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Ultratech: What lies ahead?
Sep 20, 2006

Despite being one of the largest cement manufacturers in the country, it has been a roller coaster ride for Ultratech Cement over the last two years. Post the takeover by Grasim, while there have been palpable improvement in key operational aspects, there is still a lot of work to do.

What is the company’s business?
Ultratech (ULT), An Aditya Birla Group company and a 51% subsidiary of Grasim, has a consolidated capacity of 17 MT, thus making it the second largest cement producer in the country (9.7% market share). The company has presence in western, eastern and southern regions. It exports over 3 MT per annum, which is about 47% of the country's total cement exports. Cement and clinker is exported to countries around the Indian Ocean, Africa, Europe and the Middle East. Its plant in Chattisgarh and Orissa are the ideal locations for export of cement and clinker to Nepal and Bangladesh.

What has driven performance?
Sweating its capacity: Capacity utilization, which was lower under L&T (its erstwhile owner), has improved from 76.1% in FY04 to 86.5% in FY06, thus boosting the topline. Ultratech net cement sales have seen a CAGR of 11.2% for the period FY04 to FY06. Despite better utilization levels, it failed to reflect at the operating level due to various internal factors, which include higher power and freight costs as a percentage of sales (given the sharp spurt in fuel costs in the last three years).

Margins – Significant upside potential: As compared to the likes of Gujarat Ambuja and ACC, the per-bag realization of ULT is significantly lower, which is subsequently reflected at the operating level (as against the average of Rs 140 per bag in FY06 for ACC and Gujarat Ambuja, ULT’s realization were just over Rs 120 per bag). Cement is a highly fixed cost intensive sector (fixed costs is 65% to 70% of total costs on an average), any increase in cement prices directly flows at the EBDITA level, which in turn expands margins. As we have seen in the last two year, ULT has significantly stepped up its branding initiatives and we believe that the scope for realization increase in higher in the case of ULT over the next year and a half. Also, the company is well-poised to benefit from demand for cement from the Middle East, given the fact that it has its own captive jetty in the western region.

Another interesting aspect is that the power costs for ULT is on the higher side as compared to Gujarat Ambuja and ACC owing to the fact that it relies relatively heavily on furnace oil, which is expensive. Cost reduction measures such as setting up of a captive power plant, debottlenceking and modernisation projects accompanied by a favorable price environment are likely to benefit the company immensely. Though flooding in its Gujarat facility and plant shutdown has had a negative impact in the past, in our view, what is imperative is to boost realization and cut power costs. This is the key to margin expansion.

Despite the fact that EBDITA margins contracted last year by 100 basis points, PBIT margins expanded by 220 basis points (2.2%). Improvement in margins is brought about by reduction in debt burden, which has led to substantial decrease in interest amount. This is reflected by interest coverage ratio, which improved from 1.4 in FY04 to 2.3 in FY06 and total debt to equity ratio, which has come down from 1.5 in FY04 to 1.4 in FY06. As cash flow strengthens in light of favorable cement prices, we expect interest burden to decline even further.

Capex plans: Over the next three years, UTL has earmarked Rs 14.2 bn as capex for reasons mentioned earlier (of this Rs 8.4 bn is towards captive power capacities, which in turn will reduce power costs). This will be funded by internal accruals and borrowings (in our view, more than 50% of this capex can be met from internal accruals).

What to expect?
At the current price of Rs 819, the stock is trading at an EV per tonne of over US$ 151, which in our view is fairly valued. Despite promising EBDITA margin expansion potential and a favorable pricing environment over the next one-year, the risk-reward equation is skewed towards risks. We expect cement prices to cool off by the end of the next calendar year.

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