Kakatiya Cement Sugar industries Limited- Sitting pretty on two hottest sectors

Kakatiya Cement Sugar industries Limited

(Before we could stop being lazy and prepare a fancy detailed write-up to put on the blog – this stock has already gone up 20% - so publishing here the quick summary catching the key points )

Kakatiya Cement Sugar Industries Limited: CMP 264 ( 8^th Apr’16)

This company is slowly gaining limelight because of the spurt in price of close to 100% (from March 8^th price of 130 exactly 1 month back, while the Sensex remained flat during the same time). 

Here are my reasons what is behind this rally and what is there for future.

Without going much in detail, KCSIL is an almost 35 year old Telangana based company mainly operating in three diversified but synergistic sectors – Cement, Sugar and Power. They own the lease for limestone for cement production, Bagasse from sugar is used for power and power is used back in running Cement and Sugar Plants and also for external sales, creating excellent synergy and industry highest margins in all three businesses.

Expected financial performance:

The first 9 months performance of FY’16–

(all segment profit nos. are before tax)

Cement business made a profit of 20 crore on 70 crore sales. Power business made a profit of 11 crore on 24 crore sales. Sugar business made a loss of (14) crore on 77 crore sale in first 9 months.

Now let’s see what might happen in Q4’16 and financial year FY-17

Profits before Tax – INR Crore	First 9 months (actual)	Q4’16 ( expected)	FY’17 and onwards ( if cement and sugar priced remain firm)
Cement	20	10 (assumed same as last year Q4)	30 (Assumed same as previous year)
Sugar	(14)	14 (assumed no. based on price increase on existing sugar inventory & 20% profits on sugar sales)	20 (Assumed 20% net profit on sugar production of 30000 Tonnes roughly)
Power	11	9 ((assumed same as last year Q4)	20 (Assumed same as previous year)
Total	17	33	70

Notes:

1)      All segment profit nos. are before tax. After taking out an approximate tax element of 30% - FY’17 Profit no. should be close to 50 crore on most realistic basis.

2)      On an average, in sugar business assuming cost per quintal is 2900 and sales and market price of 3600 avg. A 20% profit on ex-mill price can easily be assumed.

3)      These are very high level rough estimates based on past results of the company and current trend; there can be some missing points.
4)   Q4 of last year cement business made a profit of 10 crore (last qtrs. are generally good for cement companies because of higher offtake and pent up demand from Q3 due to Monsoon etc.). We can expect similar profit for this qtr. too .(though prices for cement are much better and this should be more than 10 crore.
5)   Q4 of last year power business made a profit of 9 crore. Assuming no change in business, power profits also in Q4 should be same as of last year of 9 crore.
6)  Q4 of last year sugar business also made a loss of 14 crore. – Here is the catch- during last year Q4 sugar prices were at multi-year low and all the mills were bleeding. For Kakatiya, the last year Q4 Company’s sugar sales were negligible (suggesting that they didn’t sell on losses and were holding inventory as they are cash rich and not required to sell inventory at loss to pay for farmers or to repay loans – the last year Q4 loss in sugar division might be because of loss coming from lower price of closing stock). However this year Q4, the sugar prices have been up almost 50% since then, and Q4 sugar profits should be enough to set-off the 14 crore loss on sugar business from first 9 months.

Straightaway taking out the tax 30%, still net profit for FY’16 could be 50 crore less 30% tax = 35 crore and FY’17 onwards its 70 crore less 30% tax = 50 crore. Compare this to the current mcap of 200 crore , just 4 times of Net profit !!

Enterprise Value and Asset Value: Even compared to other sugar stocks with horribly distressed balance-sheet loaded with debt and negative net worth, this company is at zero debt ( a nominal debt of 34 crore is against FD). The current Enterprise Value is equal to its market cap of only 200 crore as there is no debt. Now look at the valuation gap- from Asset value perspective  - its cement capacity of around 3lac tonne itself will be close to 30M USD based on the benchmark valuation of 100$ per Tonne ( Ultratech recently paid USD125 per ton to acquire Jaypee's cement  business) . This itself is 200 crore. Add to it the sugar and power plant (a replacement cost 125 crore for sugar capacity of 3200 tcd and 85 crore for 17MW power plant – a rough estimation). This makes it a 435 crore asset value company on a purely plant value compared to 200 crore Mcap/Enterprise value.

Operating efficiency – One thing which is very impressive and distinguish it from rest of the sugar and cement companies is the superior operating efficiency. Their cane to sugar conversion ratio is close to 10.5% which is best among industry. Similarly, The EBITDA per Tonne of Cement is above Rs. 1,000 which again is among industry highest. Power business also operates at a margin of 50% almost (presumably because the fuel comes from sugar plant).

Management and track record – The consistent track record and excellent operating records speaks volumes about excellent management quality and in its last 35 years of history nothing could be found to doubt about the integrity and commitment of management.  Company has maintained a 17 year unbreakable good dividend paying track record. Also, it is clear that this company has proved itself as very efficient in capital allocation in business (this is the first principle Warren Buffet looks at while analyzing a company) and it is expected that the company will continue to use its surplus profits for expansion of capacities profitably.

Technicals : If you think the price of this stock has gone up very high, just to highlight that this is a 10 year breakout with a very large volume. Only to give a perspective, the stock is currently at 265 compared to its 52 week low of 93. This is nowhere compared to all sugar stocks with extremely pathetic Balance-sheet and all are currently quoting at more than 6-7 times of their 52 week low.There are hardly 30 lac floating shares available in market and only 22 lac shares in Dmat form. The limited float is going to only help in sustaining higher price. Also the company gets a unique advantage because of presence in both Cement and Sugar sector. The stock attracts buyers when sugar sector is bullish, prices remain firm when cement is bullish and also the price goes up when both are bullish.

Summary : Kakatiya is a clear re-rating case due to sustained revival in sugar and cement sectors and a 10 year breakout with very huge volumes – in a conservative scenario , given the momentum & sectoral revival in sugar and cement sectors , in short term itself the company can easily command a 400 crore mcap ( Price per share of 550 on 77 lac issued shares ). If the profit nos. for Q4 and FY’17 next year actually translate into as projected above, the company should command a standard PE of 13-14 due to:

-          - High sustained margins,

-          - Management track record and consistently delivering good nos.

-          - Consistent dividend payment record.

-          - No debt.

-          - Diversified sectors of business and less business risk

This will make it a 50 crore profit* 14 PE: which is 700 crore Market cap company (translating into a price per share of approx. 900). Of course this will prevail if all remains well with the Sugar and Cement sector, and company continue to do well. The icing on the cake will be if company announces bonus as its reserves are very high and can be a good bonus candidate. Apart from this, due to high profits and management track record of delivering highly efficient business - company will continue to use its surplus profits for expansion of capacities profitably – therefore this company can be made part of long term portfolio as well for consistent value creating. The current price rise has only confirmed that the stock is finally discovered by value investors and is going to move fast. We will not be surprised if this stock turns out the stock of 2016. 


[We all are part of this wealth creation and would love to hear your comments, healthy arguments, doubts, queries, correction or any suggestion are invited]