Orient Cement is a mid-sized cement player, which is in the process of transitioning from a South/West-based player to expanding its footprint pan- India. Although Orient is among the lowest cost producers and trading at $80/ ton the stock looks cheap, after accounting for JP integration the 9.7x Sep-19E EV/EBITDA multiple leaves risk-reward capped in our view. Initiate with ‘hold’ and TP of Rs 171. 70% of Orient’s sales is in the two states of Maharashtra and Telangana. However, to expand into other markets, it bought 2 assets, BJCL and Nigrie from Jaypee Group (JP) in central India, expanding current capacity of 8mnt by 50% to 12mnt. Management has a target of 15mnt by FY20-21.
We expect the JP deal to consummate by FY18-end. Currently these plants are running at sub-20% utilisation levels. Normalisation in profitability going forward would be the key trigger to Orient’s performance. However, we are unsure of the timeline as Ultratech’s ramp up of acquired JP plants in central India may lead to oversupply.
Orient’s realisation dropped from Rs 3,629/ton to Rs 3,464/ton whereas costs increased leading to EBITDA per ton collapsing from Rs 737 in FY13 to Rs 312 in FY17. The major reason behind this weakness was lack of demand in Maharashtra (50% of sales) from housing segment given the drought situation in FY15-16 and demonetisation in H2FY17.
JP assets would almost double the absolute debt on the books of Orient. However, prima facie there is no issue of debt serviceability unless the core markets, Maharashtra and Telangana, crack to FY16-17 levels. Accounting for equity issuance, we expect the EPS to stay flat in FY18-19. Return ratios would remain depressed for a while due to slow ramp-up in JP assets with lower profitability, higher debt burden and increased equity base. Although the stock looks cheap at $80/ton on increased capacity, we don’t see much chance of a near term positive surprise in operating metrics.
Trading at 9.7x Sep-19E EV/EBITDA, we believe risk-reward is capped given lower business visibility. Initiate with Hold rating and TP of Rs171 (5% upside), valuing the stock at 10x Sep-19E EV/EBITDA (in line with other peers). Upside risk: JP assets’ profitability normalises faster. Downside risk: Realisation fails to sustain in key markets.