Equity Research Report: ACC

ACC may be another example of a good business model in temporary disruption amid Adani's chaos; may scale 2900-4500 levels by Mar’24-Mar’26

ACC Limited (Formerly The Associated Cement Companies Limited) is an Indian leading cement producer. ACC is a subsidiary of Ambuja Cements-now both under the Adani group (Adani Cements). Originally ACC was formed in 1936 when eleven cement companies belonging to Tata, Khatau, Nixon, and Dinshaw groups merged to form a single entity, The Associated Cement Companies, headquartered in Mumbai (MH). Subsequently, the management control of the company was taken over by Swiss cement major Holcim Group in 2004. ACC operated as a subsidiary of Lafarge Holcim. On 1^st September 2006, the name of The Associated Cement Companies Limited was changed to ACC Limited. The company is the only cement company to get super brand status in India.

In mid-April’22, Holcim announced that it would exit from the Indian market after 17 years of operations as part of a strategy to focus on core markets, and listed its stakes in ACC and Ambuja Cements for sale. In mid-May’22, Adani Group officially announced that it would acquire Holcim's stake in Ambuja Cements and ACC for $10.5B. In Sep’22, Adani group (Adani Cement) bought the entire Holcim stake in Ambuja Cement and ACC for around $6.40B to become India’s 2^nd largest cement player. Holcim sold its entire 63.15% stake in Ambuja Cements, which owns a 50.05% interest in ACC, as well as its 6.64% direct stake in ACC. Adani group now has around 56.64% stake in ACC directly; i.e. Adani group is now the new promoter of Ambuja Cements as well as ACC.

Adani Cement or Adani Cement Industries Limited (ACIL) is a cement company based in Gujarat. It was incorporated by Adani Group on June’21. Adani Cement is a wholly-owned subsidiary of Adani Enterprises and has not begun its business operations. It was reported in June’21 that the Adani Group planned to set up a cement plant in Maharashtra which will have an initial capacity of 5 MT/annum with an approximate investment of INR 100B The Group has also proposed a 10MT/annum Lakhpat cement plant, but later put the plans for that plant on hold. 

Now, Adani Cement primarily consists of Ambuja Cement and ACC; Adani may also merge these two cement companies into Adani Cement eventually in the coming days. But as of now, ACC and Ambuja Cements are now running as separate units with separate listed entities, while maintaining synergies at arm’s length principle. Adani Cement (Ambuja Cement + ACC) now aims to double the capacity from 67.5 MTA to 140 MTA in the next 5 years to serve growing infra and housing demand across India including Adani group’s various infra projects. As in Q1CY22 ACC has 37 MTA installed cement capacity.

Now, ACC Limited (ACC) is a leading player in the Indian building materials space, with a pan-India operational and marketing presence. At the end of 2021, ACC has 17 cement plants, 78 ready-mix concrete plants, and 470 warehouses located across India. Synonymous with cement, ACC has established its reputation as a pioneer organization that has consistently set new benchmarks with its innovative research and product development. With experience and expertise spanning over eight decades, ACC is a leading maker of building materials (cement, ready-mix concrete) in India. Like all other major cement manufacturing companies, ACC is also a major beneficiary of India's growth story, the government's push for infra CAPEX and affordable housing. ACC has strong premium brands in waterproofing, tile adhesive, and ready mix segments.

Key management: ACC

Board Members: ACC

Key Shareholders: ACC (Promoter: Adani Group)

ACC/Ambuja Cements promoter Adani Group is an Indian diversified MNC holding/incubator/trading/infra/utility conglomerate, headquartered in Gujrat’s Ahmedabad and primarily involved in the mining and trading of coal and iron ore. Through its various subsidiaries, Adani also has business interests in airport operations, edible oils, road, rail, and water infrastructure, data centers, and solar manufacturing, among others. Through its various subsidiaries, Adani group is involved in edible oils and staple foods, solar PV manufacturing, road infrastructure, water infrastructure, data centers, agri-output storage and distribution, defense and aerospace, bunkering, rail and metro infrastructure, oil exploration, petrochemicals, cement, and mass/digital media. It may also foray into B2C (direct-to-consumer) space in the coming days.

The seven listed companies of the apples-to-airports Adani group have together lost about $125B in market value since a 24^th Jan’22 report by Hindenburg Research (U.S. activist investor and a known short seller) alleged the conglomerate improperly used offshore tax havens and manipulated stock and flagged concerns over its high debt levels. Hindenburg mainly alleged 7-original Adani group companies such as Adani- Enterprise, Transmission, Total Gas, Green Energy, Power, Ports, and Wilmar about stock price manipulation and various fraudulent activities.

Now being a part of the beleaguered Adani group, ACC scrip also ran ahead of its concurrent fundamentals in late 2022 from around 2000 to 2788 (+39%) and then stumbled to almost 1695 (-39%) a few weeks ago after the Hindenburg bombshell research report. Although Hindenburg didn’t accuse ACC/Ambuja Cement directly of any fraudulent activity, both scrips were caught in the crossfire. But ACC as well as Ambuja Cements are good asset/business models, which are in temporary distress due to Adani proximity.

The market may be also concerned about the leverage of the Adani group, which also pledged a significant part of the promoter’s stake to fund the Ambuja/ACC acquisition deal. Adani pledged around 56% stake in ACC (out of 56.64% direct stake) and 63% stake in Ambuja Cements (out of 63.1% direct stake) soon after completing the takeover from Holcim in Sep’22. In any way, after the Hindenburg controversy, the Adani group may prepay $500M bridge loans taken (for 6 months) out of the total Holcim deal financing package of $5.25B. Also, as per the report, Adani may pre-pay all loans against the pledging of shares by mid-March’23. Still, the market may be also concerned that Adani will use the positive cash flow of these two cement assets (Ambuja/ACC) to repay debt and fund other CAPEX.

Highlights of Q4CY22 report card: ACC (Consolidated-INR 100 Cr=1B)

·         Core operating revenue Rs.45.37B vs 39.87B sequentially (+13.78%) and 42.26B yearly (+7.36%)

·         Operating expenses Rs.41.58B vs 39.71B sequentially (+4.71%) and 36.70B yearly (+13.31%)

·         EBITDA Rs.3.79B vs 0.16B sequentially (+2214.65%) and 5.56B yearly (-31.84%)

·         Interest payment Rs.0.19B vs 0.18B sequentially (+6.43%) and 0.13B yearly (+46.43%)

·         Core operating profit (EBTDA=EBITDA-INTT) Rs.3.60B vs -0.01B sequentially (+26986.57%) and 5.43B yearly (-33.70%)

·         Core operating EPS (EBTDA/Share) Rs.3.83 vs -0.01 sequentially (+26986.57%) and 5.78 yearly (-33.70%)

·         EBITDA margin 8.36% vs 0.41% sequentially (+7.95 bps) and 13.16% yearly (-4.81 bps)

·         Interest/EBITDA: 4.97% vs 108.11% sequentially (-103.21 bps) and 2.32% (+2.66 bps)

·         The sequential jump in core operating EPS and EBITDA margin due to lower cost of fuel (coal) and logistics

·         In the September quarter, overall performance was affected due to lower volume (extended rainy season) and higher cost of coal amid Russia-Ukraine geopolitical tensions and economic sanctions

·         Reduced cost of fuel/coal due to maximization of low-cost domestic coal and zero import of U.S. petcoke

·         Fixed price long-term contract to mitigate price volatility

·         Lower logistic costs due to serving short-led markets directly and optimization of warehouse infra

·         Improved synergies between Ambuja and ACC to cater to natural markets at the lowest logistic costs

·         Improvement in the rail-road transportation mix

·         Planning CAPEX  to increase ownership of rail rakes

·         Also improving transport through shipping/coastal movement at lower logistic costs

·         Improving plant efficiencies, usage of alternate/green fuel, higher energy efficiencies to reduce power consumption, and taking steps to reduce packing bag cost by 15% with assured long-term supplies

·         Debottlenecking initiatives at various plants to improve capacity by 2-3 MTA

·         Raw material (RM) cost is expected to reduce by 5%

·         Fly ash dryer for the usage of wet fly ash

·         Long-term contract with Thermal power companies to bring down fly ash cost by 15%

·         Replacing costly gypsum with low-cost phospo-gypsum

·         Sales volume 7.7 MT vs 7.1 MT sequentially and 7.2 MT yearly

·         Better/growing demand and stable prices for cement and clinker with capacity utilization at 81%

·         Improving EBITDA/Ton (Rs.715 vs 335 sequentially and 602 yearly) due to higher sales of premium products (higher realizations) and lower operating expenses (OPEX) including logistics

·         Lower RM cost; expected in FY24 amid lower clinker purchase, optimization of raw & source mix, replacement of costlier fly ash by cheaper conditioned fly ash, and higher consumption of cost-competitive gypsum

·         Overall demand growth is expected to remain positive, facilitate higher capacity utilization, and cost reduction/optimization will result in higher EBITDA

Highlights of December QTR earnings concall: ACC (8^th Feb’23)

·         The first full-fledged quarter under the new promoter, Adani Group

·         Aretha project has been delayed by 6 months to Sep’24 (additional 1 MT cement and 2.7 MT clinker production)

·         Salai Banwa plant for increasing grinding capacity is almost complete

·         Commissioned WHRS at Jamul and Keymore get commissioned

·         The company has in a real sense embarked on a transformational journey, which has resulted in sizable operational efficiencies across all the business parameters and which has resulted in a good jump in the financial performance quarter-on-quarter

·         On the industry level, the cement industry saw higher capacity production with a good pickup in demand during the quarter

·         Sees a healthy increase in our top line of around, coupled with a good reduction in the overall cost led by lower fuel, RM, and logistic costs along with other operational efficiencies including better synergies between various Adani groups of companies including Ambuja Cements leading to higher EBITDA margin sequentially

·         Better synergies between Ambuja-ACC and other Adani group companies

·         The top line is expected to grow healthy going forward due to increasing demand, new capacity utilization, and debottlenecking of additional capacity and asset sweating

·         Strong product portfolios and brand values along with premium products in core markets

·         Expected higher demand for cement due to higher government CAPEX for infra and housing

·         Better performance on a standalone basis than overall consolidated

·         Virtually debt free with adequate cash in hand around will help both organic and inorganic expansion to achieve scale, market leadership, and higher profitability/margin expansion (by reducing cost)

·         Better management of the working capital cycle

·         Taking further steps to strengthen ESG leadership through the sustainable development plan

·         Aiming to double capacity to 140MT (ACC + Ambuja Cements) by the next five years as committed by Adani group during take over

·         Presently emphasizing organic/debottlenecking (greenfield & brownfield) expansion to enhance the operating capacity

·          Stressing on energy saving cost and synergies between various Adani group companies for raw materials and finished products ecosystem resulting in better synergies and optimization of OPEX

·         No foul play between related entities (group companies/subsidiaries) for dealing with coal; all cola trading/supply is as per regulatory framework/rule ensuring ‘arm’s length principle

·         Supply of coal by Adani group companies resulting in lower fuel cost to some extent

·         The present synergy between Ambuja Cement and ACC under Adani Cement resulted in a lot of cost savings, but an official merger is not on the table right now; may happen later

·         No foul play in the CAPITAL ADVANCE entry in Ambuja Cement/ACC B/S and it’s a part of normal CAPEX

·         No comment about the promoter’s (Adani) personal debt to acquire Ambuja Cement and ACC (whether the promoter can use Ambuja/ACC positive cash flow); but there is a definitive dividend distribution policy in place

·         The company is looking to leverage Adani port's coastal/sea transportation synergy to optimize cost and OPEX

·         As of now Ambuja/ACC is paying advance payments to various government companies for coal, and fly ash for secure supply; but the company (Adani Cement) is also exploring such supplies from various group companies as per the RPT pricing mechanism, which will ensure optimization of OPEX as there may not be any requirement of advance payment

·         There will be also synergy in railway transportation (by taking advantage of using own railway wagons under the railway scheme)

·         Despite aiming to be lower cost cement producer, Adani Cement/ACC will not undercut the market (by cutting prices); it will stress on expanding into a new market to cater to strong brands of Ambuja/ACC

·          But for B2B large buyer segment (various government/private infra projects); it may employ various pricing strategies to win the market

·         Presently Ambuja and ACC are working as separate cement divisions under common Adani Cement management, which is ensuring cost optimization synergy ensuring profitability of both entities separately without conflict of interest

·         Despite procurement synergies with various group companies, all individual company is ensuring their business interest by ensuring arm’s length and fair pricing strategy; i.e. it will not affect the financial performance of any group company and also at the discretion of any specific group company

·         Ambuja has a captive coal mine at Gare Palma, which caters to almost 20-25% of the overall coal requirement of Ambuja; but ACC has no such captive coal mine and is thus completely dependent on 3^rd party supply including imports

·         Ambuja/ACC was already under various cost-saving programs long before the Adani takeover, but the Adani group is now trying to add value thereby optimizing/lowering the cost of fuel, RM, and logistics due to various synergies with group companies

·         Industry (cement) demand will grow by around 8-10% CAGR if the economy continues to grow around 6-8% (real GDP)

·         The company believes in India's growth story will ensure much higher per-capital cement consumption in the country in the coming years

·         EBITDA/Ton will grow robustly in the coming quarters

·         Presently Adani Cement is paying some royalty payment to Holcim, but from March QTR, there will be no such payment and the company is expected to add in cash flow

·         IT transition from the Holcim group is now almost complete

·         The company is expected to complete all the CAPEX-related expansions/debottlenecking by mid/late 2024; may provide more details during March’23 earnings concall

·         A new promoter (Adani) is infusing fresh capital into the company as per commitment, but ACC/Ambuja cement has already adequate free cash in hand while generating robust cash from operations every year; thus having a substantial cash-rich company along with zero debt status, CAPEX amount is not an issue

Conclusions:

Under the banner of Adani Cement, ACC/Ambuja now aiming to increase EBITDA margin by various cost/group synergies coupled with the expansion of capacity to cater to growing demand in India, expected to be around +10% CAGR in line with nominal GDP growths and the government emphasize on infra/housing CAPEX. India’s cement manufacturing capacity is now estimated at around 525 MTA, which may reach around 600 MTA by 2025; i.e. an average CAGR of around 7% against a projected demand increase of around 10%. India’s cement production reached 329 MTA in FY20 and is projected to reach 381 MTA by FY22 against the consumption of around 327 MTA (FY20) and an estimated 379 MTA (FY22).

There is also good pricing power as the cement industry is now in a virtual cartel among the top 10 players after consolidation, JV, MSA, etc in the last few years. India’s top-10 cement players are now Ultra Tech (market share 25%), Adani Cement (14%-Ambuja + ACC), Shree Cements (7%), Dalmia Bharat (5%), Birla Corp (3%), India cement (3%), Orient Cement (1%), and Heidelberg Cement (2%). India is the 2^nd largest producer of cement in the world after China and accounts for more than 7% of the global installed capacity. The government's thrust on various infra projects including transport, affordable housing, and the construction sector is a huge boost for the cement industry. Also, various state elections in 2023 before the early 2024 general election, the G20 presidency, and the likely bid for the 2035 Olympics by India may result in substantially higher infra spending and cement.

The Indian Federal and state government may spend over Rs.20T for infra in FY24 across various projects from transportation (railways and roads), healthcare, education, housing, and urban/rural development. Looking ahead India will also spend a cumulative Rs.100T from 2022-27 for various infra projects under PM Gati Shakti's plan. All these require incremental/huge amounts of cement. India has the advantage of the ready availability of raw materials for making cement, such as limestone, gypsum, fly ash, and coal (affordable fuel).

In 2022, the EBITDA margin of most of the cement manufacturers including ACC/Ambuja cement was affected due to higher energy (power & fuel-coal, pet coke) costs coupled with RM and logistic costs amid Russia-Ukraine geopolitical tensions, economic sanctions, and global supply chain disruptions. But now in 2023, input cost pressure is easing gradually, but still uncertain as there are no signs of any truce between Russia-Ukraine/NATO/U.S. proxy war.

Fair valuation: ACC: Rs.1533 (Present); Rs.1854-2318-2897-3622-4527 (CY23-26)

ACC reported a core operating EPS of around Rs.74.17 in CY22 against 156.58 in CY21, 122.24 in CY20, 123.76 in CY19, and 104.28 in CY18. The performance in 2020 and 2022 were affected due to COVID and Russian war disruption. Now considering various pros & cons as discussed above, Adani’s efforts to optimize the cost of production, higher volume, and the expected surge in demand for cement amid the government’s infra thrust, ACC may report +25% CAGR in core operating EPS from CY23-26. Thus assuming core operating EPS around 92.72-115.89-144.87-181.09 and an average core operating PE of 25, the fair value may be around 2318-2897-3622-4527. As the financial market generally discounts 1Y projected EPS in advance, ACC may scale 2318-2897-3622-4527 by June’23/Dec’23-Dec’24 and Dec’25.

Risk: Proximity of Adani group

Adani Cements is now trying to reduce/optimize production costs by replacement of costlier fly ash with cheaper conditioned fly ash, and higher consumption of cost-competitive gypsum. This may affect customer trust in the brand ACC/Ambuja cement under the Adani group-.

The credibility of the Adani group may be far below that of Tata, and Reliance (under Mukesh Ambani) for a long, but it’s a known fact and most of Hindenburg’s report contents/allegations are nothing new. But at the same time, no big industrialist/business entity is a saint; they are improvising as per evolving political and economic situation/reality in the country. Adani Enterprise is involved in various traditional infra and utility projects, which have a normally long gestation period, capex heavy, and low operating margins. Adani Enterprise is expecting India's growth story will reflect in its growth in the coming days.

Now considering its proximity with the current Federal Government of India (Modi/BJP), also various non-congress or even congress-ruled state governments, and infra thrust ahead of the G20 event, 2024 general election, and likely big sporting events in the next 10-20 years, the transition from fossil fuel to EV, all infra/utility/cement companies including Adani may also report robust growth in EBITDA in the coming years.

Thus without considering the Hindenburg report/allegations, Adani’s reply, and current political controversies, if we only believe in Adani’s financial statements, management commentaries, and potential India/Adani growth story, a world-class cement asset like ACC/Ambuja Cements may be an attractive investment in the current disruptive situation, especially if we consider almost zero debt for ACC/Ambuja (Adani Cements) balance sheet (unlike other Adani group companies which are highly leveraged).

In any way, Adani is an influential group. However, it’s not come under ‘too big to fall’ for the Indian economy, the government will not allow it to fall under any circumstances for the sake of the financial market and also political/BJP stability. Thus despite various controversies, the Adani group may survive eventually due to its proximity to not only BJP (Modi government), but also various opposition parties. It’s a reality that Adani is providing a huge political donation to not only BJP but also various other opposition parties including INC and TMC (like all other big business houses).

Also, as Adani is now a ‘symbol’ of nationalism and very close to the Modi admin (from Gujrat days), various government regulatory authorities may simply ignore the ‘noise’. And it may be also noted that Adani got a big break in Gujrat during Cong (INC) times (before Modi) for the Mundra port takeover. There are numerous examples of other non-BJP states, giving some infra contracts to the Adani group. But like Adani, various other big corporate houses like Ambani and Tata are also getting government contracts/policy favors and this is not a sin. Such industrialists are the pillar of the Indian growth story and create wealth, and jobs for the country.

Today’s India under PM Modi is vastly different from India under Singh/INC as far as political leadership is concerned. Modi is now very confident that the Adani ‘scam’ is not an issue with millions of voters at grass root levels; most of them are not concerned about the share market and do even not know much about the Modi-Adani relationship. Thus Adani issue will not affect the series of state elections in 2023 and the general election in early 2024, in which till now there is no alternative or credible opposition political leadership at the national level.

And despite huge falls in share prices for various Adani group companies, there is little panic among big Adani lenders or even in the market as smart investors/traders/HNI (including Ambani/Adani) all do short sell through various fronts (directly/indirectly) even their own companies in times of distress to take advantage of the volatility and possible margin call. This time, Adani is also able to meet the margin call without any big issues. In the worst case scenario due to any Adani default or growing political chaos, government/SEBI may first remove the Adani group of shares from benchmark Nifty (say, due to minimum 25% public shareholding controversy) and then government/lenders may force it to dilute holdings gradually, raise funds and reduce debt.

Once Adani is removed from Nifty, the overall adverse effect on the stock market will be minimal for any Adani mishap. Also, the actual weightage of Adani Enterprise and Adani Ports are very low in Nifty; their 1% combined volatility results in around 1.5 point move in Nifty, while 1% volatility in RIL causes around 20 points move in Nifty.

The problem with the Adani group is that it’s running a corporate house like a family business by various underqualified family members without any professional expertise/proper experience. Adani group is holding directly/indirectly almost 75-85% of the stake in their companies and then pledges a maximum of that stake to raise debt instead of the normal corporate/market process of diluting the stake gradually over years and raising money for expansion/diversification. Adani’s arch-rival Ambani family holds around 22% of the stake directly and indirectly, which is the standard global norm these days rather than relying too much on debt and controlling everything personally (including vital business decisions).

The issue with the Adani group of companies is that due to very low public shareholding and high family/personal holding, stock prices can be manipulated quite easily (through various fronts/shell companies) to skyrocketing high, paving the way for more margin/debt funding. Also, the Indian system of FNO trading makes it easier for the group/family to take advantage volatility of both sides (long/short) as one can sell in FNO without borrowing shares and vice-versa. But all these tricks may not be possible in highly liquid scrips like ACC and Ambuja Cements and the holding of the Adani family is also relatively low.

Technical view: ACC (LTP: 1835 as of 17/02/2023-EOD)

Looking ahead, whatever may be the narrative, technically, ACC has good positional support around 1695; and sustaining above 1695-1745, it may scale 1915/1955-2055/2155-2245/2375-2555/2660 and 2785 in the coming days. Sustaining below 1670-1640, ACC may fall further to 1580/1500-1475/1400-1275/1100-1055/1020 and even 885 in the worst-case scenario. Investors, looking for fresh entry or addition, may buy/accumulate ACC around 1695/1400 and 1020/885 levels.

ACC: Consolidated P&L A/C: Q4CY22

ACC: Consolidated P&L A/C: CY22

ACC: Consolidated B/S: CY21

ACC: Consolidated cash flow

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