The Ultra Acquisition!
The Indian cement industry, since liberalisation in 1992, has shown enormous growth with development activities buzzing. Be it alleged for cartelisation or price rigging, consolidation has been the key to success. Several mergers and acquisitions (M&As) have taken place until now, creating giants with huge capacities and ability to take cement to consumers in nooks and corner of the country. All these developments have come in line with faster economic growth of the country in the last two decades. When a sector grows in line with the economic development and is strongly under the influence of infrastructure sector, for which the Government is giving utmost importance, the consolidation gains are significant.
M&As have been a primary tool for many companies for faster development, and the cement industry has been witnessing M&As after liberalisation at an increased pace in different sizes and types. After the pricing de-control in 1989 and with the economic liberalisation adding momentum, the Indian cement industry has been expanding at a very brisk pace. The speed of growth is such that, as on March 2017, India is the second largest cement producer in the world.
The structure of the industry looks significant as there are 51 manufacturers in India battling against each other. Of 51 manufacturers, the top four, controlled by two groups, account for almost 40 per cent of the total market share. In the last 20 years, big size M&A deals have taken place with all the top four companies involved in it. The factories are located in clusters across India based on the limestone availability. The deal between Grasim Industries Ltd and Larsen and Toubro Ltd (L&T) was one of the biggest in the country across industries.
The Board of Directors, at its meeting on July 4,2016, had approved a scheme of arrangement between Jaiprakash Associates Limited (JAL), Jaypee Cement Corporation Limited (JCCL), a wholly-owned subsidiary of JAL, with UltraTech. The scheme was also approved by the shareholders and creditors, the Competition Commission of India, the national Company law tribunal and the Securities and Exchange Board of India. A joint application for the transfer of mineral concessions from JAL and JCCL to UltraTech was made with the respective State Governments. Since UltraTech refused to comment on the acquisition to ICR, most of the remarks and statements are taken from press releases.
For UltraTech, 2016-17 marks a major milestone. First, the company's directors approved a scheme of arrangement with JAL for the acquisition of some of its cement plants located in Madhya Pradesh, Uttar Pradesh, Himachal Pradesh, Uttarakhand and Andhra Pradesh with a total capacity of 21.20 million tonne per annum (MPTA), acquired at a value of Rs 16,189 crore.
UltraTech acquisition completed
UltraTech Cement completed the Rs 16,189 crore acquisition of JAL's six integrated cement plants and five grinding units, having a capacity of 21.2 million tonne (MT) in July 2017. Consequently, the acquired cement plants of JAL and JCCL stand transferred to UltraTech.
With this, UltraTech now has 18 integrated plants, one clinkerisation unit, 25 grinding units and seven bulk terminals. Post-acquisition, UltraTech's grey cement manufacturing capacity has gone up to 93 MTPA and has become fourth largest cement player globally with a market share of over 22 per cent, excluding the Chinese players.
UltraTech Chairman, Kumar Mangalam Birla told that this move is essentially for geographic market expansion, enabling UltraTech's entry into the high growth markets of India where it needed greater reinforcement. JAL had last year announced the sale of its cement business to the KM Birla-led UltraTech, making the biggest consolidation in the cement sector.
The move is essentially for geographic market expansion, which will lead UltraTech's entry into high-growth markets. The operations will be strengthened by the consequent technological upgradation and enhancement in capacity, post-acquisition. It will lead to creating synergies in manufacturing, distribution and logistics.
As a result, advantages such as economies of scale and reduced lead time to markets will be achieved.
With this deal, UltraTech will have a presence across regions (except North East). Jaypee's cement assets are spread across regions viz., central region (11.4 MT), north (4.8 MT) and 3) south (5 MT). The location of 11 plants of Jaypee complements the existing 40 of UltraTech. The acquisition is expected to give UltraTech access to newer markets of Satna (11.4 MT) and coastal Andhra Pradesh (5 MT). Analysts expect Jaypee to register utilisation of approx. 47 per cent in FY18E and 68 per cent in FY19E and EBITDA/t of Rs 543 and Rs 1,050 in FY18E and FY19E, respectively.
Consequent to this expansion and the acquisition of the cement plants of JAL and JCCL, UltraTech's capacity will stand augmented to 95.3 MTPA, including overseas operations.
Post-merger investment plans
Having taken over the debt-ridden 21 MTPA cement capacity of JAL and JCCL for Rs 16,189 crore, UltraTech plans to raise Rs 9,000 crore through issue of non-convertible debentures through private placement for funding its ongoing expansion projects and refinance high cost debt.
KM Birla, while addressing shareholders at the 17th annual general meeting, said that the company will be investing Rs 2,200 crore on de-bottlenecking projects, regulatory requirements, plant infra¡structure and routine maintenance.
UltraTech plans to set up a 3.5-MTPA plant at Dhar in Madhya Pradesh with an investment of Rs 2,600 crore, and the project is expected to be completed by the fourth quarter of FY-2019. The new plant will cater to southwest Madhya Pradesh and enhance presence in central India, said KM Birla. The company has commi-ssioned a cement grinding unit at Nagpur in Maharashtra and Patliputra in Bihar.
Following the acquisition of JCCL's cement assets, UltraTech accounts for 30 per cent of cement capacity in central India, making it the largest regional producer. Only in West India does the company have a higher share of the market at 37 per cent. 'UltraTech is not looking at making any major acquisitions in the near future', Birla added.
Although, acquisition of JAL's cement assets has expanded UltraTech's size, the latter's units have been operating at a high variable cost and at an abysmally low capacity utilisation of 10 per cent at the time of acquisition, as against industry average of 70-72 per cent. UltraTech may find its profitability come under pressure in the next few quarters, adversely affecting its overall earnings growth in 2017-18, said CLSA in its latest report.
Echoing the same, Karvy Stock Broking said UltraTech's portfolio comprises mostly of a premium brand of cement, and it may incur additional cost to rebrand cement made by JPA. This is even acknowledged by UltraTech saying that it will take at least another three months before UltraTech Cement re-brands and markets product from the recently acquired plants.
'There's a significant quality difference in the cement produced by UltraTech and JCCL. Also, coal supply issues have to be sorted out at these plants and it will take at least another quarter before production reaches market,' the official told. At UltraTech's annual shareholder meeting, KM Birla aid it would take about three years before the acquisition - the largest deal so far in India û begins to boost the company's earnings per share.
Another factor that can have adverse impact is the demand. Cement demand in most parts of the country is yet to see a significant revival. Recent volume off-take has not been very impressive. Cement prices, too, are cooling off. Thus, a muted macro scenario could impact the pace of ramp-up of these plants, hurting UltraTech's volume growth in the interim.
Experts opine: 'With only a few mine transfer approvals pending, UltraTech's takeover of JAL's cement assets is now a matter of time. Building in this factor in a slower ramp-up FY18-19 volume is cut by 5-9 per cent.'
Institutional investors reportedly are unlikely to change their view on UltraTech Cement in the near term. A key reason for this is the sentiment reflected in the management's conference call, which painted a subdued picture for the sector in the near term due to structural challenges.
The management pointed to demand de-growth of 2 per cent in the housing segment, which consumes about 70 per cent of the cement produced. Due to this, cement demand is likely to improve slowly. Besides fund crunch and slow growth in sales, the housing segment is also impacted with the implementation of RERA (Real Estate Regulatory Act), which according to exports, gives better pricing power to big builders as they can dictate prices to cement manufactures. As a result, cement manufacturers would be unable to record higher margins in the next two quarters.
However, improvement in execution of infrastructure projects, especially government awarded ones, should create reasonably good demand for cement manufacturers from the third quarter of the current fiscal. Two key points are made. Firstly, by FY19, the company plans to enhance capacity utilisation of the acquired plants to 70 per cent from 10 per cent at present. It also plans to achieve cash break-even by FY19. Many feel that this is quite possible in the next two years, given stable demand for cement in the central and coastal Andhra regions where these plants are located. The second point is the valuation of the company. As of late July, on FY18 estimates, the company was trading at a price to earnings multiple of 35.1, which is at 53 per cent premium to its five-year average price to earnings multiple of 22.8. This appears quite expensive.
In Q1FY2017 quarter, the company has beaten most revenue estimates by three to four per cent recording a growth of 6.8 per cent to Rs.7,034 crore on a year-on-year comparison. Its net profit grew by 15 per cent to Rs 897 crore in the June quarter in comparison with last year's June quarter.
Advantage Jaiprakash Associates
For JAL, the completion of the cement deal brings in some relief, although the group is still highly leveraged. Its group company-Jaypee Infratech Ltd-is one of the 12 borrowers that the Reserve Bank of India has referred to their creditors for start of insolvency proceedings at the National Company Law Tribunal.
By selling a part of its cement business at an aggregate value of Rs 16,189 crore, the proceeds will help JAL to reduce its debt of approximate Rs 14,000 crore, including repayment of its loan to its bankers, part payment to the holders of foreign currency convertible bonds, repayment of all outstanding fixed deposits and interest thereon, and other priority payments.
The business comprised operating cement plants spread over Uttar Pradesh, Madhya Pradesh, Himachal Pradesh, Uttarakhand and Andhra Pradesh, besides a grinding unit, which is currently under implementation in Uttar Pradesh.
JCCL has thus demonstrated its serious intent to de-leverage its balance sheet in pursuit of its objective of reducing debt, which is fully backed by adequate and high-quality assets. This objective could have been achieved much earlier but for various time-consuming regulatory approvals and amendments in various laws from time to time.
Manoj Gaur, Executive Chairman, JAL, observed: 'Jaypee Group has time and again shown its unflinching will to take proactive steps to help it tide over these turbulent times caused by economic slow-down.'
He further emphasised that Jaypee Group will now leverage its expertise in the fields of Engineering & Construction, Real Estate and other areas of national importance. Post this deal, Jaypee Group has retained a total of 10.60 MTPA capacity cement plants spread in across Madhya Pradesh, Uttar Pradesh, Andhra Pradesh and Karnataka.
For a consortium of banks led by ICICI Bank Ltd, it was the conclusion of the biggest 'stressed assets' resolution as yet in the country. As part of the deal, Rs 12,000 crore of loans on the books of JAL will move to UltraTech. Being classified as an NPA, the debt will be upgraded to AAA status (the highest credit quality). 'This is the largest asset resolution in the country so far and I hope that this landmark transaction will pave the way for more such resolutions,' comments Chanda Kochhar, CEO, ICICI Bank.
'The focus now will be on sweating these assets, consolidating and absorbing them. We will also be investing in these assets to upgrade them,' KM Birla said. He further added that despite the size of the acquisition, UltraTech's financial health remains extremely strong. 'Our debt to equity ratio is 0.6 and the debt to EBITDA is 2.6 times. We have refinanced the debt of the acquired assets,' he said. This debt has been refinanced by the lenders at a lower rate of interest, reports said.
The immediate benefit for the lenders will be in the form of reversal of provisioning, or the money set aside by lenders to cover stressed loans. For Q4 FY17, lenders had to make additional provisioning because the deal was yet to close. ICICI Bank, for instance, classified Rs 5,378 worth of exposure to JAL's cement assets as non-performing in that quarter.
Apart from ICICI Bank, Axis Bank, YES Bank and other lenders to JAL will see profitability increase on account of this deal in Q1 FY'18.
Birla Group's acquisition of cement business has come after a gap of almost 14 years and is said to be the largest acquisition of cement assets in India, admit the bankers. However, it is also the biggest 'stressed assets' resolution as yet in the country. The conclusion of the transaction, which the two parties had entered into in July 2016, comes after major developments in the Aditya Birla Group. It has seen merger of group companies Grasim Industries Ltd and Aditya Birla Nuvo Ltd, the spinning off and listing of the group's financial services business, and a mega telecom merger of its Idea Cellular Ltd with Vodafone's Indian business. However, this merger comes with both pros and cons. It has made UltraTech the largest cement entity in the country, when the country will witness cement demand grow -5 per cent over the next 5-6 years, which will be a challenging period for UltraTech. Consolidation in cement business will continue as a few are in offing including Ambuja Cement and ACC, which can trigger fight for market share in coming years.
- NITIN MADKAIKAR