Orient Cement-Jaypee deal: debt, other concerns weigh on the stock

The bottom line is deal will aid Orient Cement scale up, diversify and save on freight cost, but analysts expect it to take more than two years to become earnings per share accretive


The outgo from Orient Cement for these acquisitions is nearly Rs1,730 crore, which entails significant equity dilution; at current market price, on the targeted D/E, it works out to around 11-13%. Photo:
The outgo from Orient Cement for these acquisitions is nearly Rs1,730 crore, which entails significant equity dilution; at current market price, on the targeted D/E, it works out to around 11-13%. Photo:

In an attempt to boost capacity and expand its footprint into new markets, Orient Cement Ltd has struck a two-pronged deal with Jaypee Group to purchase a pair of cement businesses at an enterprise value of Rs1,950 crore.

The deal was announced post-market hours on Thursday and is in line with Orient’s strategy to nearly double its capacity from the current eight million tonnes per annum (mtpa) to 15 mtpa by FY20. This acquisition will take its total capacity to 10.2 mtpa.

Orient Cement will buy a 74% stake in Bhilai Jaypee Cement Ltd (BJCL), which has an equity value of Rs850 crore excluding debt of Rs600 crore. Secondly, for the Nigrie Cement grinding unit in Madhya Pradesh, the company will shell out Rs500 crore, which includes debt of Rs 90 crore.

This deal will be funded through a mix of equity and debt and the target debt-to-equity (D/E) ratio has been set at 1.6 times, the company’s management said in a conference call post the announcement.

But investors didn’t cheer this development, as shares of Orient Cement were under pressure on Friday and closed more than 6% down. What could have made market participants nervous is the debt that comes along with these assets and the fact that this move will dilute the company’s earnings and return ratios in the near term, said analysts.

According to brokerage firm HDFC Securities Ltd, the outgo from Orient Cement for these acquisitions is nearly Rs1,730 crore, which entails significant equity dilution; at current market price, on the targeted D/E, it works out to around 11-13%.

“Orient is just emerging from a capex cycle having commissioned Chittapur plant in 2QFY16 with elevated leverage (D/E: 1.23 times). The new debt will delay the benefits of Chittapur capex from accruing as it ramps up and profitability improves,” said HDFC Securities.

Currently, both Bhilai and Nigrie plants are not operational, but the Orient management seems confident of a turnaround within two years and expects to reach utilization of 70% once it resumes operations. But as of now, there is limited visibility on how a turnaround will happen, so this may also have added to the pressure on the stock, added analysts.

Talking of expansion, Orient Cement would get a foothold in central and eastern India markets once this deal goes through, but the challenge is to make a mark in the east, which is a crowded market.

Meanwhile, since this acquisition is subject to a slew of approvals, from Steel Authority of India Ltd (in case of BJCL), the Competition Commission of India and other regulatory nods, the company expects this transaction to close in the first half of 2017.

The bottom line is this move will aid Orient Cement scale up, diversify and save on freight cost, but some analysts expect this deal to take more than two years to become earnings per share accretive. Hence the pressure on the stock may continue for now.

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