4.8 Mn T in South (for hedging against regional fluctuations as presently they are in eastern and central parts of India) of India. Prism has recently added 3.6 Mn T (full operations not realized yet) at the same location, Satna in MP. They have done a commendable job of adding this capacity at $60/T which is $30-35/T lower than replacement costs. But in doing so, they now have a debt position of Rs 1100 Cr against NW of Rs 700 Cr. Further to make matters worse, the additional output has to be sold at higher lead distances which consequently will increase freight and negatively impact margins. Back of the envelop shows that they will have to travel 60% longer distances (sqrt of 6Mn T/2.5 Mn T) and hence their margins will be lower by Rs 180/T or about 70-75% of long-term EBIDTA margins in that market. Ideally, I would have liked had they paid off the Debt and then added capacity. So if they proceed with the 4.8 Mn T expansion as planned they could be in trouble with more Debt and this may provide investors a better value opportunity in 12-18 months - But who knows how prices might behave then!
Both TBK and RMC businesses are operating in favourable markets. Markets for these are likely to grow at 15% in the foreseeable future led by some fundamental drivers - increasing housing & commercial construction and benefits of RMC over on-site mixing. Both these business do not require much capital to run and generate strong returns on capital. Given their relatively strong positions in these markets, I do not see much concern in growing profitably.
But value investors must always look at conservative scenarios. So I am lowering profitability and growth assumptions to reduce margin of error in making investment decisions.
Exhibit: Estimates

Valuation
For valuation purposes, I have assumed the following:

• Company goes ahead with its plan to add greenfield capacity of 4.8 Mn T post which there will not be any further addition
• TBK and RMC businesses will grow at 5% on a terminal basis. Given their expected contribution in later years, terminal growth rate for the entire business will be 3.5%
• Unquoted investments at 80% of cost and liquid and quoted at market value

Exhibit: Valuation

The shares are valued just about the right discount of 25% to its value. But I do expect more stress for the business going forward. As value investment technique requires one NOT to SPECULATE, I can't say for sure whether prices will be more attractive during difficult periods (next 12-18 months). My strategy will be to  buy this scrip now and when prices go down buy some more at far greater discounts.