UltraTech Cement: All set to grow

The stock of UltraTech Cement is up 19 per cent since our buy call in May 2016. At ₹3,762, it quotes at a premium to its peers — Ambuja Cements and ACC. Its enterprise value per tonne of $209 is higher than the replacement value of $150 per tonne. Among the large-cap cement stocks, while Ambuja Cements quotes at an enterprise value per tonne of $200, it is $114 and $296 for ACC and Shree Cement respectively.

However, this premium for UltraTech Cement is justified, given its huge scale of operations and market leadership in four of the five big markets in the country. The stock quotes at a price to earnings ratio of 38 times, which is in line with its three-year average. Moreover, the company is best placed to benefit from the demand recovery in the cement sector. Investor with a two to three-year perspective can buy the stock.

In the December 2016 quarter, UltraTech’s volumes were down by 2.3 per cent Y-o-Y to 11.7 million tonnes (mt), which were slightly better than the industry average. The company benefited from its expanding footprint that balanced out the diverse trends of the regional markets. In the South, volumes were up in double-digits on a Y-o-Y basis, while they wereup by about 5-6 per cent in the East.

These two markets comprise 40 per cent of the company’s sales. Higher infrastructure-led investments boosted volumes in these regions. Moreover, the South was relatively lesser affected by demonetisation than the North. In contrast, volume growth in its other markets — North and West — were down by 8 per cent and 4 per cent respectively.

The company managed to beat the slowdown through higher institutional sales and improvement in market share. While the demand from the individual housing business took a hit from demonetisation, especially in the tier 2 and 3 cities, that from institutional sales improved. The company does about 70 per cent of its sales through institutions which mostly have non-cash transactions.

The company’s capacity utilisation was at 67 per cent at the end of December 2016 as against 60 per cent for the industry. At the industry level, capacity utilisation is bottoming out with demand expected to exceed supply in the next three years.

With capex cycle almost over for the industry, only 21 mt of cement manufacturing capacity would be added over the next three years as against incremental demand of 59 mt, as per industry estimates. This will add to operating profits for the company when capacity utilisation improves. The company recently announced its greenfield project at Dhar, Madhya Pradesh; about 3.5 million tonnes (mt) of capacity would be added at a cost of ₹2,500 crore. The plant will commence operations by March 2018.

This along with the pending acquisition of JP Cement will take the overall capacity of the group to 95 mt. The company is awaiting the NCLT (National Company Law Tribunal) hearing scheduled on February 15 to conclude the acquisition. On completion, its overall market share in the country would improve from the 18 per cent currently to 22 per cent.

Moreover, the southern markets, especially Telangana and Andhra Pradesh, are reporting double-digit growth in volumes triggered by investments in infrastructure and irrigation. And, with larger thrust to infrastructure and rural income in the recent Budget, cement volumes are expected to improve.

In 2015-16, the company’s sales were up 5 per cent Y-o-Y to ₹25,551 crore. While volumes were up by 8 per cent, prices were down by about 3 per cent.

For the nine months ending December 2016, sales remained flat Y-o-Y at ₹20,536 crore, while net profit was up by 20 per cent to ₹1,989 crore.

Power and fuel costs, which were down by 10 per cent, boosted profitability. During the year, the company changed fuel mix in favour of petcoke (currently 78 percent) as against coal to save on costs.

In the December 2016 quarter, when demonetisation took place, sales were down by 1.4 per cent to ₹5,927 crore while net profit was up by 5.1 per cent to ₹595 crore. It managed to improve its operating margin, up by 51 basis points Y-o-Y to 18.9 per cent largely due to lower power and freight costs. Also, tax expenses — were down 27 per cent Y-o-Y . The debt-to-equity ratio is at manageable level of 0.5 times.