Cement stocks at new lows; the Ultratech effect

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The above is a collection of the largest cement companies in India by capacity. Of course, we have excluded ACC and Ambuja from the list as it would distort the picture since both the stocks are part of ongoing merger deal with the Adani group.

We have also included Grasim, which is a diversified company but its chunk of revenues comes from the consolidation of Ultratech. The story is the same across the board. Every cement company is trading close to its 52-week lows.
 

What exactly is this cement story?

Even before the Ultratech expansion plan was announced, the stock of cement companies were already under pressure. Most of the cement companies had tremendous cost pressure issues.

For example, power, freight and fuel is a major input cost for cement companies. In the last few months all these were in short supply and prices had gone through the roof. While the costs were going up, the cement companies were also increasing.
 

However, that only solved half the problem. Too much of price hikes invites a rap from the CCI on cartelization and hence cement companies have to be cautious. However, in a tight and competitive market, they can only increase prices to a point.

Hence in the last two quarters, the cement companies were witnessing an increase in sales with higher volumes and higher price realization. However, operating profits and operating margins were taking a hit on account of a spike in operating costs. That put pressure on stock prices.

Why was the Ultratech expansion the trigger for a big fall?
 

When Ultratech announced plans to expand its cement capacity by another 22.6 MTPA to 159.25 MTPA, it was obviously a response to the aggression shown by Adani group.

They had acquired ACC and Ambuja shares from Holcim and were putting nearly $10.5 billion on the block for control of 70 MTPA of cement. For Ultratech, the message was clear.

They had to run faster to stay in the same place, especially knowing the big volume that Adani group likes to play. That was the trigger for the Ultratech expansion plan at $76/tonne.

The expansion announced by Ultratech will be a mix of brownfield and greenfield capacity across regions on a pan-India basis. The additional capacity is proposed to be funded by a mix of debt and internal accruals.

The entire 159.25 MTPA capacity will be ready for going on production by mid-2025. The impact on the debt of the company was not supposed to be too high with debt/equity ratio at 0.2X. But that is also where the problem start.

The challenge for Ultratech, and what the markets are worried about, is that the capex plans could delay UltraTech's ability to go net cash positive by 2024. That was the original target and was expected to be a valuation booster.

With the new expansion plans worth Rs.12,886 crore, it looks very likely that the target of net zero debt would be achieved only by the financial year 2026. Net zero debt refers to having enough cash on books to repay full debt.

The real problem is that in times of weak demand and high fuel costs significant capacity expansion announcement tend to be negative. The higher input costs are likely to enhance the variable cost of cement manufacture by 10-15% and that will also impact the profits.

Also, more competition means tighter pricing and the pricing power of the cement producers may move back to the consumers. That is not positive for valuations.

Just in the last 1 week since the deal announcement, most of the large cement stocks have fallen between 8% and 13%. Things could get just about get tougher for cement stocks.