Ultratech is India’s largest producer of cement and aggregates. Earnings growth is highly dependent on the domestic construction cycle, and on infrastructure spending.
Net sales in the first quarter of this financial year are below our expectations. This was led by fall in price realisations and fall in adjusted Earnings before interest, tax, depreciation and amortization (EBITDA) margins. The subdued pricing, especially in South India, has impacted the profitability.
We maintain our narrow moat rating on the company, which is underpinned by Ultratech's strong pricing power in key markets which helps in generating sustainable excess returns on invested capital. The industry-level entry barriers that benefit Ultratech stem from the proximity to raw-material sources that manufacturing plants require, capital intensity, and cement's low value-to-weight ratio. High fair value uncertainty reflects exposure to construction and housing, which are cyclical and linked to economic activity.
All-India average cement prices have moved by about 9% in June to Rs 322 per bag from Rs 297 per bag. Recent price hikes will help improve the profitability of Ultratech's operations in south and east India. Our 5-year forecast includes 10% compounded capacity addition buoyed by both organic and inorganic expansions to achieve this growth. Long-term demand for building materials remains attractive as the Indian government pursues its spending on infrastructure and housing while per capita consumption of cement remains low as compared to the developed countries.
Also, we expect Ultratech will lead the industry consolidation, as smaller competitors struggle to achieve capacity expansion that keeps pace with demand growth, and rising power and freight costs. The implied exit multiple in our discounted cash flow model is about 10 times enterprise value/EBITDA or EV/tonne of $200 for fiscal 2016.
Our fair value estimate remains Rs 2,319 per share, which was about 18-20% discount to the prevailing market price at the time of initiation of coverage of Ultratech in June this year. Since, then stock has corrected to Rs 2410, about 3-4% at the premium to our fair value, clearly affirming our thesis.
