UltraTech’s war on debt overshadowed by cost pressures


It is well known that the Indian cement industry is struggling with cost inflation. Even industry leader UltraTech Cement Ltd is feeling the heat. In the September quarter, UltraTech’s operating margin fell 340 basis points (bps) year-on-year (year-on-year) to 22.6% due to energy cost inflation .

In a conference call after the results, management said raw material costs had increased due to higher prices for slag and gypsum. With the continued rise in thermal coal prices, the company has increased its dependence on petroleum coke (petroleum coke). The composition of petroleum coke in its energy mix has gone from 17% at T1FY22 to 19% at T2FY22. However, management expects the costs of ??200 / tonne at T3FY22 due to rising fuel prices.

Management is waiting for another ??500 / tonne increase in fuel cost over the next few quarters due to higher spot coal prices; however, they view the current surge as transient. Freight costs are also expected to increase due to rising diesel prices.

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Debt reduction frenzy

Not only fuel costs, higher personnel and maintenance costs also weighed on operating margins. Labor costs have increased due to the payment of incentives and salary increases. The same is expected to be streamlined over the next few quarters, management said. Management expects fixed costs to remain within the range of ??5,000 to 5,500 crore in FY22.

Simply put, operating margins are threatened in the short term by high raw material and fuel costs. However, investors can take comfort in management’s plan to pass on the impact of rising fuel costs to rising cement prices over the coming months. UltraTech suffered a price increase of ??10-15 per bag in October, thus returning to pre-monsoon price levels, management said, adding that the current round of price increases has held up in most markets.

Analysts say UltraTech would need an additional price increase of ??35-40 / bag to maintain the margin growth of previous quarters. In addition, the short-term trajectory of the stock’s performance depends on the price outlook. That said, analysts note that the outlook for strong demand gives UltraTech an opportunity to raise prices.

The company faced weak volume growth in T2FY22 due to strict regional restrictions and heavy monsoons across India. Cement volumes increased 6% year-on-year to 20.4 million tonnes, while remaining stable sequentially.

Management said volumes showed marginal improvement since October in line with the retreating monsoons. While management has refrained from giving guidance, they expect demand to rebound strongly after the monsoons. In the second half of the year, he expects volume growth of 6-8% year-on-year. Management expects to recoup lost volumes thanks to a strong recovery in demand, mainly driven by a recovery in commercial real estate and higher government spending on rail, road and irrigation projects.

Amid the battle against cost inflation, the company’s efforts to further strengthen its balance sheet are eclipsed, analysts said. Investors would expect UltraTech to have embarked on a wave of debt reduction in recent quarters and aim to free itself from its net debt by fiscal year 23. It should be noted that the reduction in debt Debt is seen as one of the factors likely to close the valuation gap between UltraTech and its rival Shree Cement Ltd. On an EV / Ebitda basis, the former is trading at a multiple of 16, while the latter is the most expensive listed domestic cement stocks with a valuation multiple of 22 times. It should be noted that Shree Cement is net cash positive.

EV stands for enterprise value. EBITDA represents earnings before interest, taxes, depreciation and amortization.

UltraTech’s net debt increased 6% sequentially, but fell 47% year-on-year to ??6,300 crore in September. Net debt increased despite strong operating cash flow due to the seasonal rise in the value of working capital and higher capital expenditures during the quarter. Net debt / Ebitda remained stable at 0.5 times in T2FY22 against 1.3 times in T2FY21.

“With strong operating cash flow, we estimate a free cash flow yield of 4-6% in fiscal year 2021-24E despite the growth investments and to help UltraTech become positive net cash over the course of fiscal year 2022E, ”analysts at Kotak Institutional Equities said.

Analysts also said UltraTech has in the past added leverage for inorganic growth. However, given that no major cement assets are on the block, there is no probable risk of merger and acquisition.

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