UltraTech cementing future growth

Increasing capacities will help gain market share, improve geographical presence and drive volumes

UltraTech’s recent announcements on capacity addition have surprised many on the street, given the muted demand environment. But it is not significantly different from the past, when it continued expanding capacities even during tough times. While the capacity plans reflect the company’s confidence over its long-term prospects, the expected recovery in cement demand and margin trends are key factors the street will be monitoring.

Focus on growth, reach 

UltraTech announced setting up a 3.5-million-tonne (mt) cement plant in Pali, Rajasthan, estimated to start production by June 2020. Earlier, in the September quarter, it had announced an integrated 3.5-mt cement plant in Dhar, Madhya Pradesh, which is to commence production in the March quarter of 2019. These moves come shortly after the country’s largest cement producer, in the September quarter, completed acquiring 21.2 mt of JP Group’s cement assets, all of which reflect its appetite to grow organically and through acquisitions.

Analysts say the expansions are necessary for driving volumes, geographical presence, and market share. For instance, the Pali expansion will cater for the markets in western Rajasthan, where UltraTech does not have a significant presence, whereas the Dhar project is also targeted to enhance its central India presence (catering for south-west Madhya Pradesh). The acquisition of JP’s cement assets was also to strengthen UltraTech’s presence in central and northern India (Madhya Pradesh and Himachal Pradesh regions) as well as in Andhra Pradesh and Telangana. 

Capacity increases have been crucial for driving volume growth in the past years too, despite challenges on the demand front. As peers such as ACC and Ambuja Cements (which lagged in terms of capacity additions during calendar year 2016, which is also their financial year) had seen sales volumes decline by 2.7 per cent and 1.2 per cent, respectively, UltraTech saw a 1.6 per cent increase in domestic volumes in FY17. Other peers such as Shree Cement also continue to drive volume growth, led by timely capacity expansions. UltraTech, after the acquisition of JP’s cement assets and commissioning of grinding units in Maharashtra and Bihar, had seen its capacities grow to 96.5 mt per annum (mtpa) by the September quarter and the latest expansion plans will help it cross the 100-mt per annum mark.

Value accretion, profitability not far behind

UltraTech’s move to create capacity comes at a time when the street is expecting consolidation (mergers and acquisitions) in the industry. Analysts were expecting the company to rather concentrate on cement assets acquired from the JP Group to drive earnings. 

One reason for UltraTech preferring to create capacity could be the higher valuations of assets on sale in the market. For instance, estimated valuations of the Binani group’s Rajasthan-based cement assets are high. Recent news reports also suggest that Dalmia Bharat is planning to bid for Binani’s 6.25-mt cement plants, which are currently under the scrutiny of the National Company Law Tribunal. Since lenders were seeking an enterprise value (EV; equity plus debt) of Rs 600 crore for these assets, Binod Modi at Reliance Securities says that this translated into EV/tonne of $148, which is a 10-15 per cent premium to its replacement costs, and also higher than $121/tonne paid for JP’s cement assets. Modi also says that the expansions indicate the company’s bullish outlook for domestic demand, and especially in north India.

The cement demand for the most part of the current year has remained soft because of adjustments related to the good and service tax (GST), sand-mining issues and labour problems in some states, and the execution of the Real Estate Regulatory Authority (RERA) Bill. But, it is expected to improve, helped by the demand from the housing and infrastructure sectors. Also, the ensuing quarters (March and June) are seasonally strong and the situation may improve. A recent note by SBI Research says the government’s strong focus on infrastructure development to boost economic growth with accelerated spending on infrastructure will spur the economy. “We believe the cement sector will immensely benefit,” it adds.

In the interim, cost pressure remains and although players are cautiously pushing price increases, margins may see some impact. UltraTech, which has been among the best in the industry on profitability, needs to work fast on driving synergies from the JP acquisition. The acquired assets are estimated to have clocked a capacity utilisation of 35-40 per cent in the September quarter, and UltraTech is aiming to increase to 60 per cent by the start of FY19, say analysts. The sooner it gets there, the faster it will add to UltraTech margins.

Overall, given its growth plans, profitability and scale, most analysts have UltraTech as their top pick. The target prices of Motilal Oswal Securities, Emkay Global, JM Financials, etc indicate a potential upside of 8-16 per cent from the current levels of Rs 4,220.