UltraTech Cement: Hold

UltraTech Cement: Hold
Published: 22 December 2008

Shareholders of Ultra Tech Cement can continue to hold the stock, as the current valuations have already factored in the prospect of a slowdown in earnings. The quarters beginning March 2009 are likely to reflect cost savings by the company on the fuel front. A 60 per cent fall in international coal prices since July, a slump in shipping rates and a cut in domestic fuel rates are all set to lower the company’s costs and strengthen margins. The stock trades at an attractive enterprise value per tonne of INR2645 (estimated) and a price-earning ratio of five times, the lowest among the large cement players.

The cement sector, as a whole, has seen positive news flow over the last few weeks. Cost pressures, which have dented the profits over the last two quarters, look set to ease with the correction in input and energy costs. The sharp interest rate cut on housing loans of less than INR20 lakh and the INR20,000-crore stimulus package for infrastructure companies are also expected to support revival of demand for cement in key pockets – the north and west – helping players such as Ultra Tech.
Ultra Tech’s total cement capacity stands at 23.1Mt after its recent capacity-addition at the Tadpatri project at Andhra Pradesh. Many of the company’s thermal power plants are also to commence operations in 2009. Apart from being a major player in the west, with plants at West Bengal, Maharashtra and Gujarat, the company also has a presence in the South in Andhra Pradesh, Karnataka and Tamil Nadu, helping diversification.

Coal and diesel, the two most significant cost elements, are cooling off from their highs, relieving the company from the cost pressures of the last quarter. Thermal coal, which traded at US$193 in July in the Australia’s New South Wales port had fallen to US$78 in December. The landed prices of coal have corrected even more sharply given the fall in shipping rates.

The latter appears unlikely to recover significantly, given the prospect of global recession. Ultra Tech, which imports 40 per cent of its coal requirements, is likely to be among the key beneficiaries of these trends.

Fuel (with power) costs for the company were 28 per cent of sales in the September, higher by six per cent over the corresponding previous quarter. The other boost to margins may come from the recent cut in diesel prices, which can lead to distribution costs savings.

There may be no margin benefits to the company from the excise duty cut of four per cent. Of the excise duty savings of about INR10/ bag, about INR2.5/bag may be taken away by the hike in railway freight. The remaining savings have been passed by way of cuts in cement prices. Given that the declines in fuel and distribution costs have been recent, the impact of the cost savings may reflect mainly in the March quarter numbers. It may also be a couple of quarters before the recent reduction in lending rates filters down to Ultra Tech’s financials. With the company in a capex phase, interest expenses for the September quarter were higher by 52 per cent year-on-year.

While margins may stage an improvement, realisations may not witness any significant improvement. Even before the excise duty cuts, the southern and northern regions saw a fall of INR2-3/bag in November on signs of reduced demand. Prices remained flat in the western and eastern pockets.

While the prospect of new supply from ongoing capex plans of cement companies does exist, possible delays in the commissioning of this capacity due to the funds crunch, appears possible. Demand may also revive following the home loan package that makes low-cost housing more attractive and the re-financing package for infrastructure companies.

The company’s entrenched position in the west and south, also offers it an edge over others. The demand outlook for South continues to be bright; the region witnessed a growth of 12 per cent last October.