With limited capex needs going forward, strong FCF generation (~7% yield) will likely drive deleveraging and 550bps improvement in RoE over the next two years.
UltraTech Cement (UTCEM) has underperformed the Sensex by 10% over the past three months due to weak cement demand and the dismal performance of the acquired Century Cement assets in Q2FY20. Here, we present (i) the premise for our expectation of an improvement in profitability of Century and (ii) the case studies on the turnaround of the other two acquisitions – JPA and Binani. With limited capex needs going forward, strong FCF generation (~7% yield) will likely drive deleveraging and 550bps improvement in RoE over the next two years. Against this promising backdrop, we maintain our positive stance on UTCEM —our top pick in the sector.
Century—turnaround begins, contribution to consolidated Ebitda set to increase
Century assets generated nil Ebitda in Q2FY20, impacting UTCEM’s profitability by 10%. Ebitda/t was down to Rs 1,021 (Rs 1,131 excluding Century) in the quarter.
However, Century assets have started showing signs of a turnaround, which will likely drive an improvement in earnings over the next six quarters. We forecast Century Ebitda to increase to Rs 1.6 bn in Q4FY20 and ~Rs 7 bn in FY21, contributing 5% and 6%, respectively, to the company’s consolidated Ebitda. Profitability improvement will primarily be driven by lower costs with better fixed cost absorption, reduced energy costs and freight cost savings. Realisation will likely improve in Q4FY20 as most of Century’s capacities transition to the UltraTech brand by Dec’19.
Case studies: Turnaround of JPA and Binani acquisitions
When UTCEM had acquired JPA (21.2 MMTPA) and Binani (6.25 MMTPA) in Jun’17 and Nov’18 respectively, their Ebitda was only Rs 100-300/t. However, the company turned these acquisitions around to generate estimated Ebitda of ~Rs 1,300/t. According to management, both these assets have achieved PBT break-even, despite high acquisition cost of $160/t for Binani and $125/t for JPA.
Strong FCF to drive deleveraging
We expect strong FCF generation of >Rs 75 bn per annum (7% yield) from FY20, which should drive deleveraging and stock price appreciation. Net debt/Ebitda is expected to reduce to 1.1x by Mar’21 from 2.2x now. RoE is expected to rise by >550bp to 13.8% over FY19-21, driven by strong growth in Ebitda (26% CAGR) and lower interest costs from deleveraging.
Valuations attractive; Maintain Buy
UTCEM trades at 11.7x FY21e EV/Ebitda and ~$158/t on EV, which are at ~15% discount to the 10-year average. The stock also trades at ~35% discount to peer Shree Cement – the highest in past 10 years. The stock is not ascribing any value to its >20 MMTPA low-cost brownfield expansion wherein long-term growth visibility is good. We value UTCEM at 14x FY21e EV/Ebitda to arrive at a target price of Rs 5,050 (implied EV/t of $185/t on FY21 capacity). Maintain Buy.