JPMorgan: UltraTech Cement - Strong quarter as expected, driven by volume growth (strongest y/y in ~ 3 years); large PAT beat due to lower tax rate

UltraTech Cement Ltd (UTCEM IN) Strong quarter as expected, driven by volume growth (strongest y/y in ~ 3 years); large PAT beat due to lower tax rate		Neutral Price: Rs2,169.70 23 Apr 2014 Price Target: Rs1,560.00 PT End Date: 31 Dec 2014

UTCEM reported strong 4Q FY14 results driven primarily by 9% Y/Y volume growth (higher than JPMe) and 4% Q/Q decline in operating cost/MT (vs. JPMe of flat cost/mt q/q). EBITDA for the quarter of Rs12.7B (-1% Y/Y; +60% Q/Q) was 7% ahead of JPMe and 9% higher than consensus. PAT for the quarter at Rs8.38B (+15% Y/Y; +127% Q/Q) was sharply higher than our and consensus estimates due to a lower-than-expected tax rate (14% vs. 9M FY14 of 28% and JPMe of 28%).

· Strong volume growth drove EBITDA beat…: UTCEM reported 4Q FY14 EBITDA of Rs12.7B (-1% Y/Y; +60% Q/Q) ahead of JPMe of Rs11.9B and consensus of Rs11.7B. EBITDA/T stood at Rs1044/T (-9% Y/Y, +31% Q/Q), while EBITDA margins stood at 21.3%. The strong earnings were driven by volumes with 4Q volume growth at 9% Y/Y, the highest in ~3 years. Implied blended ASP/T actually was flat q/q but cement realization were up 1-2%, which was lower than our estimate of a ~4% increase Q/Q. The large volume growth in our view does not reflect total industry demand revival but was more likely driven by market share gains, especially in North India, as one industry participant (Binani Cement, Unlisted) had to shut down operations (they are yet to re-start). Results also benefited from an across the board cost decline q/q, with operating cost/t falling ~4% q/q mostly driven by higher volumes q/q.

· …while sharply lower tax rate drove large PAT beat: Reported PAT stood at Rs8.4B (+15% Y/Y; +127% Q/Q) vs. JPMe of Rs6.5B and consensus of Rs6.4B. The large PAT beat was driven by a sharply lower tax rate (reported 4Q tax rate stood at 14% vs. 27% in 3Q FY14) as the company saw reversals of earlier provisions. The company announced DPS of Rs9 for FY14 implying a payout ratio of 12%. Net debt was Rs8.6B vs. net cash of Rs1.6B in Sep-13.

· How sustainable are the current strong earnings? In the near term, this would depend on whether the shut capacity re-starts quickly or not: The cement market in North and West has benefitted from Binani’s shutdown leading to higher volumes and realizations for incumbents. We are positive on the demand cycle recovering over the next two years, but this is likely to be back ended, in our view. Therefore, for the current quarter trend of strong earnings to continue into FY15E, the industry (particularly in North and West) would need to see continued restrained supply. This is difficult to predict given the dependence on the court process. Valuations at ~$170/T EV/T, ~10x EV/EBITDA (FY16E) are nearly at multi-year peaks.

· Update on projects: UTCEM during the year commissioned clinker unit of 3.3MT and cement mill of 1.5MT at Karnataka. UTCEM also commissioned power plants across AP (25MW), Chhattisgarh (30MW) and a 1.6MT cement mill in Odisha, taking total year end capacity to 53.95MT. The company commented that a total of Rs100B has been earmarked for the current round of capex, which would be commissioned in a phased manner by 2015.

· Update on JPA Gujarat plant acquisition: On the acquisition of JPA’s Gujarat unit, UTCEM highlighted that the transaction has been approved by the shareholders, creditors of JCCL and UTCEM, the Bombay High Court, and the Allahabad High Court. The Competition Commission has also approved the proposed transaction and now awaits final approval of SEBI.

· Our earning estimates are currently under review.

Table 1: UTCEM: 4Q FY14 results summary

Rs in millions, year-end March

	4QFY13	3QFY14	4QFY14	% y/y	% q/q
Net sales	54,720	48,179	59,599	9%	24%
Dec / (inc) in stock	257	190	589	129%	211%
Raw material consumed	7,613	7,198	8,229	8%	14%
Purchases of finished goods	625	781	916	47%	17%
Staff Cost	2,609	2,443	2,352	-10%	-4%
Power and fuel	10,559	10,023	11,869	12%	18%
Freight	11,955	11,193	13,655	14%	22%
Other expenditure	8,280	8,394	9,279	12%	11%
Total expenditure	41,899	40,222	46,888	12%	17%
EBITDA	12,821	7,956	12,710	-1%	60%
Interest	478	905	739	55%	-18%
Other income	1,005	681	577	-43%	-15%
Depreciation	2,460	2,645	2,785	13%	5%
PBT	10,888	5,088	9,764	-10%	92%
Tax	3,626	1,391	1,384	-62%	0%
Net profit (loss)	7,262	3,698	8,380	15%	127%
Sales cement	11.13	9.98	12.18	9%	22%
EBITDA %	23.4%	16.5%	21.3%
Tax rate	33%	27%	14%
Realization/MT	4,842	4,796	4,788	-1%	0%
Operating cost/MT	3,765	4,030	3,850	2%	-4%
EBITDA/MT	1,152	797	1,044	-9%	31%

Source: Company reports and J.P. Morgan estimates.

Figure 1: UTCEM: ASP Trend and % yoy change (RHS) Source: Company reports.

Figure 2: UTCEM: Volume (mt) and % yoy change (RHS) Source: Company reports.

Figure 3: UTCEM: Quarterly EBITDA/Mt (Rs/MT) and % yoy Chg

Source: Company reports.

Investment Thesis

UTCEM has re-rated significantly over the past two years and is now at a significant premium to replacement cost and, more importantly, earnings metrics are at multiyear highs, even as underlying profitability remains steady. The Indian cement industry continues to witness oversupply, with low demand trends and entry by new players leading to volatile pricing environment. While we think the expansion plans are positive for long term investors, in the near term muted industry volume growth would likely weigh on the company.

Our Neutral rating is primarily a valuation call given the stock’s 13% decline over the last three months (vs. SENSEX down 4% over the same period), coupled with an expected improvement in earnings in FY15-16E.

Valuation

Our Dec-14 PT of Rs1560 is based on 7.5x FY16E EV/EBITDA. Our target multiple for UTCEM is at the high end of the company’s trading range given the continued strong underlying profitability.

Risks to Rating and Price Target

Key upside risks include 1) strong pick up in cement demand, 2) lower coal and other costs, and 3) better-than-expected realizations.

Key downside risks include 1) further decline in demand, 2) lower utilizations with capacity additions not supported by demand, and 3) large scale overseas acquisition.

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