Why UltraTech Cement is a good long-term buy despite near-term challenges

With the India infrastructure theme playing out for most part of FY20, the stocks of cement manufacturers found favour with investors , despite companies recording weak sale volumes in the first nine months of FY20.

However, with the pandemic impacting the construction space severely due to labour and capital shortage, cement stocks lost their sheen and corrected 35-40 per cent from the peak in mid-January.

But the healthy set of numbers reported by players in the March quarter has once again brought these stocks under focus.

While sales volumes were weak as expected, companies reported healthy gains in EBITDA per tonne on account of better realisations and savings on logistics and power-cost fronts.

UltraTech Cement, with an installed capacity of 114.8 mtpa (million tonnes per annum), recorded its highest EBITDA per tonne (since inception) of ₹1,236 in FY20.

The leading cement manufacturer, which owns about 21 per cent of the country’s installed cement capacity, is a good long-term bet at this juncture.

While concerns around weak cement demand remain, the stock seems to have already priced in the same. It is now trading at a price-to-earnings (PE) of 18.8 times, which is 56 per cent lower than its three-year average PE of 43 times. Interestingly, the correction in valuation is due to a fall in stock price as well as increase in earnings (EPS).

In FY20, the consolidated net profit of the company more than doubled to ₹5,815 crore, from ₹2,404 crore in FY19.

Even excluding the one-time gain on account of reversal of deferred tax liabilities, worth ₹2,112 crore (due to cut in corporate tax rate), net profit saw a 54 per cent jump from FY19 level.

Strong financials

UltraTech continued to witness growth in profit despite weak sales volumes throughout FY20.

Consolidated cement sales volumes were up 8 per cent (y-o-y) in FY20 to 82.3 mt, predominantly on the back of its acquisition of Century Cement. Excluding that, the volumes of the existing plants of the company saw an 8 per cent and 7 per cent decline in grey and white cement volumes, respectively.

However, the blended realisations inched up by 5 per cent in FY20 to ₹5,038 per tonne due to an increase in share of premium products in the sales mix. This, coupled with a 13 per cent and 7 per cent decline in power and logistics costs, respectively, lead to a 24 per cent spike in operating profit to ₹9,379 crore in FY20.

The company’s cash cycle also remained healthy, witnessing a 42 per cent decline in its working capital requirements. In FY20, the firm generated a free cash flow of ₹5,274 crore, after a capex spend of about ₹ 1,600 crore.

This helped lower the total debt by 10 per cent in FY20 to ₹22,898 crore. When considering its existing cash reserves, the net debt outstanding in FY20 is ₹16,860 crore, down 24 per cent from last year.

Continuing with its strategy to conserve cash, the management has guided for a lower capex spend in FY21, to the tune of ₹1,000 crore.

Silver lining in prices

That apart, the management has decided to defer the brownfield expansion plans in Bihar and West Bengal by a couple of quarters, owing to near-term slowdown in construction activities.

A recent CRISIL report, based on a survey of cement dealers, indicated the likelihood of a 30 per cent decline in cement volumes in FY21. However, the channel check reports of leading brokerages suggest a silver-lining.

While the complete lockdown in April and in most part of May led to a 60-80 per cent drop in volumes, cement prices have gone up in the first quarter of FY21 so far. This was driven by the pent-up demand from rural and semi-urban pockets.

That apart, many dealers even saw strong pre-buying in the trade (retail) segment since most construction players wanted to complete the work before the onset of monsoon.

Consequently, cement prices were up by 4-31 per cent y-o-y across regions.

That said the sustainability of the short-term fillip in prices is uncertain, given the weakness in the non-trade segment. The channel check reports indicate that the non-trade segment has witnessed a huge decline in volumes, with large infrastructure players saddled with labour and capital shortages.

However, cement companies can continue to shine in the near term, thanks to lower input costs. In the first quarter of FY21 thus far, imported coal and pet coke prices fell by 10 per cent and 25 per cent (y-o-y), respectively. This, along with a marginal drop in diesel prices, can aid the operating margins for cement manufacturers, including UltraTech, for most part of FY21.