Ultratech Cement: Research Report By Nirmal Bang

Demand recovery prompts massive expansion plans

Ultratech Cement Ltd (UTCEM) has announced massive expansion plans to increase its capacity by 19.5mn mt by FY23. The long term stated goal of the company was to add 50mn mt capacity by 2030 and a large part of that plan is being front-loaded with this announcement. The recent recovery in demand in various regions, especially in East, Central and North India, coupled with capacity constraints in East during peak period has prompted the company to announce its highest ever capacity addition plan.

A significant cue on economic recovery came from Kumar Mangalam Birla, who's investing over 5400 crore to expand Ultratech's capacity. An invest in core infra sector is huge & signals the revival of private investment cycle. #skininthegame

— Chandra R. Srikanth (@chandrarsrikant) December 4, 2020

The capacity expansion programme includes ongoing expansion of 6.7mn mt of cement capacity and new capex of 12.8mn mt of cement, accompanied by 11.4mn mt of clinker capacity and close to 57MW of waste heat recovery system (WHRS). Total capital outlay for this project is Rs65.3bn, including Rs10.5bn for the existing projects. This translates into capex cost of mere US$45/mt, which is one of the lowest in the industry. Reason for the low capex/mt is that 70% of the expansion is brownfield in nature. The East region will get the highest share of capacity addition (52% of total) followed by the Central region (26%) as the management believes that these are the lowest per capita consumption regions in the country and hence growth potential is the highest there. We see this expansion as positive for the company as it will lead to increased market share and will help the company to maintain its leadership position. Historically, UTCEM has grown volume at higher-than-industry growth rate and we expect that momentum to sustain in the medium term. Moreover, the recent inorganic acquisitions have occurred at relatively expensive valuations. This brownfield capex will help it to balance capital costs and lead to higher return ratios. We maintain our positive stance on the company with a BUY rating and target price (TP) of Rs5,640 (unchanged).

Capex plan in numbers: Total of 19.5mn mt capacity addition by FY23, out of which the East region will see capacity addition of 10.1mn mt, the Central region 5.1mn mt, North 2.5mn mt and West 1.8mn mt. This translates into 18% of UTCEM’s existing total capacity whereas for the East it translates into 62% of its existing capacity. It will take UTCEM’s total capacity in India to 130.9mn mt from 111.4mn mt currently. As % of total India capacity, this expansion is 4% of total and for the East region as a whole UTCEM’s capacity expansion is 10.4% of total regional capacity. As a result, UTCEM’s capacity share is likely to increase by 2.2% from 22.6% currently to 24.9% in FY23. 85% of output from the expansion will be blended cement, which will improve cement-to-clinker ratio for the company.

Return ratios to inch up: UTCEM expects IRR/ROCE of ~15% for this expansion based on the back of lower capex costs. This expansion will also help it to reduce logistics costs as material which used to move from Maharashtra or South India to East will come down. UTCEM’s ROCE for FY20 was close to 11.5% whereas higher ROCE from the expanded capacity is likely to move overall ROCE higher.

Despite capex, UTCEM will be debt free by FY23: The company expects to spend Rs25bn per year on total capex, including maintenance capex of existing plants. Given the higher level of current profitability, cash flows are expected be superior (Rs110-120bn per year) and we expect the company to be debt free by FY23 despite the renewed capex plans.

Top pick in Large Cap cement space: We believe that the company’s pan-India presence, continued capacity expansion programme, huge scope for further volume growth given lower utilisations, improving efficiency parameters and faster deleveraging make UTCEM stand out as a strong candidate to play the upcoming cement rally. Maintain Buy with TP of Rs5,640 (unchanged). Key risks include lower-than-expected demand and supply pressure from the peers.