Adani aims to be market leader by 2030; uncertainty to weigh on cement sector valuations: IIFL Capital Services

19 Sep 2022 , 10:57 AM

Adani becomes the 2^nd largest cement player

Adani Group has completed the acquisition of Ambuja Cements (ACL) and ACC Ltd (announced in May-2022), and has become the 2^nd largest cement group in India, with 67.5m MT operational capacity or 12% capacity share. Adani Group paid US$6.5 billion (~US$170/MT) to acquire Holcim’s stake and for the open-offer in the 2 companies – ACL and ACC. With this, Adani now holds 63.15% in ACL and 56.69% in ACC (of which, 50.05% is held through ACL).

Karan Adani to lead the cement business; Ajay Kapur appointed as CEO

Post the ownership change, the Board of the 2 companies has been reconstituted with Gautam Adani and Karan Adani appointed as the chairman of ACL and ACC respectively. Although Karan Adani is appointed as the non-executive director in both companies, media reports suggest that he will be leading the business. He is also heading the port business of the Group— the largest port company in India. ACL also appointed Ajay Kapur as the new WTD & CEO – a veteran with >25 years of industry experience, who started his career with ACL in 1993, and was with the company until 2019 when he was the MD & CEO. He being an old hand in the company, analysts at IIFL Capital Services believe, would facilitate a smooth and swift transition.

Building a war-chest to become the market leader

Another key decision taken by ACL’s new Board was to raise Rs200 billion equity through preferential allotment of warrants (at Rs419/share) to promoters (this would increase Adani’s stake in ACL from 63.15% to 70.3%). This would ensure company is ready for any inorganic growth opportunity, and is in line with Adani’s vision to ramp up capacities (including acquisitions) to become the largest cement company by 2030 (UltraTech is currently the largest player with 116m MT domestic capacity with plans to increase capacity to 200m MT over time).

Assuming per-ton cost of US$100-150 (greenfield/acquisition), the equity raised along with 1:1 leverage could support 35-50m MT capacity addition (50-75% of ACL-ACC combined capacity). Also, strong balance sheet of ACL-ACC (net cash position of Rs110 billion) with robust cash flows (OFC of ~Rs50 billion p.a.) would further drive capacity additions.

Industry could see further consolidation

Adani Cement (ACL +ACC), given its balance sheet and operating cash flows, can add 60-70m MT capacity (without leverage) in next 8 years, or 2x of that with 1:1 leverage. However, organic expansion is likely to be constrained by other challenges such as:

1) Long gestation period of greenfield projects (4-6 years).

2) Costly new limestone mining lease (post 2015 mines are awarded on auction basis where pricing is proving to be prohibitive).

3) Capacity constraints of equipment suppliers resulting in delays in execution.

Thus, if one is targeting to add capacities in immediate future, dependence on acquisitions is likely to be high. This, coupled with Adani’s plan to ramp up capacities, would mean industry could see another round of consolidation. Immediate target companies for Adani could be in region/states, where it has relatively lower market-share, to ensure faster approvals from CCI. Analysts at IIFL Capital Services note – based on the current capacity mix of ACL-ACC (on combined basis) – it has smaller presence in South India, Madhya Pradesh, Rajasthan, and Bihar.

Acquisitions at premium could limit the scope for aggressive pricing

A key overhang for the industry is – Can Adani adopt an aggressive pricing strategy to garner higher market-share with increase in capacities (the current utilization of 85% leaves little scope for market-share expansion)? However, if Adani were to ramp up capacities through acquisitions (high likelihood) and assuming deals are consummated at ~US$100-150/MT (~10-40% discount to Adani-ACL deal), even then to earn pre-tax ROCE of 14% (CY22 estimate for combined ACL-ACC), the EBIT/t has to increase by 2x-3x to Rs1,300-1,900/t (at 85% utilization). Although Adani has the potential to improve current profitability through cost optimization, given adjacencies with other group businesses (fuel sourcing, renewable power, logistics, etc.), savings are likely to be in the region of Rs200-400/t (the gap versus UTCEM and Shree), while the balance (Rs300-1,000/t) has to come through higher realizations. In this regard, there is no case for Adani to be aggressive on pricing, unless it acquires companies at much lower premium, or is ok to operate on lower ROCEs.

Also, as Adani needs to service the US$4.5 billion debt taken to fund the ACL-ACC acquisition, this would also require additional Ebitda/t contribution of ~Rs400 – assuming 7% cost of debt (including cost of hedging).

Uncertainty likely to weigh on sector valuations

Although analysts at IIFL Capital Services believe Adani is unlikely to lower industry profitability through aggressive pricing given the uncertainty (Adani is yet to share its plans— clarity likely in coming weeks) and the expectation of an aggressive capacity additions — is likely to weigh on sector valuations. The large cap companies could be more susceptible as some of the mid and small size players, are speculated to be the acquisition targets; could see rerating. As of now, analysts at IIFL Capital Services are not changing their positive stance on the sector, considering the strong medium-term outlook (expected demand growth of 6-8% p.a.). However, stock volatility expected in near term. Analysts at IIFL Capital Services will closely monitor events in the coming days, and revisit their view post more clarity by Adani Group on its expansion and profitability plans.

Adani has become the 2^nd largest cement player in India

Company	Domestic Capacity (mtpa)	% of India capacity
UltraTech Cement	114.5	20.3%
Ambuja + ACC *	67.9	12.1%
Shree Cement	46.4	8.2%
Dalmia Bharat	35.9	6.4%
Nuvoco Vistas Corp.	23.3	4.1%
The Ramco Cements	19.6	3.5%
Birla Corp.	19.3	3.4%
Chettinad Cement	18.3	3.2%
India Cements	15.5	2.8%
JK Cement	14.7	2.6%

Source: Company, IIFL Research * Combined capacity taken