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UBS Investment Research
UltraTech Cement
Biggest cement firm, but looks fully valued
„ Largest India cement firm; trading at 20% premium to replacement cost
UltraTech Cement (UltraTech) is India’s largest cement company, with a domestic
capacity around 49mt (with plans to expand its capacity by 25mt over the next five
years) and a well-diversified exposure across various regions. It is also a leader in
cement value-added products. We initiate coverage with a Sell rating and a price
target of Rs1,030. The stock is currently trading at more than a 20% premium to
replacement cost and we believe at current valuations the risk reward is not
favourable.
„ We are cautious on the India cement sector in the near term
We believe sector profitability will be under pressure due to 1) over-capacity until
FY12 (led by large capacity additions), and 2) increasing industry fragmentation
that will likely impact pricing power. Although we expect industry utilisation to
bottom-out in FY11, we expect operating rates to remain weak at about 85% in
FY12. Recovery will be gradual, in our view, and even a demand surprise in
FY12E is unlikely to help.
„ Coal price rise might impact earnings as low-cost inventory is exhausted
UltraTech imports about one-third of its coal requirements. International coal
prices have been on an uptrend and UltraTech’s low-cost historical coal inventory
will likely suffice only until FY11. Hence, increased coal prices will impact from
FY12E onwards. We forecast FY11/12/13 EPS of Rs49.3/73.0/83.8.
„ Valuation: Rs1,030.00 price target based on a target EV/EBITDA multiple
We value UltraTech on a target one-year forward EV/EBITDA multiple of 6.5x, in
line with other cement companies.
Investment Thesis
UltraTech is India’s biggest cement company and the eighth-largest globally. Its
total capacity is around 52mt, comprising 49mt domestic capacity and 3mt
overseas capacity (in Bangladesh, Bahrain and UAE). It is also a leader in valueadded products, such as white cement, wall-care putty, and ready-mix concrete.
UltraTech intends to expand its capacity by 25mt in the next five years and has
already announced brownfield expansion projects of 9.2mt, to be commissioned
by FY13. It has a pan-India presence, with well-diversified exposure across
various regions. This helps protect its average realisations from region-specific
issues. It also has a strong brand name that leverages on its group identity.
In the near term, we are cautious on the cement sector as we believe profitability
will be under pressure. Although we expect industry utilisation levels to bottom
out in FY11, recovery will be gradual, in our view, with operating rates
remaining weak at about 85% in FY12E. Pricing power is also likely to be
impacted in such a situation, as industry fragmentation is increasing across
regions.
The stock is currently trading at an EV/T of about US$144/t or more than a 25%
premium to replacement cost. We believe that given the industry outlook over
the next 12 months, the risk-reward is not favourable at current valuations and
we initiate coverage of UltraTech with a Sell rating and a 12-month price target
of Rs1,030. We base our price target on a 6.5x one-year forward EV/EBITDA
multiple.
Key catalysts
Industry over-capacity to keep profitability under pressure
Although industry over-capacity should bottom out in FY11E, the recovery is
likely to be gradual, and we expect FY12 industry-wide operating rates to
remain weak at around 85% (below the historical average). We expect margins
to remain under pressure and believe the downside risks to our estimates are
greater than the upside risks.
Industry fragmentation increasing across regions, impacting pricing power
Most of the capacity additions across regions are by smaller cement companies,
or those not among the top five in each region. This should increase competitive
intensity impacting pricing power in the industry
Higher coal prices to increase costs
A big risk to earnings comes from higher input costs—particularly coal prices
and freight costs. UltraTech currently imports about one-third of its coal
requirements. We expect imported coal costs to rise about 20% in the next two
years for cement companies (in line with UBS estimates for coal prices). Coal
prices rose about 40% in H1 and the beneficial impact of UltraTech’s historical
low-cost inventory is likely to wane by the end of the year. FY12 earnings could
hence be impacted by higher coal prices as UltraTech might not be able to pass
on the entire cost increase amid industry over-capacity. Further, diesel prices
rose about 15% in H1, this should impact freight costs.
Overseas ambitions a burden on resources
UltraTech has recently taken management control of ETA Star Cement (3mt
capacity), which has cement plants in UAE, Bahrain and Bangladesh. UltraTech
intends to establish a strong presence in the Indian Ocean rim. This is in line
with the group’s strategy of enhancing its global presence. However, as the
company plans to expand its capacity in the domestic market, we believe its
overseas ambitions might put an additional strain on its financial and
organisational resources.
Risks
We believe the key downside risks for UltraTech are: 1) a demand-supply
imbalance in the industry that is likely to continue in FY12 and keep
profitability in check; 2) lower realisations in its key markets of South and West
India (the South has the maximum over-capacity and South-India-based
companies are supplying to the West, which is also impacting realisations in that
region); and 3) high investments in acquiring capacity overseas that might put a
strain on its organizational resources. Key upside risks, in our view, come from:
1) cement price increases due to execution delays in the capacity expansion
projects of other companies that would keep supply in check; and 2) premium
valuations for UltraTech given its size, scale and regional diversification.
Valuation and basis for our price target
We base our price target on an EV/EBITDA multiple of 6.5x—the average
multiple at which Ambuja Cements (Ambuja) traded in FY01-05 (average
utilisation levels of about 90% during this period with an average price increase
of about 2-3% pa, broadly in line with our expectation for FY13). We use
Ambuja as a reference to value other cement companies as its valuation has been
more stable than other companies, such as ACC (its multiples have been high
because of takeover speculation in the past) and India Cements (its valuation has
fluctuated because of high debt levels and losses in the past). At 6.5x
EV/EBITDA (one-year forward) we arrive at a price target Rs1,030 for
UltraTech.
UBS versus consensus
Our estimates are higher than consensus (Bloomberg) likely because: 1) some of
the estimates that comprise consensus do not reflect the impact of the Samruddhi
merger, 2) a large part of consensus has not yet factored in the ETA Star Cement
acquisition to estimates; and 3) our cement price realisation estimates are higher
than consensus.
Sensitivity analysis
The results of our analysis suggest that a 1% higher increase in prices than our
assumptions in FY12 and FY13 would increase our valuation by 6% and a 1%
higher increase in volumes than our estimates in FY12 and FY13 would increase
our valuation by 1%.
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