‘Reduce’ rating to Ultratech Cement shares: Impact of Jaypee asset buy

UltraTech Cement’s ownership of the Gujarat cement plant helps it further consolidate its share in the West market (extant capacity of 8 mtpa pre-acquisition),and prevents the entry of an aggressive competitor,implying improved pricing discipline. However,the acquisition shall likely be earnings dilutive as (i) the plant currently operates at a utilisation of only 65% in its second year running,not contributing much to operating profits,and (ii) the deal shall result in additional debt of R36.5 bn. At an enterprise value of R38 bn (138/share of UltraTech Cement),Ebitda (earnings before interest,taxes,depreciation and amortisation) contribution from the plant would be approximately R4.5 bn in FY15e in an optimistic scenario,assuming (i) capacity utilisation of 73%,(ii) realisations of R5,534/tonne and (iii) profitability of R1,265/tonne.

Assuming a pessimistic scenario in which the extant operational performance of JCCL Gujarat is sustained at (i) capacity utilisation of 65%,(ii) realisations of R4,035/tonne and (iii) profitability of R49/tonne,the deal shall dilute Ultratech earnings by R13/share (12%) for FY2015e. We maintain our Reduce rating on the stock with a target price of R1,650/share.

Jaiprakash Associates—asset sale initiates the process of de-leveraging: While the deal shall result in reduction of JAL consolidated debt by R38 bn,it is an important start to the much anticipated de-leveraging post an era of hyper capacity expansion. The sale of the cement business in Gujarat is positive due to losses of R4.9 bn contributed by JCCL with an aggregate debt of R36 bn for FY13 plus an incremental R36 bn payable to JAL & related parties.

We are not as optimistic of the proposed sale of operational power plants held under Jaiprakash Power Ventures (JPVL),which shall help a further debt reduction of R120-130 bn,as it will also include the better part of the power portfolio (operational hydro projects). We maintain our earnings estimates and target price of R57/share as our earnings model had not factored an earnings contribution from the recently sold JCCL Gujarat capacities.

JCCL: Underutilised capacities lead to losses of R5 bn for FY2013: JCCL has an operating capacity of 9.8 mtpa in Gujarat (4.8 mtpa) and AP (5 mtpa) and another under-construction capacity of 3 mtpa in Karnataka. The current deal envisages sale of capacities of 4.8 mtpa at Sewagram and Wanakbori in Gujarat. While the capacity utilisation for Gujarat capacities was 65% during FY2013 (9-month period,June 2012-March 2013),the Andhra capacities remained significantly underutilised at 37%. JCCL reported net sales of R20 bn,operating profit of R243m and net loss of R5 bn for FY13. The gross debt of R36 bn as on March 31,2013 includes capacity-linked debt of R17 bn (Gujarat,AP and Karnataka capacities) and corporate level debt of R19 bn. We highlight that the current liabilities of R43 bn also include payables of R30 bn to JPA and R6 bn of advances to related parties.

In April 2012,JPA had demerged the cement capacities at three locations—Wanakbori,Gujarat (2.4 mtpa),Sewagram,Maharashtra (2.4 mtpa) and Jaggayapeta,AP (5.0 mtpa) and transferred them into a wholly owned subsidiary called Jaypee Cement Corporation Ltd (JCCL) for a consideration of R40 bn. Further back in February 2011,JPA had acquired 100% stake in JCCL,earlier known as Zawar Cement Private Limited (ZCPL). ZCPL had been incorporated as a project SPV for executing 3.0 mtpa cement grinding capacity at Gulbarga,Karnataka in 2010,with an estimated capex of R140 bn (R45 bn incurred till March 2013) and scheduled to be commissioned in September 2013.

—Kotak Institutional Equities