NCL Industries – Resumption of growth?

About The Company:
NCL Industries (NCL – Nagarjuna Cements Ltd) started in 1984 is a predominantly-cement company with its Cement plants in AP & Telangana. They have other business segments, but the revenue contribution from other segments is not meaningful.
It has five business segments –
1. Cements (81.56%)
2. Boards (11.86%)
3. Ready mix concrete (5.71%)
4. Energy (0.82%)
5. Prefab (0.05%)
Cement has been their mainstay and even if we look at the average revenue contribution for the last five years, the average is about ~80% from cements segment. Their sales is predominantly through the retail network, and their current dealer numbers stands at about 1500 dealers. As with any retail oriented business, they collect deposits from these dealers(interest payable @ 6%) before enrolling them.

Capacity:
They have a total of 2 million ton capacity. Capacity utilization for Q12016 was about 62%. This # looks optically low because NCL had shut down its plants during the first quarter to take up repairs and maintenance. (Per the company MD, they weren’t able to take this up during the last 2 years as they were facing difficult times financially). The company is looking at 75% capacity utilization for the full FY2016.

Here is a snapshot at their numbers for the last 5 quarters: (Sourced from Screener.in)

Here is a snapshot at their numbers for the last 5 years: (Sourced from Screener.in)

AP Cement Industry in FY14 & FY15:
Andhra Pradesh’ total cement capacity currently stands at 15 MT. Cement industry in the erstwhile AP underwent demand compression as political unrest, and societal disturbances due to bifurcation of the state, took a toll on the construction activity. As a result, Cement companies in this region, had sub-par capacity utilization for FY 15, & FY 14. As a result of this, there was a significant negative impact on cement demand, and hence cement companies from this state – Sagar Cements, Deccan Cements, KCP & NCL had a tough time in these two financial years. During these two years, the B/S of these companies worsened, and there was no incremental capacity addition in these two years.

NCL in FY14 & FY15:
NCL has a ~ 13.33 market share by capacity in AP. Due to the reasons discussed above, NCL reported poor set of numbers(refer to the above table) and in fact it was unable to service the interest obligations, and the company went into CDR – Corporate Debt Restructuring. It restructured its entire outstanding debt on July 2013(except 7.23 crores), to be repayable in 28 quarterly instalments starting from March 2014.

Current state of the AP Cement Industry in FY2016:
Now with bifurcation of the state over, construction activity has started picking up and as a result of which, Cement demand & prices have started improving. Please refer to the MOSL report which shows the price trends of cement prices in South. All the cement companies in this region have started reporting better numbers. -> The current cement price stability/improvement is attributable to absence of capacity addition in above 2 years & also due to inability of these companies to add capacity as their balance sheets were battered. (classic case of demand vs supply equation)

NCL in Recent Quarters:
NCL has turned around last september, and the full impact of the demand and improved prices are visible in the performance of NCL in the last 2 quarters. In the current quarter, their topline grew 65% and the company reported an operating profit of 39.14 crores. NCL also took up repair works in the last quarter which impacted their capacity utilization. Promoters recently infused capital by having a preferential issue of 17,95,455 shares, as per the terms of CDR.

CMP – 90
EPS TTM(Diluted) – 13.2
P/E – 6.89
EV/Tonne – Rs. 2600/Tonne(or ~$40/Tonne)

If the cement prices were to remain stable at the current levels in AP, and if NCL has a 75% capacity utilization as guided by the management, we are looking at ~ 4PE (at CMP) at the end of FY16.

The above #s were the key reason why this stock interested me. At a P/E(TTM) of ~7 and EV/Tonne of about ~$40, there is a reasonable Margin of Safety. But, what could make a mockery of this MoS? Here are some risks:

1. Cement price correction in AP – The probability of this risk materializing is low for now as the below articles show that cement demand is still intact in AP. This demand scenario might turn very quickly if many of Central + State government’s projects turn out to be mere announcements. – A case in point being smart-city project which is yet to take-off.
   http://www.thehindubusinessline.com/companies/cement-sector-upbeat-as-telangana-ap-set-to-buy-3-million-tonnes/article7562242.ece – This article highlights the government’s(AP + Telengana) intention to procure 3 MT of cement.
   http://www.motilaloswal.com/site/rreports/HTML/635756587693471670/index.htm – This article highlights the price trends in South.

2. Company’s culture of funding growth through debt – NCL historically has been a company which has been reasonable levered. In one of the recent interactions, management had commented that it was looking at getting out of CDR by July this year. Apparently they decided against this. A company in CDR, faces a lot of restrictions/controls on capacity expansion, imposed by the lenders. NCL wanted to expand capacity but they were unable to do so, as they are currently in CDR. – This is a big risk to me as the culture of taking debt to fund growth is detrimental.

@NikhilJain, I liked this pick after you had commented in one of the other threads that you were taking positions in this. This is a quick attempt at explaining the stock story – Please cover any opportunities/risks that I may have missed out.

Thanks,
Ravi S
Disclosure – Invested, My views may be biased. Please do your due-diligence.