Deccan Cement : Dull company.Dull business.Big wealth creation opportunity

I have been wanting to write this for a long time, finally got around to it thanks to a long weekend , most of which was dry !

Deccan Cements is one of the smaller cement companies in the south. What impressed me most about the company is the financially disciplined conservative management and the

Lets begin with the most basic facts

Started in 1979 by a technocrat MB Raju

The plant started productionin 1982 current capacity is 2.3 million tonne per annum

The plant is 165 km from Hyderabad and appx 175 km to Guntur district, where the new capital of Andhra Pradesh ( Amravati ) is going to come up

The plant manufactures a wide variety of cements, including specialty cements. The regular grades of cement manufactured include OPC 43, OPC 53, PPC and PSC. Specialty cements produced include S53 for railway applications, SRC (Sulphate Resistant Cement), Low Heat Cement, Low Alkali Cement etc. ( source : Co website )

One of the main inputs in the production of cement is limestone. Deccan’s own captive limestone mine, having abundant high quality limestone, is contiguous to the plant premises

The other main input is power. Here also the company is more or less self sufficient with a Captive Thermal Power Plant (15MW), Hydro-electric Power Plant (3.75MW) and Wind Mills (2.025MW) under its fold.

Equity is only 7 cr

10 paid up

56% with promoters

No pledge. No warrants outstanding. No equity overhang

CMP 445. Mcap 311 cr

Long term debt as on 31st March 2015 was 116 cr. Thus total EV = 427 cr. I am ignoring short term debt on books as current assets > current liabilities by 50 cr

Thus EV per tonne in USD for Deccan is = 427cr converted to $ divided by 2.3 million = 28$ per tonne, which is way off the rates at which integrated cement plants have been valued in the recent past ( JPsold its plants to Ultratech for 140$/tonne . Lafarge recently sold 5.15 mt plant to Birla Corp for 5000 cr at an implied value of 149$/tonne )

Q1 2105 operating profit was 28.73 cr as compared to 6.42 cr in the same quarter last year

Last year the company sold 1.07 mt of cement against an installed capacity of 2.3 mt, implying a capacity utilization of 46%.

Even at this level of under performance, the company made 89cr of operating profit for FY15.

The EBITDA per tonne comes to 830/- for last year. Cement prices have since then firmed up and now realizations are upwards of 1000 per tonne.

Q1 EPS is 19.88 ( not annualized )

Stock already owned by IL&FS trust (9.5%) and UTI Midcap (5%). Institutional ownership is up by 10% over the last 4 quarters

Sagar cements releases monthly sales figures for themselves . Sales are up 18% yoy with accelerated growth in recent months. EBITDA per tonne is also up. Should apply to Deccan also.

what i like about the company

To the best of my knowledge , the company has not diluted the equity since its listing

Company increased its capacity from .3 mtpa to 2.3 mtpa without raising capital. It was funded from internal accruals as well as debt.

company has no capex planned in the near future

company generated 408cr as cash flow from operations between FY2010 to FY2015. This needs to be seen in the backdrop of the downturn of Andhra fortunes after the demise of YSR Reddy in 2009. Also, the subsequent Telangana issue has hampered growth in Deccan’s key markets

Out of 408 cr CFO, the company repaid loans worth 359 cr ! ( gives comfort on realness of the number )

By FY16 , the company is expected to be debt free.

The operations seem to be very efficient in terms of wage cost. Comparison of peer companies is as follows

Company name Wage %
Sagar Cements 4.56%
NCL 4.22%
KCP 3.84%
Deccan Cements 3.01%

The executive directors take the minimum wages as per the companies act ( source page 41, FY15 AR )

Company will benefit from its proximity to both Amravati and Hyderabad.

Construction of the capital will lead to a multi year boom for cement companies operating in the region. Search 'Amravati Andhra Pradesh Capital ’ on google images to see the image of the proposed city.

Valuation for FY19

Investment has to be made with a 3 year horizon

I am assuming capacity utilization will hit 80%

Sagar cements in their latest concall have indicated an EBITDA figure of 1500 per tonne in AP already. I am assuming it at 1200 per tonne in 2019

Debt will be zero.

Tax rate will be 25%

The number can look something like this

Total capacity : 2.3 mtpa

Capacity Utilization : 80%

Total sales : 18.40 mt

EBITDA per ton : 1200

Total EBITDA in lacs : 22080

Less Dep in lacs : - 2000

Less Tax in lacs: -5020

PAT in lacs : 15060

number of Shares in lacs : 70

EPS : 215

Given the potential for development in the region, capacity utilization of 80% seems reasonable.

Also, the company would have close to 400 cr of cash generated from FY16/17/18 operations. I also believe with no impending capex / loan repayments, the company may aggressively step up its dividend payout or go in for buybacks.

Sometimes , a boring companies in a boring business can generate a lot of wealth. I believe Deccan at this juncture merits closer viewing.

Mcap when posted : 311 cr
Disclosure : invested at these levels

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Very nice write up. But why would you think it can compete with UntraTech/ACC/India cements, are they not in a position to serve the demand of new construction? And what will happen after the capital construction boom slows after 4-5 years? Does the managament have inherent quality to expand the foot print and explore newer markets?

Nicely researched report.

one more thought is, building a capital requires huge quantities of cement and generally it would be better to acquire cement from 2-3 vendors who are large enough to provide in such huge quantities. Does Deccan cement currently have that capability? How does its capacity weigh when compared to giants in this industry.

OUT OF TOPIC: Also, investment thesis depending on capital construction may not be a safe idea, as we never know what Chandrababu Naidu would do while giving tenders to cement companies? Given that the opportunity is so huge, he may build a cement plant or buyout an existing one and up the capacity so it becomes captive plant for capital needs? Or Crony Capitalism may play a part here and all cement procurement tenders would go to some of his buddies’ business outfits. Again, as indicated, this is just to be careful thought as dealing with govt. orders will have its share of red-tapism, I do not imply that this will happen.

How does Sagar Cements look like in comparison to Deccan cements?

They already sell in all the south markets. I believe they have a decent brand recall but obviously will get dwarfed by the biggies. Which is why i feel it is a specific 2019 stock story.

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really impressed man. good write up.
the company is located at such a perfect location. also a tech zone is planted in raysellam district, a dam,a capital, polavvaram canals.

its being at the right place at the right time.

Transportation of cement is one of the biggest costs. Local cement companies will have huge cost advantages compared to those far away. The cement required has to be supplied by all…one guy just cant do it. the rising tide will lift all the boats, we just need to see which will give the maximum ride with highest margin of safety.

Sagar is a confusing story. They sold a plant. Then they bought another plant. Debt levels are also high.

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Thanks Ashish. there are many infra triggers in the region. Google will give you all the details.

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agree.

I’m looking if it has a moat here as Cement is a commodity and entry barriers are not very high.

I gather from your report the below advantages --> can they become moat?

  1. Proximity to new capital.
  2. Lower transportation costs leading to ‘low cost’ supplier.
  3. One time BIG construction activity for next few years.

a. Having captive power plant and limestone are good but even other cement companies mostly have it, like Sagar cement.

During your research, what did you feel about promoters? Any nice points, any blemishes? Do they have the passion to make it big in the business?

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Promoters are very reputed. One good thing i heard is that they even pay intrerest to banks many months in advance , which is rare and commendable.

The other moat is that it takes many years to setup a plant. Getting mining leases , etc is tedious and time consuming.

Sometimes it is better to have a promoter who is not very ambitious. There are many instances where promoters chasing growth have misread the demand leading to companies going under.

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Again nice story, promoters have made it integrated (sorry I havnt verified but counting on your summary), but considering the age of company and though they had decent cash flows why couldn’t they expand the market to utilize the capacity to even half?

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The capacity expansion happened along with the slowdown in the andhra region. in cement, you cannot expand markets too far from you.

Also, its not that they are totally laid back. Sales have gone up 5 times in last 10 years @ 15% cagr.

I agree over all it looks very interesting and valuations are attractive.
However the sales have gone up only from Rs340cr to Rs440 cr, I know you mentioned the issues of Andhra /Telangana but how do you explain the demand in housing loans in general last few years in Andhra? We have to make sure it can grow and continue to grow, thats what will create wealth.

i come to my knowledge that a entry tax is imposed on material from telangana in andhra pradesh and vice versa

leading to increase of price of cement to 320-340 per bag from 220-240.
it is goodd as well as bad

i had visited hyderabad in 2012.
we are travelling from tirupati to hyderabad.its a 12 hour journey but due to strife, the train stopped just outside hyderabad for 8 hours. we need to change the train in between the tracks. our entire schedule got disturbed and we never ever thought of going back again.
so this telangana strife is disastrous. no new power pplants, construction, property market at rock bottom.
it is going to lookup definately.

Can somebody give some reasons of its clear preference over sagar cements because it’s debt levels are at .42 . So it’s not too high and also pe levels are comfortable .

Both are different kind of plays on the same theme. Sagar is more financially adventurous and aggressive. Deccan is more sedate. It depends on ones own investment comfort which one to choose.

Good analysis but i feel we need a company visit/ meeting the management.Thanks again

  • Current Interest coverage ratio is 1.8 and it has never been > 3 in last 5 years.
  • Tax paid last year is just 1.46 Cr against the PBT of 21.35 Cr. That’s less than 10%.
  • The EPS has fluctuated widely in last 5 years. If you take average of EPS for last 3 years, it comes to around 15. With that the P/E ratio comes to around 30x, not exactly cheap for cement business. Agreed that TTM EPS is more than 50 and with that 3 year average comes to 30. That’s still P/E of 15 - not exactly cheap for cement business.
  • CFO is consistently +ve and that’s a good thing but net cash flow has flirted between +ve and -ve and that doesn’t reflect promoter’s conservativeness.
  • Poor ROE and ROCE ratios. Working Capital days between 40-60 in last 5 years and that’s again a good thing.

Disc: Not invested and not looking to

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Caution there. there are some 15 similar sized companies in the same vicinity of 30KM radius, famously the Raasi Cements which was forcefully took over by N Srinivasan of India Cements and Ex BCCI president in 90’s. The area is rich in lime stone on both either side banks of Krishna river which falls into both states, Deccan I suppose is on Telangana Side and India Cements also on Telangana Side, then there is penna, duncan, KCP etc etc … Mostly all political big pins own a medium size cement plant in AP & TG. I am not sure of the dynamics of market but usually most politicos are also big contractors here, so usually the cement plants are for kind of captive consumption … Some one should through a light on corhporjate governance and pollution issues beand union issues … Historically its a naxalite effected areas but nothing dangerous happening now but still I guess AITUC is having a strong union in these areas.

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