The Shree Cement Ltd stock took a beating on Friday, correcting more than 3%. In the December quarter, the firm’s cement volumes grew moderately; realizations were weak and its power and fuel costs continued to surge. But these issues are not new and were already baked into Street expectations. So, what has weighed on the stock? It’s the cement maker’s first foreign acquisition.
Shree Cement has announced the acquisition of a 92.83% stake in Union Cement Co. (UCC), a United Arab Emirates (UAE)-based firm. The move is aimed at boosting the former’s cement capacity from 29.3 million tonne per annum (mtpa) to 33.3 mtpa.
At an enterprise value (EV) of $305 million (around Rs1,940 crore), the implied EV on a per tonne basis works out to $76, which is nearly a 41% discount to replacement cost in India, analysts said.
While this makes the deal look lucrative, there are concerns that cannot be overlooked.
According to Kotak Institutional Equities, the history of Indian firms venturing into West Asia has not been very promising. “Ultratech acquired Star Cement for a consideration of $290 million in April 2010. In FY17, Star Cement had a revenue of Rs12 billion (Rs1,200 crore) with Ebitda of Rs2 billion and PAT of Rs718 million, with no significant growth in the past three years," it said in a report.
Ebitda stands for earnings before interest, taxes, depreciation and amortization. PAT is profit after tax.
Others cautioned the UAE market is prone to price regulations and higher fuel cost, making it difficult to gauge the scope of improvement in margins for the acquired entity. The calculation of Edelweiss Securities Ltd shows UCC is likely to generate a low return on equity (RoE) of 6-7% at its current Ebitda margin of nearly 22%.
There is no risk of earnings per share, or RoE dilution, said the domestic broking house; but then, it doesn’t also see any great merit in the acquisition at current margins.
As the accompanying chart shows, most cement firm in UAE have similar Ebitda margins and a low RoE profile.
One may say the move is in line with the firm’s strategy of making acquisitions at lower costs and generating better return ratios. But how efficiently Shree Cement is able to meet its objective with this acquisition in a new geography is difficult to predict. “In our view, asset creation in India would have generated far higher returns for the amount invested and, hence, find it a sentimental negative in the immediate term," Edelweiss said.
UCC, which is currently a public joint stock firm listed on the Abu Dhabi Stock Exchange (ADX), will undertake the process of getting itself converted into a private joint stock company and delisting from ADX.
A slew of approvals are yet to be taken; hence, the transaction is expected to be completed in around nine months from now.
Meanwhile, the Shree Cement stock trades at a one-year forward price-to-earnings multiple of 35 times. It enjoys a premium over peers, given its ambitious target to become a pan-India firm by 2019 end and aims to surpass 40 mtpa cement capacity. The North-focused firm has been expanding domestically by adding capacities in other regions as well.
This means that to justify its rich valuations, domestic capacity additions have to be on schedule, and also this new acquisition has to prove lucrative. Without timely benefits of expansions reflecting in the company’s earnings, sustaining such high valuations will be tough.