Synergy benefits can drive up to 14% EPS upgrade

Transcription

1 BSE Sensex S&P CNX 19,380 5, September 2013 Update Sector: Cement CMP: INR184 TP: INR188 Neutral Synergy benefits can drive up to 14% EPS upgrade Structure reduces equity dilution, increases EPS accretion Stock Info Bloomberg ACEM IN Equity Shares (m) 1, Week Range (INR) 221/148 1, 6, 12 Rel. Per (%) 6/2/-15 M.Cap. (INR b) M.Cap. (USD b) 4.6 Financials & Valuation (INR b) Y/E March E 2015E Sales EBITDA NP Adj. EPS (INR) EPS Gr. (%) BV/Sh. (INR) RoE (%) RoCE (%) Payout (%) Valuations P/E (x) P/BV (x) EV/EBITDA (x) EV/Ton (USD) Price as on 27 Sep 2013 Shareholding pattern % As on Jun-13 Mar-13 Jun-12 Promoter Dom. Inst Foreign Others Stock Performance (1-year) Proposed restructuring is value neutral for (ACEM), ex synergies and hold-co discount. Cash usage limits equity dilution, and offers better upside once benefits of synergies start percolating. Synergies of INR7.8b-9b (8-10% cost savings) are likely to support profitability (4-14% EPS accretion in CY14/CY15) and dilute our concerns over gradual decline in subsidy benefits post CY15. We expect synergies of 20%/50% in CY14/CY15. Balance sheet is likely to remain self-sustaining, despite usage of cash for stake purchase. We expect net cash to reduce from ~INR35b in CY14 pre-deal (standalone) to ~INR27b in CY14 post-deal (consolidated). While investors are concerned about hold-co discount for ACEM s stake in ACC, we believe ACC s higher payout and operating control by Ambuja may off-set concerns pertaining to normal hold-co structure. We are yet to factor in for this deal and resultant synergies. However, based on our preliminary estimates, ACEM trades at 8.9x CY14E EV/EBITDA and EV/ton of USD111. Maintain Neutral, with a revised target price of ~INR188. Restructuring fair at valuations for ACEM Holcim s restructuring transaction, in our view, proposes at-par valuation for ACEM (ex INR9b of guided synergy benefits and hold-co discount). Cash usage in deal structure limits equity dilution. Compared to an all-share deal, it is EPS decretive immediately, but offers better upside, once benefits of synergies and up-cycle start percolating. Balance sheet remains self-sustaining despite cash usage We expect ACEM s balance sheet to remain self-sustaining, despite INR35b cash outgo, as a net debt situation will arise only if ACEM goes for additional 10% stake purchase in ACC. We expect net cash to reduce from ~INR35b in CY14 predeal (standalone) to ~INR27b in CY14 post-deal (consolidated). Synergies to drive profitability, potential ~14% EPS upgrade in CY15 The management expects to derive INR7.8b-9b of synergy benefits (8-10% cost savings) comprising (1) INR3.5b-4b from supply chain optimization (cement and clinker swap), and (2) INR4.5b-5b from shared services, procurement and fixed cost reduction. The benefits would accrue over the next 2-3 years and would offset gradual reduction in subsidy, driving 5%/4% EPS accretion in CY14/CY15 (after factoring impact of cash outgo). We expect material swap to also (a) enable volume synergies by lowering regional capacity constraints, and (b) improve market mix by expanding reach. We are factoring in for synergy benefits of 20%/50% in CY14/CY15; entire benefits would accrue only in CY16. Jinesh Gandhi (Jinesh@MotilalOswal.com); Sandipan Pal (Sandipan.Pal@MotilalOswal.com); Investors are advised to refer through disclosures made at the end of the Research Report.

2 Synergies priced in at current valuations; maintain Neutral We are yet to factor in for this deal and resultant synergies, and await further clarity over the timeline and magnitude of the same. While investors are concerned about hold-co discount for ACEM s stake in ACC, we believe ACC s higher payout and operating control by Ambuja may off-set concerns pertaining to normal hold-co structure. ACEM trades at 8.9x CY14E EV/EBITDA and EV/ton of USD111. Maintain Neutral with a revised target price of INR188 (9x CY14E EV/EBITDA, assuming 20% synergy benefits and no hold-co discount). Use of cash optimizes EPS accretion vis-à-vis all-share deal Current All Share deal CY13E CY14E CY15E CY13E CY14E CY15E EPS impact ex-synergy benefits EPS (INR/sh) Pre-deal EPS (INR/sh) Accretion (%) Assuming 20%/50% of target synergy benefits of INR9b in CY14E/15E EPS (INR/sh) Accretion (%) * Assuming cash outflow of ~INR35b for purchase of Holcim India 24% stake happens in Jul-14 Estimate post-deal CY14E-based target price at INR175/share (including synergies) INR m CY13E CY14E CY15E Without synergies S/A EBITDA 18,673 24,285 29,037 Target EV/EBITDA (x) EV 168, , ,333 Less: Net Debt (adj CWIP) -45,362-18,695-34,043 Add: ACC's value 87, , ,907 Total Equity Value (INR m) 300, , ,283 Equity shares (mn) TP (INR/sh) w/o synergies With synergies S/A EBITDA 18,673 25,185 31,287 Target EV/EBITDA (x) EV 168, , ,583 Less: Net Debt (adj CWIP) -45,362-18,695-34,043 Add: ACC's value 87, , ,034 Total Equity Value (INR m) 300, , ,660 Equity shares (mn) TP (INR/sh) with synergies September

3 Transaction at par ex synergyies, holdco discount Use of cash limits dilution, balance sheet to remain self-sustaining Holcim s restructuring transaction, in our view, is neutral for ACEM (ex INR9b of guided synergy benefits and hold-co discount). Cash usage in deal structure limits equity dilution, and optimizes upside once the benefits of synergies and up-cycle start percolating. Synergies can drive up to ~14% EPS upgrade. Balance sheet would remain self-sustaining despite INR35b cash usage. We expect net cash to reduce from ~INR35b in CY14 pre-deal (standalone) to ~INR27b in CY14 postdeal (consolidated). ACEM and Holcim India to merge; ACEM becomes hold-co for ACC The deal that rejigged Holcim India s structure Holcim (ACC and ACEM s parent) has announced major restructuring of its India operations, which includes: Merger of its 100% subsidiary, Holcim India with ACEM Transfer of Holcim India s 50.01% stake in ACC to ACEM, making ACEM the holding company of ACC Acquisition of Holcim India s 50.01% stake in ACC by ACEM will take place in a two-step process comprising: Step I: ACEM to acquire 24% stake in Holcim India for INR35b in cash Step II: Holcim India to merge into ACEM, as ACEM will issue 584m shares to Holcim (Parent) for remaining 76% Holcim India s 9.8% stake in ACEM to be cancelled Post merger, Holcim will hold 61.39% in ACEM and ACEM will hold 50.01% in ACC. As an implied valuation, the deal derives ACEM / ACC swap ratio of 6.6, and Holcim India / ACEM swap ratio at 7.4. ACEM intends to further increase its economic ownership in ACC by up to 10% over 24 months following the transaction completion, not triggering an open offer. In-principle approval of ACEM Board is in place for a maximum amount of INR30b. This implies ~45% premium to current ACC share price. How the holding structure will change : 30 September

4 Based on the market price on the transaction date, Holcim India valuation is estimated at INR144b and overall Holcim holding at INR266b Deal valuation neutral to minority shareholders and parent Based on the current holding structure, Holcim s stake in ACC and ACEM was valued at INR145b (as per deal valuations), which is largely the consideration to be paid in cash and ACEM equity to Holcim (parent) by ACEM. The transaction does not have material financial impact on the valuation of Holcim s India holdings or minority shareholders. However, the impact on ACEM s valuation would be a function of hold-co discount ascribed by the market to its 50.01% stake in ACC. Otherwise, we believe the deal is proposed at fair valuations (0% hold-co discount). What Holcim used to hold in ACC and ACEM through Holcim India and directly Market cap (INR b)* Holcim India stake Value (INR b) ACC % ACEM % 28.9 Valuation of Holcim India ACEM % ACC % 0.7 Direct holding Holcim (Parent) valuation of India assets * Based on CMP on 24th July-13 and that is what ACEM is paying to Holcim to get Holcim India merged Consideration of INR145b (in cash + equity) for Holcim India has been at par STEP 1 - Purchase of 24% stake in Holcim India Cash Outflow (INR b) 35 Total valuation of Holcim India 144 Implied value of 24% stake 35 STEP 2 - Purchase of 76% stake in Holcim India Shares Issued to Holcim (m) CMP 189 Implied value of 76% stake 110 Total consideration 145 Source: Company/MOSL Transaction impact Holcim: No valuation impact transaction at par ACEM: At par assuming no holding company discount 30 September

5 ACC stake acquisition at relatively reasonable valuations Valuation (USD/Ton) Capacity (MT) Adhunik - Dalmia Lafarge - Barings PE Shri Jayajothi - CRH JP Gujarat - UltraTech ACC - Ambuja Synergy and up-cycle benefits to percolate better in current deal structure versus all-equity deal Use of cash limits dilution, allowing higher EPS accretion due to synergies We consider the proposed deal structure to be prudent as use of cash payment of INR35b would limit the equity dilution to 22% v/s potential dilution of 28.6% in case of all-equity deal. Moreover, yield on cash of ~8% (as at CY12) is lower than cost of equity. Cash usage in deal structure limits equity dilution, and optimizes upside once benefits of synergies and up-cycle start percolating. Synergies can drive up to ~14% EPS upgrade (v/s 11% upgrade in all-equity deal). Proposed deal format to outpace all-share deal in terms of EPS accretion in CY15 (with synergies) Use of cash optimizes EPS accretion vis-à-vis all-share deal Current All Share deal CY13E CY14E CY15E CY13E CY14E CY15E EPS impact ex-synergy benefits EPS (INR/sh) Pre-deal EPS (INR/sh) Accretion (%) Assuming 20%/50% of target synergy benefits of INR9b in CY14E/15E EPS (INR/sh) Accretion (%) * Assuming cash outflow of ~INR35b for purchase of Holcim India 24% stake happens in Jul-14 Balance sheet (ex synergies) remains self-sustaining despite cash outgo Post restructuring, ACEM s balance sheet strength should see interim deterioration on account of INR35b cash outgo for Holcim India s 24% stake. We expect ACEM to generate operating cash flow (OCF) of INR60b+, which would be sufficient to drive ongoing capex (including Nagaur Plant) of ~INR40b over CY Our estimate doesn t factor in benefits derived from synergies. On standalone basis, we estimate ACEM to remain net cash of ~INR12b/INR18b in CY14/CY15, after factoring in for cash outflow of ~INR35b for purchase of Holcim India s stake in July Even if it goes for additional 10% stake purchase in ACC from CY15 onwards for a maximum amount of ~INR15b per year in CY15/CY16, it will remain net cash at ~INR3b in CY15. On consolidated basis (pro-rata for 50% stake in ACC), we estimate ACEM s net cash to reduce from ~INR42b (pre-deal) to ~INR26.6b in CY September

6 ACEM s healthy OCF enables net cash position in balance sheet despite organic and inorganic growth ACEM s standalone balance sheet to remain strong (ex synergies) INR B CY13E CY14E CY15E Bengining cash balance OCF ACC dividend Capex Restructuring outgo Dividend outgo Y/E cash balance Additonal 10% ACC stake purchase -15 Y/E cash balance ACEM s consolidated cash position (pro-rata, ex synergies) INR B CY13E CY14E CY15E Bengining cash balance OCF Capex Restructuring outgo Dividend outgo ACC dividend income ACC dividend outgo Y/E cash balance Additonal 10% ACC stake purchase -15 Y/E cash balance ACEM s balance sheet to remain net cash (INR b) 30 September

7 Synergies to drive profitability Reduction in subsidies to be offset by synergy benefits Management expects to derive INR7.8b-9b of synergy benefits (8-10% cost savings). Synergies include (1) supply chain optimization of INR3.5b-4b (cement and clinker swap), and (2) INR4.5b-5b by shared services, procurement and fixed cost reduction. Benefits would accrue over the next 2-3 years and drive EPS accretion of 5%/14% in CY14/CY15. Over the long term, synergy benefits would offset the reduction in government subsidies from CY17 onwards. We expect material swap to also (a) unleash volume synergies by lowering regional capacity constraints, and (b) improve market mix by expanding reach. Synergies to drive meaningful cost savings The management expects the transaction to drive meaningful synergy benefits of INR8b-9b to be achieved within two years of completion of the transaction. The synergy benefits are almost equally attributable to ACC and ACEM. These include: Supply chain optimization: INR3.5b-4b Fixed cost reduction and procurement: INR4.5b-5b The management expects the benefits of supply chain optimization to percolate sooner than the benefits of fixed cost optimization, which may take 2-3 years. We have factored in for 20%/50%/100% benefits of targeted synergies in CY14/15/16. INR7.8b-9b of synergy benefits would require 2-3 years to percolate and would be equally distributed between ACC and ACEM Restructuring opens up scope for synergy benefits of INR7.8b-9b INR b Supply Chain optimization INR b INR2.7-3b INR b Fixed cost optimization INR0.1b INR7.8-9b Cement swaps and logistics Clinker swaps Procurement Fixed cost reduction Shared Services Total Synergies Key aspects of supply chain benefits comprise lower freights, lower cost of kiln and better service level Supply chain optimization Supply chain optimization would be targeted through five layers of synergies: (a) lead distance reduction, (b) cement/clinker swaps, (c) optimize production from lowest cost kilns, (d) shared assets at hubs, and (e) servicing high contribution areas by lowest cost plant. Cement/clinker swaps are key to optimization of supply chain and include the following swaps based on initial assessment: Clinker swaps with two ACC plants supplying clinker to two ACEM units. Clinker swaps with two ACEM plants supplying to four ACC units. Cement swaps with 13 ACEM plants supplying in parts of 21 states for ACC. Cement swaps with 10 ACC plants supplying in parts of 16 states for ACEM. 30 September

8 These initiatives should help to reduce cost to serve by 8-10% of per ton of freight cost, lead distance reduction and service level improvement. We expect material swap to also (a) unleash volume synergies by lowering regional capacity constraints, and (b) improve market mix by expanding reach. Scope of fixed cost reduction hinges on standardization, improving efficiencies, sharing backend, and power of negation on procurements Clinker and cement swap strategy will reduce lead distance and may result in volume synergies by expanding market reach Swap strategy will improve market mix and may lead to better realizations Shared services and fixed cost reduction Benefit from economies of scale in procurements, improvement in efficiencies, and common utility of back-end services, as follows: Integrated procurement through (1) process standardization and centralization, (2) vendor consolidation global / regional / local, and (3) service cost reduction and negotiation. Improve effectiveness and efficiency through fixed cost reduction: (1) achieving 85% of global benchmark in plants, (2) reduction in overall fixed cost by 5-6% in the fields of operations, administration, management and third party / outsourcing costs. Expand on existing IT model to join transactional backend processes, and HR, Commercial and Finance functions. Comparative regional advantage may enable volume synergies Cross-company clinker/cement swap could (a) curb the regional capacity constraints of ACC and ACEM by compensating through unutilized capacity of the other, and (b) increase overall market reach and dispatch volumes by releasing supply from capacities in proximity (refer illustrative examples on page 9 and 10). ACC s high utilization and no expansion plan in the North would be offset by ACEM s relatively lower utilization and expansion plan in the region. Similarly, ACEM s high utilization in Gujarat can be supported by ACC s Wadi plant while catering to the western parts of Maharashtra. Better market reach may lead to higher incremental volumes in the South and North-East. Pricing synergy and market reach augmentation ACC-ACEM s combined market share should enable better command on pricing, though the management has repeatedly hinted about competitive operations between the two entities. Additionally, as each one increases market reach due to complementary capacities of the other (grinding units, terminal etc), we expect overall improvement in market mix towards better pricing zones. 30 September

9 Fixed cost synergies focused on improving efficiencies and driving economies of scale Staff Cost (INR/ton of capacity) Other Expenses (INR/ton of capacity) MCEM SRCM ^ ACEM UTCEM * ACC + ACEM ACC MCEM SRCM ^ ACEM UTCEM * ACC + ACEM ACC ^ incl Merchant Power; * incl White Cement & RMC ^ incl Merchant Power; * incl White Cement & RMC Capacity map of ACEM and ACC: Various location advantages A few illustrative examples highlighting possible synergy benefits We have analyzed some logistics benefits ACEM may derive through clinker and cement swap with ACC, based on their plant locations and our understanding of the current dispatching zones of these plants. 30 September

10 Dadri grinding (ACEM) would get clinker supply from Lakheri plant (ACC) instead of Rabriyawas (ACEM). Western MP market would be catered better by Lakheri (ACC) than Rabriyawas (ACEM), freeing up capacity for the North. Dadri (ACEM) would free up Tikaria (ACC) capacity to focus more on East UP and Bihar, and Chaibasa (ACC) would focus more on West Bengal market at lower lead distance. This should free up ACEM s WB capacity to supply to Assam and other North East states, and thus, enhance market reach. Farraka and Sankrail grinding (ACEM) would get clinker from Chaibasa and Bargarh (ACC) rather than from Bhatpara (ACEM). Current cement supply from Chaibasa (ACC) to North East could be done through Farraka grinding (ACEM), helping to achieve savings on cement transportation cost. Ambujanagar plant (ACEM) supplies cement to its Cochin terminal and upcoming Mangalore terminal, which could be serviced by TN/Karnataka plants of ACC. Maratha plant (ACEM) may go for cement swap with Wadi plant (ACC) to cater to West Maharashtra, and in turn focus more on catering to East and Central Maharashtra. Red dotted line ( Blue line ( ): Existing arrangement for clinker/cement supply ): Potential arrangement for clinker/cement supply to reduce lead distance Source: MOSL 30 September

11 Synergy benefits to off-set impact of gradual reduction in subsidies Gradual decline in government subsidies has been a key overhang against sustenance of ACEM s profitability. ACEM enjoys ~INR4b of annual government subsidies, which implies INR /ton of EBITDA on ACEM standalone dispatches. Existing benefit will start gradually reducing from CY17, new incentives for upcoming capacities would dilute impact of exhaustion of existing subsidies. Further, we believe the restructuring synergies, as quantified by the management at ~INR4.5b for standalone ACEM (and INR5.6b-7b for consolidated ACEM) over the next 2-3 years, would be a strong cushion to offset the impact of gradual reduction in subsidies. Lastly, Ambuja would also benefit from Holcim Leadership Journey program which focuses on further strengthening market and cost leadership globally, including India. Government subsidies have been a key contributor to ACEM s cost advantage Subsidies from Govt (INR m) 3,200 3, Subsidies from Govt (INR/ton) 4, CY10 CY11 CY12 Holcim Leadership Journey In 2012, Holcim globally launched Holcim Leadership Journey (HLJ) program to further strengthen market and cost leadership globally, with aim to increase operating profit by at least CHF1.5b by end CY14. The HLJ program would focus on: Customer excellence by improving customer focus and innovation Cost leadership by a) increasing energy efficiency, b) use of alternate fuels/raw materials, c) reducing logistic costs by at least 5%, d) streamlining of procurement globally and e) fixed cost savings Reduction in working capital and selective divestments Reduction of the investment cost per ton of new cement capacity by up to 20% Further development and generation of talents and leaders as well as strengthening of the social dialogue with all stakeholders Ambuja and ACC are also part of the HLJ program, and would benefit from this global drive by Holcim. It has charted out blue-print of various projects to be undertaken, benefits of which will start coming from CY14 onwards. This program is independent of synergies of ACC s acquisition. 30 September

12 Synergies priced in current stock valuations High dividend payout of ACC, ACEM to limit hold-co discount The transaction gives ACEM a strong pan India footprint and meaningful synergy benefits at fair valuation, and a reasonably prudent structure. While investors are concerned about hold-co discount for ACEM s stake in ACC, we believe ACC s higher payout and operating control by Ambuja may off-set concerns pertaining to normal hold-co structure. ACEM trades at 8.9x CY14E EV/EBITDA and EV/ton of USD107, and offers limited nearterm upside. Maintain Neutral a revised target price of INR188 (9x CY14E EV/EBITDA, assuming 20% synergy benefits and 0% hold-co discount). Deal is attractive The deal will give ACEM (and ACC) a pan India capacity footprint, with combined capacity of 59.5m tons (ACEM s stake: 46.7m tons) as at CY13 and 68.3m tons (ACEM s stake: 59.4m tons) by CY16 post completion of ACC s Jamul (Chhattisgarh) and ACEM s Nagaur (Rajasthan) expansion. As discussed in the earlier section, we believe the transaction proposes (1) atpar valuation, (2) reasonably prudent structure, (3) does not overstress the balance sheet, and (4) renders meaningful synergies to drive profitability. The deal also offsets concerns over declining cost advantages due to diminishing subsidy benefits and rise in Holcim royalty, by providing synergy benefits. but current stock valuations fairly factors in for the same Pre-transaction, we valued ACEM at 9x CY14E EV/EBITDA or INR173/share. While we believe that the transaction fairly values ACEM, the impact on valuation would be driven by the extent of hold-co discount, if any, for its 50.01% stake in ACC. We assume 0% hold-co discount, translating into a revised target price of INR188 (9x CY14E EV/EBITDA, assuming 20% synergy benefits). We are not yet factoring in the synergy benefits in ACEM s profitability, as we await further clarity on the magnitude and timeline of the same. Our target price (post hold-co discount) implies EV/ton of USD103 on ACEM s effective CY14E capacity of 44.9m tons. ACEM trades at 8.9x CY14E EV/EBITDA and EV/ton of USD107, and offers limited near-term upside. We maintain our Neutral rating on the stock. Re-rating hinges on (a) faster realization of synergy benefits, driving up profitability, and (b) faster return of pricing power to the industry. 30 September

13 Our revised target price of INR188/share assumes 0% holding company discount, and factors in for 20% synergy benefits in CY14 Estimate post-deal CY14E-based target price at INR188/share (including synergies) INR m CY13E CY14E CY15E Without synergies S/A EBITDA 18,673 24,285 29,037 Target EV/EBITDA (x) EV 168, , ,333 Less: Net Debt (adj CWIP) -45,362-18,695-34,043 Add: ACC's value 87, , ,907 Total Equity Value (INR m) 300, , ,283 Equity shares (mn) TP (INR/sh) w/o synergies With synergies S/A EBITDA 18,673 25,185 31,287 Target EV/EBITDA (x) EV 168, , ,583 Less: Net Debt (adj CWIP) -45,362-18,695-34,043 Add: ACC's value 87, , ,034 Total Equity Value (INR m) 300, , ,660 Equity shares (mn) TP (INR/sh) with synergies Impact on ACEM valuation hinges on holding company discount market would like to ascribe for ACC stake Target price sensitivity based on holding company discount on ACC stake Holding Co. Discount W/O Synergies With Synergies 0% % % % % % September

14 Financials and valuation 30 September

15 Financials and valuation 30 September

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