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Thursday, August 29, 2013

Feature: A win-win deal for UltraTech and JP Associates
Sharekhan Research/Mumbai 29, Aug 13
Photo, Courtesy: The Economic Ti mes
Event: JP Associates-UltraTech deal for 4.8mt Gujarat cement plant in final stage

According to media reports, JP Associates (JPA) after a long negotiation for more than one year to sell stake in its Gujarat cement plant is close to finalising a deal with UltraTech Cement (UltraTech). JPA had earlier transferred its cement plants located in Gujarat and Andhra Pradesh with a total installed capacity of 9.8mtpa to its wholly owned subsidiary, Jaypee Cement Corporation. Jaypee Cement Corp, as the new company is called, runs two plants in Sewagram, Kutch, and Wanakbori, Gujarat, each with a capacity of 2.4 million tonne, and a 5-million-tonne unit in Andhra Pradesh's Krishna district. 

Deal value: EV/tonne of $120 (@Rs65/USD); lower than expected and at discount to recent deal values

According to media reports, the deal with UltraTech for the Gujarat cement plant of capacity of 4.8mtpa is likely to cost Rs3,700-3,800 crore, which turns out to EV/tonne of around $120 (at exchange rate of Rs65/dollar). This is a step down from the earlier expectation of EV/tonne of $160-170 by JPA’s management even after considering the steep depreciation in the rupee against the dollar. If the valuation figure being speculated in the media is right, the deal would cost almost half of the $230/tonne paid by Baring Private Equity for a 14% stake in Larfarge India. Thus, we believe that the deal could also involve the transfer of some debt related to the cement business to UltraTech. Especially since JPA’s cement plants are strategically located (with access to both western and central regions) and the deal value is at a steep discount to the recent deals in the cement industry.

Positive for the debt-laden JP group

Notwithstanding the lower than expected valuation, the de-leveraging of the balance sheet through the sale of an asset is a positive step for the debt-laden JPA. As of June 2013, the company has total borrowings of over Rs45,000 crore at the consolidated level (a debt/equity ratio of 3.8x) and around Rs23,000 crore (a debt/equity ratio of 1.8x) on a stand-alone basis. 

Asset sale to unlock value and re-rate the stock

Even at the speculated deal valuation, we believe the transaction would be earnings (earnings before interest, tax, depreciation and amortisation) positive for JPA. Moreover, the high debt burden was a drag on the stock’s valuation and the cash inflow would provide the much needed breathing space to the company. Going ahead, we expect JPA to monetise its cement asset located in Andhra Pradesh as well to further de-leverage its balance sheet. Moreover, we believe a huge land parcel in its real estate division will generate healthy cash flow over the longer run. In terms of valuation, we continue to value the JPA stock using the sum-of-the parts valuation methodology and arrive at a price of Rs63 per share. Hence, we maintain our Buy recommendation on the stock. 

UltraTech: opportunity to consolidate its leadership position at a reasonable price 

The development is positive for UltraTech as the demand environment in the western region is relatively better which will support the company’s volume growth in the coming years. Further, with the commissioning of its 9.2-mtpa cement capacity in Chhattisgarh and Karnataka, the outlook for volume growth of UltraTech is better than that for its peers. The company derives around 25% of its sales from the western region which we believe will improve on account of the likely deal with JPA. What’s more, going by media reports, the deal has been negotiated at attractive valuations taking full advantage of the market conditions. 

Retain preference for UltraTech

Among the large-cap cement companies, we have had preference for UltraTech for a long time due to its scale of operations and strong balance sheet. Further, the deal to buy a stake in JPA’s Gujarat cement plant and the commissioning of its own 9.2mtpa cement capacity would improve UltraTech’s volume growth outlook. However, the key risk remains in terms of higher than expected pressure on cement prices and an increase in the freight cost due to the de-regulation of diesel price. Hence, we maintain our Hold recommendation on the stock with a price target of Rs2,100.

Valuation:

We believe the deal is likely to be a win-win situation for both the companies as JPA could deleverage its balance sheet and reduce its interest outgo to some extent. On the other hand, UltraTech will be benefited in terms of an increased market share and the deal is at a decent valuation.

Going ahead, we believe JPA will monetise more cement assets located in Andhra Pradesh by way of stake sales which could further de-leverage its balance sheet.  

Source: Sharekhan Research