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June 29, 2014

elara on orient cement

Magnitude
In the past few weeks, prices of cement in South India have increased sharply. If prices were to remain high, then South-based firms would see a sharp improvement in earnings. Orient Cement (ORCMNT IN), which is the lowest cost producer in the southern region, is likely to regain its margin leadership in Q2FY15 when it would benefit from the full quarter impact of the recent price hike. Given that the existing plant (which has an inherited cost advantage due to proximity to raw materials sources and the market) is likely to generate a ROCE of 12% even at a replacement cost of INR 6,000/tonne, its valuation should command 1x replacement cost. As AP has sustained high cement prices for the past six months to 2 years, we conclude that these prices could sustain at the current levels for some more time.
Orient is also expanding capacity from 5 mn tonnes to 8 mn tonnes by Q1FY16. The new 3-million-tonne plant is coming upin the oversupply Gulbarga cluster and is likely to have a higher landed cost of fly ash and fuel. To address investor concerns regarding low profitability, we assume the plant will be unable to generate sufficient returns above its WAAC for the next five years. Hence, we assign 1x replacement cost of INR 6,000/tonne over the next five years where this plant’s ROCE would be equal to its WACC and discount the same value of WACC at 12% for the next five years. Based on these assumptions, valuation of new capacity would be at INR 3,405/tonne.
Triggers
Weighted average targets multiple works out to be at INR 4,937/tonne. The stock is currently trading at an EV/ tonne of INR 3,560/tonne on FY16 capacity
Watch the Diet
After valuing the company at a target multiple of INR 4,937/tonne, fair price under the blue sky scenario would be INR 147, implying upside potential of 58% from the current levels.

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