UltraTech Cement: What Should Investors Do?

UltraTech Cement, India’s largest cement producer, is set to become even bigger in the next three years. The cement industry is consolidating and simultaneously increasing its production capacity, and UltraTech is at the forefront of this growth. The company is complementing its capex programme with cost efficiency investments, which could improve the profitability of the larger cement company. With a positive macro outlook, the case for UltraTech is strong, limited only by the current valuation premium. We recommend investors to hold the stock, which has the potential to deliver strong earnings growth over the next two years.

Consolidation and expansion

UltraTech Cement aims to increase its installed capacity from the current 150 million tonnes (mt) to 200 mt by the end of fiscal 2027. The company seems to be on track to achieve its targets. The company added 15 mt (commercialized and contributing to revenue) in the last year and expects similar growth in the next three years.

UltraTech has built almost half of its current capacity through acquisitions. This includes 21 mt from Jaypee Cements (EV110/tonne in July 2016), 6.2 mt from Binani (EV140/tonne in November 2018) and a consolidated 14.6 mt from Century Textiles (EV95/tonne in May 2018).

The company has completed two more deals in the last six months – Kesoram Cements was acquired in a share swap deal (at an implied valuation of EV 80/tonne) in November 2023; in two deals starting in June this year, UltraTech acquired a controlling stake in India Cements at an average price of EV 110/tonne for a capacity of 14.7 tonnes in South India.

Overall, the 200-tonne target implies a volume CAGR of 11 per cent by FY27, if achieved. Against the industry capacity utilisation of 70 per cent, UltraTech was operating at 85 per cent in FY24 and is expected to maintain the same.

Improving performance

The core costs of cement production are raw materials, energy and fuel, and logistics. The company aims to significantly improve two controllable factors, energy and logistics, over the next two years. Shipping distances are aimed at controlling logistics costs. Shipping distances were reduced by 15 km in Q1FY25 to 385 km for the consolidated operations. This resulted in an improvement in logistics costs in Q1FY25 of 5 percent/2 percent year-on-year and quarter-on-quarter on a per tonne basis. The company is targeting a reduction of 25 km over the next two years and is poised to surprise positively on this front given the Q1 results. Recent acquisitions are playing a role in the volume growth and also contribute to the geographical spread in the country, which is the basis for improving shipping distances.

Compared to the unit cost of traditional energy of ₹7, WHRS (waste heat recovery system) costs a fraction, and green energy costs ₹4 per unit. The company aims to achieve 60 per cent energy from WHRS and green energy by FY27 and 85 per cent by FY30. The company has improved from 25.7 per cent green energy in Q4FY24 to 29.4 per cent in Q1, resulting in a 2 per cent improvement in fuel cost per tonne during the quarter.

Finance, valuation

The company is targeting volume growth coupled with profitability improvement. Consensus estimates are for revenue and PAT to grow by 12 per cent and PAT by 25 per cent CAGR in FY24-26 due to dual impact. This is reflected in the valuation premium assigned at 35 times annual EPS compared to the 10-year average of 28 times.

But there are also headwinds that the company is facing. Realisations have been down 3 per cent in the last two quarters. This could be due to the election-related drop in demand and increased competition. While the election impact is a one-off, the latter will be a structural factor. Raw material costs have also been soft as crude oil costs have fallen. They are expected to rise in the coming quarters, even if a sharp increase is not expected.

The key drivers for the industry are overall demand and improved productivity, and UltraTech is well-positioned on both fronts. Rising demand in India has been met by increased supply (which has kept prices steady). The Indian cement industry has added 7 percent of its production capacity in fiscal 2024 to 626 tonnes, and overall demand is expected to remain in the 6-8 percent growth range in fiscal 2025. The rebound in rural housing construction is expected to take the lead from urban housing demand, helped by strong monsoons, and will come out of the persistent weakness in the rural economy over the past two years. The country’s ambitious infrastructure plan has maintained its momentum post-election, and capex has been maintained at higher levels.

With the industry expected to grow by 6-8 percent in volume growth, UltraTech could deliver a 200-basis point premium along with improving expense ratios. However, valuations should deter investors from holding the stock at the moment.