Name- Sushant Sarode IIM Indore Email- [email protected].

in

Contact No- 09224596457

Table of Contents
INDUSTRY PROFILE.....................................................................................................3 NEW INVESTMENTS....................................................................................................4 MERGERS AND ACQUISITIONS....................................................................................5 Outlook:......................................................................................................................5 SHREE CEMENT - AN OVERVIEW.................................................................................6 CORPORATE GOVERNMENT ANALYSIS........................................................................6 RELATIONSHIP WITH FINANCIAL MARKETS.................................................................9 RELATIONSHIP WITH THE SOCIETY...........................................................................10 STOCKHOLDER ANALYSIS.........................................................................................11 RISK AND RETURN....................................................................................................14 COST OF DEBT..........................................................................................................15 COST OF EQUITY.......................................................................................................16 MEASURING INVESTMENT RETURNS.........................................................................17 ECONOMIC VALUE ADDED........................................................................................17 STRUCTURE CHOICES...............................................................................................18 CURRENT COST OF CAPITAL.....................................................................................19 MANAGEMENT TRUST...............................................................................................20 CHANGING DIVIDEND POLICY...................................................................................20 VALUATIONS.............................................................................................................21 RATIO ANALYSIS.......................................................................................................26 FREE CASH FLOW CALCULATION..............................................................................27 SENSITIVITY ANALYSIS:.............................................Error! Bookmark not defined. RECOMMENDATION..................................................................................................28

RECOMMENDATION

INDUSTRY PROFILE
With 142 cement plants and a total installed capacity of around 270 million tonnes per annum (MTPA) both as of Dec 2010, the Indian cement industry is the second largest in the world, the largest being China, which produces over 1 billion tonnes of cement annually. Indias per capita cement consumption is around 155kg compare to China which is around 1100kg and world average of 450 kg .Increase in demand from infrastructure and real estate has supported the cement demand growth in India. Cement sector has experienced consumption growth (CAGR) of more than 10% during FY06 - FY10. The main factors prompting this growth in demand include the real estate boom during 2004-08, increased investments in infrastructure by both the private sector and Government, and higher Governmental spending under various social programs. The latest data shows that passive capacity utilization in the cement industry which is due to capacity addition and weak off-take of cement owing to monsoon and a high base effect. The below figure show that the cement demandsupply scenario in India. In contrast to strong domestic consumption growth, the capacity addition has been slow by the industry mainly due to excess capacity surpluses between 2001-02 and 2003-04. Thus, the capacity utilization was also subdued between 2001-02 and 2003-04 and increased thereafter due to increase in demand

Cement is a highly freight-sensitive product, given that it is a high-bulk, low-value commodity, The Indian cement market therefore is largely a regional one, which also means that the demand-supply dynamics may be different for the various regions and the country as a whole. The top five States in terms of cement consumption, viz. Maharashtra, Andhra Pradesh (AP), Uttar Pradesh (UP), Tamil Nadu (TN) and Gujarat, accounted for almost 50% of the total domestic

consumption of cement. This is largely a factor of the population levels in these States as well as the development activities being undertaken there. The some of the important demand drivers for the cement industry are: Infrastructure development, housing segment, industrial segment, commercial construction. According to the Confederation of Real Estate Developers' Associations of India (CREDAI), the demand for affordable housing & reasonable prices of land would encourage India's real estate companies to develop new properties and commercial offices. There are also upcoming SEZ projects in cities like Bangalore, Bhubaneswar, Indore, Nashik and Pune which would further boost cement demand.

The cement sector witnessed some revival in demand after the monsoon season showing strong pick up in dispatches in October. Cement industry is proposed to add around 33 million tonnes of capacity in FY11 compared to 55 million tonnes in FY10. It is also expected to add around 25 million tonnes of cement capacity in FY 12.

NEW INVESTMENTS
Dalmia Cement, South Indias second largest cement maker will invest over USD 652.6 million to add 10 MT capacity over the next 2-3 years. India Cements Ltd will invest USD 104 billion to set up two thermal power plants in the southern states of Tamil Nadu and Andhra Pradesh. Anil Ambani Group owned Reliance Infrastructure will invest USD 2.1 billion to set up cement plants with a total capacity of 20 mtpa over the next five years. Reliance Cementation, an Anil Dhirubhai Ambani Group (ADAG) company, plans to set up a 5 MT integrated cement plant in Yavatmal district of Maharashtra at a cost of USD 463.2 million. Swiss cement company Holcim plans to invest USD 1 billion in setting up 2-3 greenfield manufacturing plants in India in the next five years. The expansion will take the companys total cement-making capacity to 60 mtpa from 50 mtpa currently. Jaiprakash Associates Ltd will invest USD 973.07 million to take its cement manufacturing capacity from 20 mtpa to 33 mtpa by 2012. Chettinad Cement, the flagship company of the diversified Chettinad group, has chalked out an aggressive expansion plan to boost its capacity to 13 mtpa in another four years from its current capacity of 7.5 mtpa at an investment of USD 259.42 million.

Kolkata-based Shree Cement plans to invest USD 432.38 million to increase its cement output by two million tonnes to 12 MT by March 2010 and raise power generation capacity by over four-fold by FY'12.

MERGERS AND ACQUISITIONS

Holcim strengthened its position in India by increasing its holding in Ambuja Cement from 22 per cent to 56 per cent through various open market transactions with an open offer for a total investment of USD 1.8 billion. Moreover, it also increased its stake in ACC Cement with USD 486 million, being the single largest acquirer in the cement sector. UltraTech Cement, a unit of conglomerate Aditya Birla Group, is absorbing sister unit Samruddhi Cement, to form India's biggest cement firm. Leading foreign funds like Fidelity, ABN Amro, HSBC, Nomura Asset Management Fund and Emerging Market Fund have together bought around 7.5 per cent in India's third-largest cement firm, India Cements (ICL), for USD 124.91 million. Cimpor, the Portugese cement maker, paid USD 68.10 million for Grasim Industries' 53.63 per cent stake in Shree Digvijay Cement. Vicat SA, a French cement maker acquired a 6.67 per cent stake in Hyderabad-based Sagar Cement for USD 14.35 million.

Outlook:
Cement prices in some regions were raised by approx Rs 10-20/bag. However, Northern region didnt face any price hike and cement prices remained flat around Rs 215-220/bag. Indian cement sector is affected by accelerated growth in capacities, sluggish demand, spike in input costs and weak pricing. On a relative basis, the capacity additions are steeper in the Southern Region, which has come at a time when the region has witnessed sharp deceleration in demand growth. Once there will be steady improvement in cement consumption, prices will also start hardening. Overall one can expect increase in cement off-take over next 3-5 years. FY05 Actual Capacity (Mn T) 145 Effective capacity (Mn T) 145 Effective production (MnT) 128 FY06 152 152 142 FY07 166 165 155 FY08 189 173 168 FY09 212 205 181 FY10 267 233 199 FY11E 290 263 219 FY12E 300 291 241

Effective Utilization (MnT) Capacity 88% Cement Dispatches (MnT) 126

94% 140

94% 154

97% 167

88% 180

85% 199

83% 219

83% 241

SHREE CEMENT - AN OVERVIEW

Shree Cements is one of the premier cement makers in India and is the largest player in North India. It is among the top 5 cement makers in the country and is promoted by Bangur Family. With Registered office in Beawar, Rajasthan and corporate office in Kolkata the company has the highest market share in the northern India. Shree Cements produced 100 Lacs MT of cement in 2009-10, increase of 23% over the previous year. It pursues multiple brand strategy. The three major brands Shree Ultra Jung Rodhak Cement, Bangur Cement, and Rockstrong Cement appeal to different customer base and thus help the company to widen its customer base. Two of its units are located in Beawar while five units are located in RAS near Beawar. The sites for manufacturing at Beawar give it a distinct advantage of proximity to customer place and reduce the transportation costs.Shree Cement is also into the power sector with a Power generation capacity of 210 MW which is set to go up to 560 MW by December 2011. Shree Cements has set up waste heat recovery projects of 46 MW capacity which is the largest waste heat power generation capacity in world cement industry excluding China. Shree Cements follows the triple bottom-line approach of measuring performance against the three benchmarks of Economical, Social and Environmental. Shree is an active participant at Climate change forums.

Last one year share price movement (SHREECEM)

Shree Cement NSE Symbol BSE Symbol Current Share Price (Rs) SHREECEM 500387 1716.95

Market Cap (Rs Cr)

5,971.68

CORPORATE GOVERNMENT ANALYSIS

Shree Cement India Limited has three Executive Directors and six independent non Executive Directors. The brief profile, remunerations, and stock holdings for the Board of Directors in the company are discussed in the section below. BOARD OF DIRECTORS MR. B. G. BANGUR Mr. B. G. Bangur is a commerce graduate and brings with him a long experience in the industry. He is the Executive Chairman of the company and is also a Director in number of companies. He is also involved in various philanthropic and charitable institutions. MR. H. M. BANGUR Mr. H. M. Bangur is a Chemical Engineer from IIT Mumbai and is the Managing Director of the company. He is also the President of Cement Manufacturers Association (CMA). He is also the main driver behind the technical pursuits of the company. MR. M. K. SINGHI Mr. M. K. Singhi is the Executive Director of the company and joined the company as President in 1995. He brings with him more than 30 years of experience in the industry. He is Fellow Chartered Accountant and a science and law graduate. He is the leader of Cement Task Force for energy conservation appointed by Bureau of Energy Efficiency, Ministry of Power. MR. R. L. GAGGAR Mr. R. L. Gaggar is an Arts Graduate and is a renowned Solicitor and Advocate based in Kolkata. He has been practicing law for more than last 50 years. Mr. Gaggar is also on board of Somany Ceramics Ltd., Sarda Plywood Industries Ltd., TIL Ltd., Peria Karmalai Tea and Produce Co. Ltd., Paharpur Cooling Towers Ltd., International Combustion India Ltd., Subhash Projects & Marketing Ltd., Machino Plastics Ltd., Sumedha Fiscal Service Ltd., Financial & Management Services Ltd., Machino Bassel India Ltd., Eastern Silk Industries Ltd. and Bhaskar Silicon Ltd. MR. O. P. SETIA

Mr. O. P. Setia is M.Com from Delhi University and is Ex Managing Director of State Bank of India and has held many key positions in associate banks. MR. SHREEKANT SOMANY Mr. Shreekant Somany is a science graduate and is an eminent industrialist. Currently he serves on the boards of Somany Ceramics Ltd, S. R. Continental Ltd, Somany Retail Ltd, Cosmo Ferrites Ltd, Sarvottam Vanijya Ltd, and Scope Vinimoy Pvt. Ltd. DR. ABID HUSSAIN Dr. Abid Hussain is retired IAS officer and ex ambassador of India to United States. He is member of Planning Commission and Secretary, Ministry of Industries. In 1988, he was awarded Padma Bhushan. Currently he serves on the board of Hyderabad Flextech Ltd, Nagarjuna Oil Corp. Ltd, GVK Industries Ltd, GVK Taj Hotels and Resorts Ltd, GVK Power and Infrastructure Ltd, Zodiac Clothing Co. Ltd, Wockhardt Ltd, Havels India Ltd, and Gangavaram Port Ltd. DR. Y. K. ALAGH Dr. Y. K. Alagh is a prominent economist and holds a Doctorate and Masters in Economics from University of Pennsylvania. Currently, he is on the board of Tata Chemicals Ltd. MR. AMITABHA GHOSH Mr. Amitabha Ghosh is a Fellow Chartered Accountant and Fellow Member of Indian Institute of Bankers. He is former Deputy Governor of RBI and currently serves on the boards of Centenary Leasing Co. Pvt. Ltd, Kesoram Industries Ltd, Joonktolle Tea and Industries Ltd, Heidelberg Cements (India) Ltd, Peninsula Land Ltd, Orient Paper and Industries Ltd, Palit Consultancy Pvt Ltd, Sahara India Life Insurance Pvt Ltd, Sahara Prime City Ltd, Shreyas Shipping and Logistics Limited, Shreyas Relay Systems Ltd, Xpro India Ltd, Zenith Fibers Ltd, Sahara Infrastructure and Housing Ltd, and Sahara Hospitality Ltd. During the financial year 2009-10, four board meetings were held, details of which are shown below. The next table shows the remuneration details of the Board of Directors.

As can be seen from the two tables above, the promoters of the company are also the managers. Mr. B. G. Bangur is the promoter and Executive Chairman of the Company. Currently, the board has three full time directors and six non-executive directors. There are three insider directors in the company who owns significant stake in the company. The incumbent management is very powerful considering that all the full-time directors are promoter family members and they are in key positions of the company. Thus, there is a significant control of management in the board and no difference between the owners and management. The profile of all the independent directors on the board is commendable. Majority of them hold position of Directors in number of other companies. One of the Director, Mr. O. P. Setia, is an Ex Managing Director of State Bank of India while Mr. Amitabha Ghosh is Ex Deputy Governor of Reserve Bank of India. Overall, the members bring huge experiences in diverse domains ranging from economics to industry. It is quite clear from the table above that the three full time directors are earning huge salaries running in to crores. More than two-third of their salaries are in the form of commissions. The company has shown good growth in the last few years which is reflected in the high proportion of commissions in the total salary of insider directors. As of now, the company has not issued any special class of shares which carries special voting rights with them. Each share carries one vote with it.

RELATIONSHIP WITH FINANCIAL MARKETS

The firm is well followed by analysts from a number of well-known financial institutions. The wide following by analysts indicates significant interest in the company by the investor community. Wide following of the company helps the retail investors by acting as a significant information source and also helps in maintaining trading volume. The table below shows the details of analysts following Shree Cement Ltd.

There are good volumes on the counter of Shree Cement which results in number of benefits for the investors: Liquidity: Good Volumes help in low execution costs as well as minimal execution delays for any buy and sell order by maintaining a tighter spread. Price Discovery: High volumes help in efficient price discovery of the stock. It helps create more sustained momentum whether the stock is going up or down. The table below shows the average volumes for the firm.

The firms press releases are easily available on its website and the firm is well covered by leading business papers. The free float of the firm is 34.44% which is comfortable. This ensures that there is no manipulation of stock prices by somebody. The company has received few complaints from its investors in the last fiscal but has resolved all of them.

RELATIONSHIP WITH THE SOCIETY

The firm has been a forerunner in taking up initiatives for the society. It pursues a policy of triple bottom-line which are - economic, social and environmental. The company is the first Indian company to join the Cement Sustainability Initiative (CSI) of the World Business Council for Sustainable Development, Switzerland. With this initiative, the company will work to reduce its energy footprint. The firm enjoys good reputation in the local community mainly due to the fact that it conducts various programs to employ local people for its operations. The Company undertakes numerous projects on healthcare, education, women empowerment, income generation, infrastructure development and other socialneed programs, especially in the two districts of Ajmer and Pali, which are within the ambit of the Company's works. It has also taken up initiatives to build infrastructure for the public. For example, it built 15 Km of roads, school buildings, and water tank for the betterment of the society. The good standing of the company within the local community is reflected by the fact that its cement manufacturing facility is one of the largest at single location in the country. Yet it has not faced any issues with the community.

STOCKHOLDER ANALYSIS
The table below shows the shareholding pattern in the company as of 31st December 2009.

Further break up of shareholding pattern is shown below.

Promoters and promoter group companies hold 65.56 percent stake in the company. Financial institutions hold 13.52 percent stake while non-institutional investors hold 20.92 percent stake. Promoters and FLT Ltd, a wholly owned subsidiary of P.L. Smith & CO. are the insiders in the company with 65.56 and 10.33 percent respectively. While the promoters play an active role in day to day management of the company, FLT Ltd does not play active role in the management. Individuals own 4.59 percent stake in the company while the employees of the company do not have any stake in the company. The insiders have not engaged in to much selling and buying of the company stock. In fact, the promoter holding has remained almost constant between 2002 and 2010 at 64-65 percent. A marginal investor is representative investor whose actions reflect the beliefs of those people who are currently trading a stock. It is the marginal investor who determines a stock's price. He is well diversified, thus faces only systematic risk and no unsystematic risk. It is clear from the above table that the institutional investors and individual investors are the marginal investors in the company.

RISK AND RETURN

ESTIMATING TOP DOWN BETA Beta measures the systematic risk of a stock or a portfolio, a risk which cannot be diversified away. It is an important parameter in the Capital Asset Pricing Model (CAPM), which is used for calculation of cost of equity. The beta for a stock can be calculated as:

To calculate the top down beta, regression was run on monthly prices of Shree Cement against the BSE 500 Index for the period Jan 2006 to Feb 2011. The results obtained from the regression are shown below

The beta coefficient obtained from the top down approach was 0.998 with a standard error of 0.117. Therefore, the actual beta for the company will be between 0.882 and 1.115 for 67 percent of the time and between 0.769 and 1.227 for 95 percent time. The R square value of 0.405 indicates that 40.5 percent risk is market specific risk while 59.5 percent is firm specific risk which can be diversified away.

The intercept of the equation is 0.0258 which when compared with Rf*(1-) = 0.0001 is much higher. This tells us that the stock did better than expected during the regression period. The intercept value also tells us the Jensens Alpha which is the abnormal return of the equity over the theoretical expected return during a time period.

ESTIMATING BOTTOM UP BETA To estimate the beta coefficient, companies operating in the industry were chosen. I took the levered beta of comparable firms and calculated unlevered beta of the firms using debt equity ratio calculated using market value of equity and book value of debt. The industry average unlevered beta was then levered with the debt equity ratio of the company. The beta coefficients for the comparable companies are shown below: Market Value of Equity Lever ed Beta Unleve red Beta 1.00 0.86 0.91 0.82 0.76 0.41 0.69 0.82 Wei ghte d Beta 0.04 0.17 0.19 0.09 0.05 0.02 0.06 0.21 0.82 0.92

Company Debt Name Value JK Lakshmi 70,26 Cement 90,322 7 1.51 1,372,1 214,2 Ultratech 46 87 0.95 Ambuja 1,763,6 16,57 Cement 96 0 0.92 India 198,8 Cement 351,673 78 1.13 Dalmia 238,8 Cement 197,816 26 1.37 Binani 140,7 Cement 148,366 80 0.66 Madras 246,3 Cement 295,201 45 1.07 1,814,6 56,69 ACC Cement 04 2 0.84 Industry Average Unlevered Beta Levered Beta for Shree Cement Ltd

D/E 0.78 0.16 0.01 0.57 1.21 0.95 0.83 0.03

Sales 141,302. 00 700,795. 00 704,070. 00 362,435. 00 212,005. 00 186,053. 00 286,586. 00 872,541. 00

Weig ht 0.04 0.20 0.20 0.10 0.06 0.05 0.08 0.25

Given the D/E ratio for Shree Cement is 0.20, the value of levered beta obtained from the bottom up approach is 0.93 which is close to the value obtained in the top down approach. I have decided to go with the beta obtained from the top down approach primarily because of the fact that Shree Cement is going to earn a significant chunk of its revenue from merchant power sales in future. None of the cement companies have a similar business structure. As the unlevered beta is 0.88, and levered beta is 0.998, it can be said that the unlevered beta captures the business risk of the firm while the difference between

levered and unlevered beta which is 0.118 captures the financing risk or risk due to leverage.

COST OF DEBT
The cost of debt is the effective rate that a company pays on its current debt. Since interest expense is tax deductible, we will use after tax cost of debt to calculate cost of capital. There are following options to calculate the cost of debt: Using the latest bond yields: If the companys bond trades in the secondary market, case of Shree Cement, none of the debt issued by the company trades in the secondary market. Synthetic Method: Since Shree Cement is a mid-size manufacturing firm, I used the tables given by Aswath Damodaran. The table showing the default spread along with the bond rating and interest coverage ratio is shown in the table below.

Based on the tables given, the spread between government bonds and companys debt is 0.75 percent for AA rating. The long term government bond yield is 7.89 percent. The cost of debt and spread are shown in the table below.

CARE has rated the debt issued by the company as AA or PR1+ which shows that the debt is of superior quality. The default risk for the debt is quite low.

COST OF EQUITY
The cost of equity is calculated using the CAPM. The key parameters and calculations for the CAPM are shown in the table below:

The market return was calculated as geometric mean of the monthly return on BSE 500 for the period between Jan 2005 and Feb 2010. Thus the cost of capital for the firm is 16.55%.

MEASURING INVESTMENT RETURNS

In this section, the quality of the firms projects and managers abilities to contribute to increasing the firms values has been analyzed. The analysis relies on the valuation of the returns of the projects based on accounting methods. In particular the return on equity (ROE) and the return on capital (ROC), which will be defined below, will be compared to the current cost of equity in the first case, and to the cost of capital in the second. This will enable us to determine whether the companies have excess returns over costs. ROE AND ROCE ANALYSIS The returns on equity and capital are widely used accounting measures of returns. They can be measured as: ROE= Net income/ Average Book value of equity The Return on Capital Employed is defined below:

The table and figure below show the ROE and ROCE for the firm between 2005 and 2010. Although the accounting returns such as the ROE and ROC are good indicators of a companys ability to create value, they tend to look at the past performance rather than to future prospects. The company has shown an increasing trend for both ROE and ROCE which reflect that the company has been able to select good and profitable projects for its investors. 2005 2006 2007 2008 2009 2010

Net Income Book Value Equity ROE (%) Capital Employed EBIT ROCE

2,906.5 9 of 35,292. 72 8.20% 72,391. 99 5,096.2 1 7.00%

1,840.3 9 35,098. 79 5.20% 87,696. 58 6,121.0 7 7.00%

17,700.2 3 50,377.9 6 35.10% 171,975. 48 17,794.4 0 10.30%

26,037.2 0 67,280.5 3 38.70% 248,340. 54 46,049.0 2 18.50%

57,796.9 4 121,001. 69 47.80% 339,034. 63 82,827.2 7 24.40%

73,646.1 3 179,840. 25 40.95% 490,618. 77 105,024. 26 21.41%

ECONOMIC VALUE ADDED

ROE and ROCE captures the accounting return to the investors but it does not take into account the opportunity cost of the capital used in the projects. To take the opportunity cost of capital in to account, Economic Value Added (EVA) is used. EVA is computed as the difference between ROCE and the cost of capital, multiplied by the capital employed. Additional value is created only if the ROCE exceeds the weighted cost of capital. EVA by a firm is calculated as follows: EVA = NOPAT Cost of Capital*Capital Employed EVA by the firm for 2010 is shown below. Cost Of Equity NOPAT Capital Employed EBITDA EVA 16.55% 86,555.56 490,618.77 162,067.24 5,358.15

STRUCTURE CHOICES
Capital structure refers to the way a firm finances it assets through a combination of equity, debt and hybrid securities. Thus, a firms capital structure is composition or structure of its liabilities. There have been a number of propositions regarding optimal debt structure of a firm. Most prominent of them is the one proposed by Modigliani and Miller which forms the basis for modern day theory on capital structure. As per MM proposition, in a perfect market devoid of any taxes and transaction costs, the firm value is independent of capital structure. Based on this proposition, the modern theories on capital structure are based which defines the factor affecting the firm value due to capital structure choices which states that a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs, taxes, information asymmetry, etc. This

analysis can then be extended to look at whether there is in fact an optimal capital structure: the one which maximizes the value of the firm. It is known that a Firm that use debt rather than equity benefits in two ways. First, the firm gets a benefit of interest tax shield since interest expenses are tax deductible, whereas dividends paid to stockholders are not. Second, Debt allows firms to impose discipline on mangers. Firms have to make regular payments to debt holders, and managers who choose to invest in poor investments increase the likelihood that they will be unable to make these payments. Therefore, value of levered firm will be higher than value of unlevered firm by the amount of present value of interest tax shield. However, debt has its own disadvantages as well. One of the major costs associated with debt is the bankruptcy cost. It can be defined as the increase in costs brought about due to the higher risk of bankruptcy on taking up more debt. It is expressed as a product of the probability of bankruptcy with the cost incurred as a result of bankruptcy. To evaluate the cost of bankruptcy, we compare the operating cash flows relative to the interest obligations of the firm. Another major cost associated with debt is agency costs. However, in case of Shree Cement, the agency costs are low since it is a family run business. The marginal tax rate faced by the firm is 33.99 percent which include 30 percent of corporate taxes and surcharges on tax. The company also gets tax deduction from the depreciation which helps to reduce the tax bite. The company enjoys high interest coverage ratios in the range of 10-11. In the last 2-3 years, the company has taken steps towards using the excess cash to set up power plants using waste heat recovery systems and other multi fuel boilers. This has helped the firm to become a seller of merchant power. The merchant power division enjoys high EBITDA margins (about 50 percent) mainly due to low cost of generation and high merchant power rates. This has helped the firm to give good returns to stockholders and also tackle the cyclicality of cement business. The firm has enjoyed high interest coverage ratios over the last few years. The cash flows generated by the company have been increasing over the years mainly due to robust economic development in the northern part of India which is the main market for the company.

CURRENT FINANCING MIX The table below describes the financing arrangements employed by the company. Type of Financing Share Capital Reserves and Surplus Shareholder Funds Amount Lakhs) 3,483.72 (INR

179,840.25 183,323.97

Secured Loans Unsecured Loans Total Debt

178,853.25 31,770.52 210,623.77

CURRENT COST OF CAPITAL

The current cost of capital is calculated based on the market weights of the debt and equity in the capital structure. The cost of capital with the current structure is obtained as 16.55 percent in the preceding sections. There are multiple techniques which can be used for finding the optimal capital structure of a firm. I have used the Adjusted Present Value approach for finding the optimal capital structure of the company. In this approach, the firm value at different debt levels is calculated by adding the present value of tax benefits from the debt to the unlevered firms value, and then subtracting the present value of expected bankruptcy costs. The debt ratio at which the firms value is highest is taken as optimal debt structure. I have used the template given on Aswath Damodaran website to do the required calculation as the template provides probability of bankruptcy at each debt ratio and the total cost of bankruptcy. The weights of equity and debt are based on market values in this calculation.

MANAGEMENT TRUST
The management performance in picking profitable investments can be gauged from the return on equity and return on capital employed. As noted in the previous sections, the management has been able to deliver significantly high ROE and ROCE in the last few years. The ROE and ROCE over the last few years have been significantly higher than the cost of equity and cost of capital of the firm. As noted in the previous sections, the company has significantly invested in merchant power generation capacity. The company expects to commission 565 MW of merchant power by FY 2012 out of which only 100 MW will be consumed for captive consumption. Since the power business is expected to be a high EBITDA margin business, the ROE and ROCE are expected to improve in the coming few years.

CHANGING DIVIDEND POLICY

On comparing the dividend policy with the recent FCFE and the kind of returns management is able to give over and above cost of capital we can trust the management and firm is paying reasonable dividend and managing the firm well. The firm is giving sufficient dividend vis--vis other firms in the industry. The firm

has carried out significant capital expansion in the last few years and this expansion is expected to continue for another two fiscals. Going forward, I believe that the firm should continue with the existing dividend payout for the coming two fiscals and can increase the dividend if there are no specific capacity expansion plans.

VALUATIONS
CASH FLOW CHOICE Shree Cement Ltd is expected to raise more debt in the Fiscal year 2011 (based on management guidance) to fund the capital expansion plan. The debt raised in 2011 is expected to be sufficient to fund the expansion plans and company is not expected to raise further debt or equity in the coming years. It implies that the leverage is expected to change over the forecasted period. Therefore, the valuation will be done using the Free Cash Flow to Firm (FCFF) approach. A three stage model is used for valuation. In the first stage, the free cash flows are calculated for next five years using the forecasted financial statements based on various assumptions. In the second stage, the cash flows are increased at a CAGR of 6 percent till 2020 and afterwards, a terminal growth rate of 5 percent is used. ASSUMPTIONS The various assumptions and their rationales are given below: The production volume is expected to reach 130 million tonnes per annum in FY2014 based on the capacity expansion plans chalked out by the management.

Gross realizations will decrease due to excess capacity in the market based on the projections done by ICRA. Merchant power sales will reach to 1.8 billion units by FY 2012 based on the generation capacity expansion plans. Realization per unit for power sales will decrease from current value of Rs. 6 per unit to 5.25 per unit by FY 2014. Excise duty will increase by 2 percent following the hike done by the government. Terminal growth rate is assumed to be 5 percent. Tax rate is assumed to increase gradually to 33.99% once the aggressive capex is over. Power and fuel expenses are expected to decline in 2010 due to lower fuel prices; however, it will increase again with the expected increase in fuel prices. Raw material prices are expected to remain low in 2010 due to low prices of pet coke, limestone, and gypsum. However, with economic recovery, the prices are expected to increase. Freight and selling expenses are expected to increase owing to increase in fuel prices Debt level is expected to increase to INR 1,660 crores in FY2010 based on guidance given by the management. The company is expected to spend INR 2,580 crores by FY2012 for capacity expansion based on guidance given by management.

Investments are expected to increase by 10 percent every year so as to manage huge cash balances generated by the company. The forecasted financial statements are shown below.

INCOME Sales Less: Excise Duty Net Sales Other Income

EX PENDITUR E

S OUR CESOFF UNDS S hareholders' F un Share Capital Reserves & Surp

Jain | Section B 29

L oan F unds Secured Loans

All figures in Rs. Lacs except Share Capital Reserves and Surplus Profit After Tax Dividend Payout Dividend distribution t Secured Loans Unsecured Loans Gross Block

All figures in Rs. Lacs except TOTAL SALES Sales Cement Sales Pow er Sales Other Income Interest Income As % of cash balance Others As % of Sales

RATIO ANALYSIS

Sales Growth yoy EBITDA Margins Operating Margins Net Profit Margins EPS Growth Payout Ratio
Valuation Ratios: 2010 2011E 2012E

Interest Coverage Ratio Return on Capital Employed

Liquidity: Shree Cement has a cash position of about INR 416 crores and investments of INR 1592 crores in its book at the end of FY2010. Though the company is on a capital expansion, it does not face a liquidity problem as of now. Moreover, the company has already achieved financial closure for all of its capital expansion plans and thus have comfortable liquidity situation Working Capital: Working Capital requirements for cement business are fairly moderate to low as WC constituted about INR 273 crores or 20 percent of the invested capital. Major input is pet coke and fuel cost. Inventory turnover days for the company is about 33 days (historical average) and average debtor turnover days is 8 days (historical average) Revenue Growth: The last 5-6 years have been exceptionally good for the cement industry owing to rapid economic growth leading to buoyant demand from real estate and construction sector. The company has also gained from common wealth games to be held in Delhi in 2010. The company has invested heavily in capacity expansion and is expected to ramp up its capacity to 13-13.5 mtpa by FY12-13. The company requires about 85 MW of power for captive usage. By the end of FY09, the company has capacity of about 120 MW which is expected to be ramped up to 565 MW by FY12 which will drive the revenue and help to avoid cyclicality of cement business

EV/EBIT DA P/E Ratio EV/Sale s

3.72 8.18 1.50

4.36 12.10 1.43

3.99 16.50 1.30

FREE CASH FLOW CALCULATION

Free Cash Flow Years Discount Factor PV of cash flows

Terminal Value Stage 1 Growth Rate (Till 2020) Perpetual Growth Rate Horizon Value in 2020 PV of Horizon Value Sum of Discounted Cash Flows Less Debt Value Implied Equity Value Shares Outstanding Per Share Price

6% 5% 1,638,460 .87 407,460.4 0 937,343.1 9 210,623.7 7 726,719.4 2 348.37 2,086.06

14,

11

RECOMMENDATION
The share price obtained from the analysis is INR 2086.06 which is 20.57 percent above the price observed on 28th February 2010. It implies that there is an upside of 20.57 percent possible in the stock price of the firm. So I assign Shree Cement Grade of 4/5 upside (1050% from CMP).

References
1. Annual Reports http://www.shreecement.in 2. Cement Manufacturers Association http://www.cmaindia.org 3. http://pages.stern.nyu.edu/~adamodar/