Investor's Eye: Update - Shree Cement (Price target revised to Rs3,550), Max India (Price target revised to Rs262)

Investor's Eye [August 24, 2012]  Sharekhan www.sharekhan.com

Summary of Contents STOCK UPDATE Shree Cement Cluster: Cannonball Recommendation: Hold Price target: Rs3,550 Current market price: Rs3,450 Price target revised to Rs3,550  Result highlights Robust earnings supported by lower depreciation and higher margin: In the quarter ended June 2012 Shree Cement, which has changed its accounting year from March to June, posted robust earnings of Rs351.5 crore as compared with the earnings of just Rs64 crore reported in the quarter ended June 2011. The performance was well ahead of our as well as the Street's estimates on account of (a) a sharp drop of 48.8% year on year (YoY) in the depreciation charge to Rs81.8 crore; (b) a lower than expected effective tax rate of just 8.3%; and (c) a better than expected operating profit margin (OPM; 33.1% as compared with our estimate of 31.1%).  A strong volume growth in cement and power businesses drives overall revenue growth: In the same quarter Shree Cement posted revenues of Rs1,455.3 crore, which was higher by 42.9% YoY. The revenue growth was driven by a 39.8% growth in its cement business and a sharp jump in the revenue from the sale of power units (around Rs173 crore as compared with Rs101.8 crore in the corresponding quarter of the previous year). The revenue growth of the cement division was supported by close to 30% growth in the volume and around 9.5% improvement in the average blended realisation. On the other hand, the power division's revenue growth was robust driven by a 64% increase in the power volume due to the commissioning of the second phase of its power plant of a capacity of 150MW. Increased cement realisation and improved profitability in power results in margin expansion: The OPM surged by 913 basis points YoY to 33.1%. The margin expanded largely on account of an increase of 9.5% in the cement realisation YoY and an improvement in the profitability of its power division, which recorded EBITDA of Rs35 crore during the quarter as against just Rs6.7 crore in the corresponding quarter of the previous year. Consequently, the operating profit increased by 97.3% YoY to Rs481.2 crore (as compared with the revenue growth of 42.9%). On a per tonne basis, the EBDITA per tonne of cement increased by 47.3% YoY to around Rs1,297 due to the increase in the average realisation and cost savings in the power division.  A drop in depreciation and lower tax rate boosted earnings growth: During the quarter under review, depreciation dropped sharply by 48.8% YoY to Rs81.8 crore, which was much lower than our expectation of around Rs2,250 crore. In addition, the effective tax rate fell to little over 8% as compared with our expectation of 20%. Hence, the earnings growth further accelerated (Rs351.5 crore compared with just Rs64 crore YoY).  CCI imposes a penalty of Rs1,175 crore; company to appeal against the order: The Competition Commission of India (CCI) has imposed a penalty on around 11 cement companies for indulging in cartelisation and managing cement prices at higher levels. As per the CCI order, Shree Cement will have to pay Rs397 crore as penalty. However, based on legal opinion the company will appeal against the order before the Tribunal. Accordingly, the company has not made any provision for the CCI penalty.  Upgrading earnings estimates for FY2013 and FY2014: We have incorporated in our estimates the better than expected volume growth of the cement division in the quarter ending June 2012. We have also factored the lower than expected depreciation in our FY2013 and FY2014 estimates. As a result, we are upgrading our earnings estimates for both FY2013 and FY2014. The revised earnings per share (EPS) estimates now work out to Rs160.7 and Rs206.9 for FY2013 and FY2014 respectively.  Maintain Hold with revised price target of Rs3,550: We believe the company's performance improved at the operating level due to a better than expected volume growth in both the cement and the power division. However, the key concerns remain higher than expected pressure on the cement realisation and cost pressure in terms of a higher freight cost. Hence, we maintain our Hold recommendation on the stock with a revised price target of Rs3,550 (valued at EV/EBITDA of 6x on FY2014 estimates). At the current market price the stock trades at an EV/EBIDTA of 7.5x on FY2013 and 5.8x on FY2014 earnings estimates.  Max India Cluster: Emerging Star Recommendation: Buy Price target: Rs262 Current market price: Rs188 Price target revised to Rs262  Key points We recently interacted with the management of Max India to understand the growth prospects of its life insurance business and the developments in its other businesses. The company is largely out of investment phase and is now focusing on growing its profits as the life insurance business is generating profits while the healthcare business is likely to turn profitable by FY2014. Further, given the comfort on the capital front (treasury corpus stands at Rs860 crore) and the steady growth in the profits, the company is likely to announce an interim dividend in H1FY2013. We now include Rs13 per share for Max Bupa (which is valued at book value) and Rs16 per share for the treasury corpus in our sum-of-the-parts (SOTP) valuation. Therefore, our price target for Max India gets revised to Rs262. We maintain our Buy rating on the company. Growth to pick up in H2FY2013, focus remains on traditional products: Max Life's APE declined by 18% year on year (YoY) in Q1FY2013 (vs a 2% growth recorded by the private players) due the regulatory overhang and a limited focus on non-par products. Unlike the other peer companies which aggressively push selected non-par products, Max Life continues to focus on high-value traditional products. As the government intends to allow tax benefits on policies having a sum assured less than 10 times the annual premium and as the stance of the Insurance Regulatory and Development Authority (IRDA) on non-par products is clear, the premium growth will pick up in H2FY2013. The company expects about 15% growth in the annual premium equivalent (APE) in FY2013.  Regulation on non-par products could shave 150 basis points off NBAP margin: During FY2012, the new business achieved profit (NBAP) margin of Max Life was about 15%, which fully adjusts the regulations relating to unit-linked insurance plans (ULIPs). The IRDA's circular on non-par policies is expected shortly (possibly in September 2012) which would affect the NBAP margin by around 150 basis points. Currently, the non-par products constitute around 10% of the product mix (par 77% and ULIPS 13%); the management aims to keep this below 20%. On a sustainable basis, the company is expected to maintain an NBAP margin of about 13.5%, which is healthy for a non-bank life insurance firm. Click here to read report: Investor's Eye     Sharekhan Limited, its analyst or dependant(s) of the analyst might be holding or having a postition in the companies mentioned in the article.

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