JP deal: Big leap for UltraTech

Acquisition of JP group's cement assets will enhance market share, but it's likely to be earnings-dilutive initially

UltraTech Cement’s acquisition of 21.2 million tonnes per annum (mtpa) cement plants of Jaiprakash Associates (JP) at an enterprise value (EV) of Rs 16,189 crore saw the stock correct one per cent on Tuesday, but the deal has many long-term benefits.

In pursuit of its leadership position, UltraTech came one more step closer to achieving 90 mt capacity with this acquisition. UltraTech’s board, in continuation of its agreement signed on March 31, 2016, approved the acquisition on Monday. Although the EV has gone up by Rs 300 crore to Rs 15,900 crore mentioned at the time of signing the agreement, it is believed to be on the back of resolution of environmental issues at one of JP’s plants and clarity on the transfer of captive limestone mines to UltraTech.

The Union Cabinet had approved amendments to the Mining bill (MMRDA Act), which now allows for the transfer of limestone assets associated with the plants. Earlier, transfer of mines was not allowed and auctions were the only viable route to acquire mines. Nevertheless, the increase in amount is not big to alter the deal valuations significantly.

UltraTech will also be spending an additional Rs 470 crore for completion of 4 mtpa grinding capacity, which is under construction. The overall EV of the deal at $116 a tonne is, however, still lower that $120 a tonne that UltraTech had paid for acquiring JP’s Gujarat-based cement assets. Analysts at Kotak Institutional Equities say valuation of $116 a tonne is at 43 per cent discount to the current trading multiple of UltraTech, while analysts at Edelweiss say the deal is net present value (NPV) positive at Rs 4,800 crore. NPV is the difference between the present value of cash inflows and the present value of cash outflows, and is used in capital budgeting to analyse the profitability of a projected investment or project.

The UltraTech stock hit 52-week high of Rs 3,600 on Tuesday before closing at Rs 3,371 as broader markets also trended down. The deal is likely to be completed in a year’s time, boosting UltraTech’s cement capacity to 91.1 mt and strengthening its presence in Central India.

About 50 per cent (11.4 mt) of the capacities being acquired are in Satna cluster of Madhya Pradesh where UltraTech has limited presence currently. Further, the other capacities being acquired in eastern UP, Himachal Pradesh, Uttarakhand and coastal Andhra Pradesh will also help UltraTech gain mileage in the North and Southern parts of India, leading to market share gains. Analysts point out that UltraTech will see significant reduction in transportation costs, too.

However, the deal can be earnings per share (EPS) dilutive in the interim. The acquired cement capacities will generate earnings before interest, taxes, depreciation and amortisation (Ebitda) per tonne of Rs 700 in FY18 according to Edelweiss, which is lower than UltraTech’s current Ebitda per tonne of above Rs 900. However, the profitability can improve thereafter through economies of scale and cost rationalisation.

For the acquisition, UltraTech will pay through a combination of redeemable preference shares and non-convertible redeemable debentures (Rs 2,820 crore consideration to Jaiprakash Associates and Rs 1,800 crore consideration to Jaypee Cement Corporation) and this essentially means that UltraTech will assume a debt of Rs 12,000 crore in its books, say analysts at Kotak. Analysts at Edelweiss say the deal has a concession from bank of five-year principal moratorium, which is a positive.

For JP group, which has around Rs 65,000 crore of consolidated debt, the asset sale will help it pare about 25 per cent of the leverage. The stock, after seeing lows of Rs 5.30 in June, has now more than doubled to Rs 11.62; it was up 28 per cent on Tuesday. However, JP will still be left with substantial outstanding debt. Though the company has more assets that it will be looking to liquidate and reduce debt, until further sales happen, it is still not out of the wood.

Even as the management claims major lenders will not to invoke strategic debt restructuring, a lot needs to be done for the Street’s sentiments to revive.

Also, the sale of assets will impact operating profits of the company. Since more profitable assets are being sold first, will the operating profits be able to meet interest costs on the remaining debt still needs to be seen, say analysts. JP had incurred losses at operating levels itself during March’16 quarter (standalone) and widening of net losses is also not a good sign.