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  • Stock Recommendation | UltraTech Cement - SELL - Target price : 2,760

    Publish date: OCTOBER 22, 2018

    High hopes versus grounded real(i)ty. UltraTech’s 2QFY19 earnings missed our estimate due to subdued realizations and higher costs. The company’s 1HFY19 EBITDA was flat yoy despite 26% yoy volume growth (aided by ramp-up of acquired capacity) due to 21% yoy decline in EBITDA/ton. Low industry utilization, large capacity additions and continued weakness in the real estate market can restrict material improvement in earnings over the next 1-2 years. Stock valuation at 16X/13X FY2019E/20E EBITDA is expensive, especially on the back of optimistic earnings estimates. We cut our estimates by 7-18% and revise TP to Rs2,760 (Rs2,950 earlier). Maintain SELL.

    UltraTech’s earnings were below our estimates—the company reported revenues of Rs78.6 bn (+20% yoy, -9% qoq), EBITDA of Rs12.9 bn (-4% yoy, -20% qoq) and net-income of Rs3.9 bn (-9% yoy, -35% qoq), against our estimate of Rs78.3 bn, Rs14.4 bn and Rs4.8 bn, respectively. Cement volumes increased 20% yoy to 15.7 mn tons led by ramp-up of acquired assets of Jaiprakash—we note that last year (in 2QFY18), the company had just completed the acquisition of these assets which were operating at low utilization rates. EBITDA/ton was lowerthan- our-estimate and declined by 11% qoq to Rs824/ton (-20% yoy) due to subdued realization (+1% qoq) and rising cost pressures—total costs increased by 4% qoq to Rs4,180/ton (+5% yoy) due to an increase in energy costs (+7% qoq to Rs1,099/ton) and other costs (+20% qoq to Rs672/ton).

    The consensus earnings estimate for FY2019E has been revised downwards by 21% over the past year—we expect another round of downgrades post 2Q/3QFY19 results; we have cut our FY2019E EBITDA estimate by 7% and EPS by 18% after 2QFY19 results. Cement prices in October 2018 were weak in most of the regions—all-India prices in are down by Rs5/bag qoq (- 2%) in October 2018 versus 2QFY19. While realizations are expected to be weak again (unless we see material price rise in November 2018), we expect costs to remain high in 3QFY19 due to lower INR/US$ (which will affect Fx related costs), imposition of busy season surcharge from the railways, etc. We also highlight that strong volume growth reported by companies in 1HFY19 is largely on the back of a low base, which will moderate from November 2018.

    We believe >78-80% industry utilization in commodities business is a must for meaningful improvement in industry profitability—or else high competitive intensity between firms will continue to depress operating margins. Given large capacity addition by domestic cement companies, we estimate industry utilization to remain close to 70% over the next two years. We cut our FY2019-20E EBITDA estimate by 2-7% and earnings by 7-18%. This results in a cut in our TP to Rs2,760 (from Rs2,950 earlier) as we value the stock at 10X March 2020E EBITDA. The stock is expensive at 16X/13X FY2019E/20E EBITDA and 35X/24X earnings.

    Changes in our estimates
    Exhibit 8 highlights key changes in our estimates.
    We raise our cost estimates for energy costs, other expenses which results in 3-8% cut in our EBITDA/ton—we estimate EBITDA/ton of Rs938, Rs1,073 and Rs1,159 for FY2019E, FY2020E and FY2021E. This results in 2-7% cut in our EBITDA estimate to Rs66.4 bn, Rs81 bn and Rs93.4 bn for FY2019E, FY2020E and FY2021E. We reduce our EPS estimates by 7- 18% to Rs103.2, Rs147.7 and Rs187.3 for FY2019E, FY2020E and FY2021E.
    Our fair value of Rs2,760/share is based on 10X March 2020E EBITDA.
    Key highlights from 2QFY19 results
    Volumes—strong growth led by ramp-up of acquired assets. UltraTech’s domestic sales volumes increased by 21% yoy to 15.1 mn tons while export sales were flat yoy at 0.7 mn tons—total India volumes increased 20% yoy to 15.7 mn tons. We highlight that strong growth in volumes was led by ramp-up of acquired assets from Jaiprakash as plant utilization rates of these assets were very low in 2QFY18 after UltraTech completed acquisition in June 2017.
    ▶ The management highlighted that infrastructure development remains a key growth driver for cement volumes in CY2018 while there is also a pick-up in low cost housing and rural housing. The average industry capacity utilization is close to 70% now though utilization in 2QFY19 was only 65%, it being a seasonally weak period for cement offtake.
    Realizations increase by 1% qoq. UltraTech’s blended realizations increased by 1% qoq to Rs5,004/ton (flat yoy) in 2QFY19. As per the company, average cement prices were up 1% qoq in 2QFY19 led by ~3% increase in North, Central and South markets and marginal increase in East (~1% qoq). Cement prices declined by 2% qoq in West region.
    Our channel checks indicated all-India retail cement prices increased by Rs3/bag (+1%) in 2QFY19 led by higher prices in North, Central and East markets. Per our checks, October 2018 cement prices are down by Rs5/bag or 2% qoq (Exhibit 5).
    Operating margin decline due to higher costs. UltraTech’s EBITDA/ton declined 11% qoq at Rs824/ton (-20% yoy, KIE: Rs916/ton) due to muted realizations and higher costs. During the quarter, overall cost/ton increased 4% qoq to Rs4,180/ton (+5% yoy)—cost increases were due to:
    ▫ Increase in energy costs by 7% qoq to Rs1,099/ton (+19% yoy). The company highlighted energy cost increase had an impact of ~3% due to INR/US$ depreciation, and higher consumption norms due to plant maintenance in the quarter (+2%).
    ▫ Increase in other expenses by 20% qoq to Rs672/ton (flat yoy). Other expenses increased due to the impact of an annual maintenance shutdown (+18%) as close to 60% of kiln capacity was shut for maintenance. The adverse operating leverage also impacted other expenses, on per unit basis.
    Net-debt increases by Rs5 bn due to higher working capital. Standalone net-debt increased to Rs125 bn in September 2018 from Rs120 bn in March 2018, due to an increase in working capital (+Rs15 bn) from inventory accumulation in the monsoon season. UltraTech’s leverage will increase if it acquires assets of Binani Cements and also completes the acquisition of Century Textiles. Management expects leverage to decline from 1QFY20 onwards.
    Other highlights from the earnings call
    Acquisition of Binani Cement. Management highlighted that the case hearing pertaining to Binani Cement is complete and the order is reserved. The delay in the order is due to ongoing vacations at the court. Once court resumes over next week, the order can be passed as early as within 15 days.
    Update on new projects. The company has not yet started work on the Pali cement project in Rajasthan as it awaits the final order on the Binani assets that it intends to acquire. The company believes that the incremental capital benefit of a brownfield expansion is higher than the greenfield projects. We note that UltraTech’s board had earlier approved setting up of a 3.5 mtpa integrated plant in Pali, Rajasthan for an investment of Rs18.5 bn which was expected to be commissioned by June 2020.
    The 4 mtpa cement plant in Bara, Uttar Pradesh is expected to be commissioned in June 2019 with a little delay on the part of contractors of the project.
    Revised axle load norms aided costs. Management stated that some benefit has started accruing from the increase in axle load norms. The movement through roads is high at 75%. Lead distance also declined by 4% qoq (-5% yoy) which aided 4% qoq decline in logistics costs despite the increase in diesel prices (+1% qoq).
    Regional plant utilization—highest in East, North. Among regions, the company’s plant utilizations are highest in the North (75 to 80%), East (80 to 85%) followed by South, West (65 to 70%) while Central region has plant utilization of close to 60%.
    Manufacturing costs to have peaked in 2QFY19, per management estimates. As per management, manufacturing costs are likely to have peaked in 2QFY19. Pet-coke prices have declined to

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.

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