Time to consolidate: Ultratech Cement

Investors with a long-term horizon wanting to ride the fortunes of the Indian cement industry can accumulate the stock of Ultratech Cement. It has footprints in all five regional markets and is either a market leader or a number two player in four of them. There are signs of the capex cycle peaking — this could improve capacity utilisation. Two consecutive droughts and lower global agricultural prices had affected rural income.

A normal monsoon predicted by IMD this time along with increased allocation for rural housing schemes, could help the cement industry clock volume growth of 7-9 per cent levels over the medium term.

At the current market price of ₹3,162, Ultratech’s enterprise value per tonne (EV per tonne) is $162, after consolidating Jaypee Cement’s assets. This is slightly higher than its replacement value as well as five-year average. ACC and Ambuja Cement, in contrast, are quoting either at replacement value or lesser. The stock’s price-earning multiple of about 39 times is also slightly higher than the five-year average of about 38 times.

But given Ultratech’s leadership position and strong balance sheet, investors with a long-term view can start accumulating the stock.

Ultratech Cement has a capacity of 68 million tonnes per annum (mtpa), accounting for 17 per cent market share. After the acquisition of Jaypee Cement, its overall capacity will increase to about 89 mtpa, bringing it closer to its 100 mtpa target. It is a market leader with ability to impact prices in different markets.

In the last decade, doubling of cement capacity had resulted in excess supply. Industry capacity utilisation is currently at a multi-year low of 65 per cent. However, there are signs of the capex cycle peaking.

Demand-supply balance is expected to improve gradually over the next three years with slower pace of capacity addition as well as likely improvement in demand. The industry added 70 million tonnes in the last three years. However, during FY2016-18, capacity addition would reduce to 32 million tonnes while incremental demand is expected to increase to 50 million tonnes. This would give players the opportunity to sweat assets and improve profitability.

Cement consumption has historically had a strong linkage to GDP growth (1.2x times). This, in effect, means the industry could clock 7-9 per cent growth over the long term. The past three years were disappointing though, with volume growth in the range of 3-5 per cent. Cement prices were also down 6 per cent for the financial year 2015-16 to ₹272 per 50 kg bag. However, there are initial signs of pick-up in cement demand with volumes rising 9 and 13.5 per cent in January and February 2016, respectively.

 The demand for cement comes from three sources — housing (60-65 per cent), commercial and industrial investments (20 per cent) and infrastructure (15-20 per cent). Cement demand has been poor from all the three sectors in the past few years. The rural market contributes to a a chunk (about 40 per cent) of overall cement market volumes in the country.

An expected good monsoon as well as strong government push for the rural sector should improve rural income over the next few years. The Budget has increased allocation for the IAY (Indira Aawas Yojana), PMGSY (Pradhan Mantri Gram Sadak Yojana) and MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act) that have the potential to further improve cement demand.

The company’s revenue grew 12.5 per cent in FY15. Its sales in FY16 grew at a slower 5.1 per cent year-on-year to ₹25,281 crore, dragged by falling realisation.

North and West — the two biggest markets for Ultratech accounting for 52 per cent of sales — witnessed a 16-17 per cent fall in cement prices in 2015-16.

Net profit in FY16 however, improved to ₹2,287 crore, registering 9 per cent growth year-on-year. This is higher than the 4.4 per cent growth registered in 2014-15.

On account of acquisition of the Gujarat units of Jaypee Cement in June 2014, the figures for FY16 are not strictly comparable to the previous year.

The company’s debt-to-equity ratio is 0.5 times. After takeover of the Jaypee Cement business, the debt-equity ratio would rise to 0.6 times.