UltraTech Cement (ULTC.BO) Sell: Cement Prices Have Downside Risk Citi

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UltraTech Cement (ULTC.BO)
Sell: Cement Prices Have Downside Risk
 Await correction — We raise TP to Rs1,000 (from Rs985) based on Sep12
(rolling forward from Mar12) adj. EV/t of $120. At our revised TP, UTCL would
trade at an EV/EBITDA of 7.7x; P/E of 14.8x. The stock has gained due to recent
price hikes (largely on the back of volume cuts), and further hikes could lead to
trading opportunities. However we maintain Sell as there are downside risks due
to surplus capacity/cost pressures. UTCL (at $137/t) is not cheap, and all else
being equal, we could become constructive when valuations dip below
replacement costs (US$120/t). We prefer Grasim for exposure to UTCL.
 Revising estimates — We do some catching up and raise PAT estimates by
46% for FY12 and 26% for FY13. This change incorporates: 1) higher prices to
reflect current trends (our average prices are 4% higher than previous
estimates); 2) lower costs than we had anticipated; 3) a reduction in volumes by
4-5%. We now assume realizations rising 11% yoy in FY12 (vs +3% earlier) and
continue to expect a marginal 2% yoy increase in FY13.
 Continued cost pressures — Costs such as coal and freight continue to be a
key issue for the cement industry. About a third of UTCL’s coal is imported and
we expect continued uptrend in international prices, which we expect will rise
from US$125/t in FY12 to US$148/t in FY14. Additionally domestic coal linkage
prices (a third of usage) have been hiked by Coal India by ~30% in end-Feb, with
a commensurate increase in the price of e-auction coal (~18% of usage).
 India's largest cement company; expanding further — UTCL plans to further
hike its capacity in India by 9.2mtpa (from 49mtpa to 58mtpa) – 4.8mtpa in
Chhattisgarh and 4.4mtpa in Karnataka at a capex of Rs52bn (~$120/t).
Additional capex of Rs59bn ($1.2bn) will be spent on logistics, power,
modernisation and RMC capacity. UTCL targets completion by FY14, but we
assume completion only by FY15.
 Low margins for international cement business — In Sep 2010, UTCL
acquired controls of ETA Star Cement: 2.3m tpa clinker capacity in UAE, and
grinding units in UAE (2.1mtpa), Bahrain (0.4mtpa) and Bangladesh (0.5mtpa).
Despite sluggish demand trends, ETA Star operates at 85-90% utilization, but
profitability is poor at EBITDA/tonne of Rs100-150/tonne.
 Upside risks — Higher prices; capacity delays; better-than-expected demand.
UltraTech Cement
Company description
UltraTech Cement (UTCL) is India’s largest cement company and incorporates the
cement businesses of the Aditya Birla group. UTCL’s merger with Grasim’s cement
division (Samruddhi) wef 1 July 2010 gives it total grey cement capacity of 49mtpa.
Its acquisition of ETA Star Cement in September 2010 has taken its capacity to
52mtpa. UTCL plans to hike its capacity in India by 9.2mtpa to 58mtpa) taking
overall capacity to 61mtpa by FY14/FY15 at a capex of Rs52bn ($120/t). A further
Rs59bn ($1.2bn) will be spent on logistics, power, modernisation and RMC capacity.
Based on its capacity for FY11, its market share was ~17%. Its markets are well
spread out, and it sells 30% in north India, 29% in west, 20% in south, 19% in the
east and 2% in the export market. UTCL also has 0.6m tpa of white cement
capacity, RMC plants with a total capacity of 10.4m cubic mtrs, and ~500 MW of
captive thermal power capacity. ETA Star Cement (3m tpa of capacity) has
operations in UAE, Bahrain and Bangladesh. ETA Star Cement operates at 85-90%
utilization levels but profitability is poor at ~Rs100-150/t. In India, ULTC is known for
the consistent high quality of its cement, and manages to earn a premium price over
other cement brands in several markets. Grasim owns 60% of ULTC.
Investment strategy
We rate ULTC as Sell/Low Risk (3L) with a target price of Rs1,000. Cement
producers have cut volumes and artificially boosted prices citing various factors
(sluggish demand/transport bottlenecks/shortage of rail capacity). This volume cut
has helped producers raise prices over the last few months by 9-27% since the lows
of Jun11 to compensate for lower volumes/rising costs. However the Indian cement
industry remains oversupplied (with at least 10% surplus until FY14) and
fragmented (~30 companies; top 5 control 51% of capacity) – and hence cement
prices have downside risk. While the recent price hikes have been positive, (and
further hikes could lead to trading opportunities) there are downside risks due to
surplus capacity/cost pressures. UTCL (at $137/t) is not cheap, and all else being
equal, we could become constructive when valuations dip below replacement costs
(US$120/t). We prefer Grasim for exposure to UTCL.
Valuation
We use EV/tonne to value ULTC, a common metric used to value cement
companies. We set our target price at Rs1,000, in line with current trends in
replacement cost of US$120/t. We value ULTC in line with replacement costs
(rather than at a discount) as long term cement demand growth is expected to be
robust and new capacity creation is slowing down. Our target price of Rs1,000
equates to an EV/EBITDA valuation of 7.7x and a PE of 14.8x.
Risks
We rate ULTC as Low Risk in line with our quantitative risk-rating system, which
tracks 260-day historical share price volatility. Key upside risks to our target price
include: (1) Continued pricing strength; (2) Delays in capacity; (3) Higher rates of
demand growth.