Deal with Jaiprakash Associates should enable Ultratech to further solidify its position in cement market though
Ultratech Cement (UTCEM) has entered into a memorandum of understanding to buy 22.4mtpa of cement capacity situated in various states for an EV (enterprise value) of Rs 170 bn (including 4mtpa of assets under construction for Rs 5 bn) from Jaiprakash Associates (JPA), giving it access to several new markets. If the deal goes through, it should expand Ultratech’s cement production capacity to 91mtpa from 68mtpa currently. The deal will be subject to approval, including crucially the approval of the Competition Commission of India (CCI).
About the assets: The 22.4mtpa includes 4mtpa of capacity at Bara Grinding Unit, which is currently under construction. We understand Rewa (3mtpa) and Chunnar (2.5mtpa), owned by JPA, are not part of the deal. The assets under construction have faced difficulties in obtaining permission for forest clearance in the past few years and appear unlikely to be commissioned within the next few years. In financial results for the first nine months of fiscal 2016, the assets being acquired delivered shipments of c7.9mt with an annualised utilisation rate of c58%. JPA’s cement business reported Ebitda/t of R534 in FY15, but the earnings split between assets offered and those not offered under the deal is not clear. Although not announced yet, we believe that Ultratech is likely to benefit from the accumulated losses at JPA’s cement assets via its cash tax rate falling to the minimum alternate tax (MAT) from maximum marginal rate currently. The assets, by our estimate, will change hands at an EV/t of c$112. However, excluding the 4mtpa project, the EV/t of the deal would increase to $130.
We keep our forecasts and target price unchanged as we await more detail regarding this latest asset acquisition. Nevertheless, we believe the deal should enable Ultratech to further solidify its market-leading position in Indian cement. The deal is unlikely to face problems with respect to the transfer of mining leases, as the corporate entity (not the assets themselves) will be transferred. It is, however, unclear what view CCI is likely to take, given it has reportedly restricted domestic players’ participation in the potential sale of the Lafarge assets (PTI, August 2015). Ultratech Cement currently trades at EV/t of $184, and investors might see a significant acquisition at $110/t as value accretive. As the deal is to be debt-financed, UTCEM’s net debt will likely rise to Rs 220 bn, which is still a small fraction of its Rs 780 bn market cap but almost 1x book. Based on our calculations, capacity acquired for $110/t would require c$19/t in Ebitda to generate a RoE of 14%. This increases to $22/t if the cost of capacity is $130/t. By contrast, the assets being acquired have reported an Ebitda/t of below $10/t. UTCEM reported Ebitda/t of $15/t, which is still lower than what UTCEM is paying (to be EVA neutral) in this latest deal.
Valuation and risks
Our forecasts are unchanged as we await more clarity and details regarding this latest asset acquisition. We maintain our fair value target price at Rs 2,140. We value UTCEM at an unchanged FY17e EV/Ebitda of 10x. Our target price of Rs 2,140 implies downside of c23% from the current market price. We therefore reiterate our Reduce rating on the stock.
Upside risks: Better-than-expected cement demand and faster-than-expected ramp-up of its ongoing projects may drive upside to our sales volume estimates.