Birla's most valuable player

THE ECONOMIC RATIONALE OF IT ALL didn’t make sense to many back in July 2004. Kumar Mangalam Birla, chairman of the now $35 billion (Rs 1.84 lakh crore) Aditya Birla Group, was pulling out all the stops to acquire debt-laden, marginally profitable UltraTech Cemco, Larsen & Toubro’s cement division. Though a drain on L&T’s finances, Birla company Grasim Industries had forked out Rs 2,200 crore over three years (see timeline) for a majority stake in what’s now called UltraTech Cement.

Grasim had valued it more than ACC and Ambuja Cement (Gujarat Ambuja then)—bigger and more profitable cement companies. The amount was six times Grasim’s net profit in FY03 and nearly three-fourths its market value. This for a company that returned a paltry 5% on assets—about half that of other cement companies such as ACC, Ambuja, and Grasim’s own cement business.
Today, UltraTech is getting ahead of Hindalco Industries, Grasim, and Idea Cellular, the biggies of the group, in more ways than one. Its market capitalisation of Rs 40,000 crore is nearly 70% more than that of Hindalco, the group’s largest revenue grosser, ranked nine on the Fortune India 500 list.

UltraTech’s FY11 cash profit of Rs 2,200 crore is more than Grasim’s Rs 1,350 crore. Though less than that of Hindalco and Idea, it is growing at a much faster clip: It doubled its cash profit in the last three years while they grew just 25%. The gap between the two companies and UltraTech is expected to narrow further given the turmoil in the aluminium and copper industries (which will affect Hindalco) and the margin pressure in telecom (Idea).

The street is expecting bigger things from UltraTech. “It has been an outstanding performer despite the industry’s down cycle the last five years. Just imagine its financial performance when the business cycle turns favourable in the next few quarters,” says Ajay Parmar, head of investment banking at Emkay Global Financial Services. He expects UltraTech’s FY12 cash profit to be Rs 3,500 crore—nearly 60% more than last year—at a time when other companies are struggling to make their numbers look good.

ALL THIS WASN’T SO OBVIOUS EIGHT years ago. The “marriage” of UltraTech into the Aditya Birla family, as L&T chairman and managing director A.M. Naik called it, had its rough patch. Speaking like a fond father of the bride, Naik had said, “I feel sad because my daughter is going away, but I am also very happy for I have found a great son-in-law in Kumar Mangalam Birla.” What remained unsaid were the financial liabilities that L&T’s cement business carried.

Well aware that many Grasim shareholders were iffy about the deal, Birla had said: “We believe it will take about two to three years for UltraTech to provide a competitive return on the aggressive price offered to its shareholders.” He was firm that buying UltraTech, which had the largest capacity in the cement industry, was necessary if he wanted to be the market leader. And dealing with doubt was nothing new. He had faced it at an inexperienced 28, when chairmanship was thrust upon him following the death of his father, Aditya Vikram Birla, in 1995. Kumar Mangalam Birla wasn’t available for comment.

The stock markets, meanwhile, did their bit in adding grist to the naysayers’ mill. At the height of the cement boom in 2006, UltraTech reported losses and the stock traded at a discount to both ACC and Ambuja Cement. But with the backing of Kumar Mangalam Birla, UltraTech plodded on.

Born into a commodities powerhouse with interests in metals, chemicals, fertilisers, and fibre, Birla may have brought in an element of the new economy (telecom, BPO, financial services) into his group, but he continues to have implicit faith in commodities. It’s in his DNA. Cement has been part of the group for over 20 years—Grasim built its first cement plant in 1985—and Kumar Mangalam Birla saw what others didn’t. That cement offers great stability.

“Cement is the world’s most used commodity after water and its technology hasn’t changed much in the last 200 years. Its retail price isn’t more than Rs 5 per kg. It’s so cheap that spending money on developing an alternative doesn’t make economic sense. So I just need to become a cost leader to be successful and profitable,” points out a North India-based rival.

Cement’s other advantage is that it’s not traded on commodity exchanges. Transporting it over long distances is uneconomical—freight accounts for nearly a fifth of the retail price—and factories typically serve the market within a radius of 300 km to 400 km.
“This makes cement a regional play, but it also insulates it from the price volatility that metals, chemicals, fibres, etc., face at commodities exchanges,” says Dhananjay Sinha, co-head, research - economy and strategy, Emkay Global.

WITH STRONG SUPPORT FROM Kumar Mangalam Birla, UltraTech ignored its detractors who were focussing on immediate performance. It set its sights on the long term, even if that meant short-term setbacks. One way was to figure out L&T’s mistakes and fix them. This meant slashing UltraTech’s power bill, reducing debt, weeding out inefficiency, and injecting fresh capital.

K.C. Birla (not related to Kumar Mangalam Birla), chief financial officer, UltraTech, recalls, “When we made our first visit to the UltraTech facilities in late 2004, we realised there had been no fresh investment for years and the company was in maintenance mode.”

L&T had imposed a virtual freeze on fresh capital investment from the time the takeover battle started in 2001. Moreover, Naik’s instincts had pointed him elsewhere. An engineer, he always envisioned L&T as a top-notch engineering and technology company. “The cement division was an anomaly in his scheme of things,” says a senior cement company manager.

Under L&T, UltraTech had the highest power costs of the large cement makers. Its needs at that time were met through four sources—state grid, coal-fired captive power plants, diesel-fired generators, and naphtha-fired captive units, each accounting for a quarter of its load. Grid power was three times more expensive than coal-based captive power and diesel generators were twice as expensive.

Power and fuel costs were equivalent to nearly a third of UltraTech’s net sales as against ACC’s 11%, Ambuja’s 25%, and Grasim’s 17%. This had a direct bearing on its operating margins, which, at 11% of net sales was the lowest among the four companies.

“L&T cement had technologically advanced plants and strong brand equity but was losing (money) due to lack of a low-cost captive power plant,” says O.P. Puranmalka, business director at UltraTech and one of the architects of the company’s turnaround.

Reducing energy costs was one of the first jobs at hand—even if it meant buying some of the priciest equipment. An investment programme of Rs 1,800 crore was launched within months to increase coal-fired power capacity fourfold to 236 MW. “Now coal-fired plants meet nearly 80% of our power requirement. We plan to maintain this level at our new facilities as well,” says Puranmalka. The gains are visible. By the end of FY10, captive coal-fired power plants met 73% of the company’s needs and power costs accounted for just 20% of net sales; operating margins nearly tripled to 30%.

The other task was to cut down debt. The cost of servicing debt took away over a third of the company’s operating profit, leaving very little for funding growth or distributing dividends. Taking advantage of Grasim’s AAA credit rating, over Rs 1,100 crore of fresh debt was raised at lower interest rates in four years to substitute equivalent amount of high-cost debt. This led to a 2% decline in the company’s cost of funds to 5% by the end of FY08.

Then, freight costs were reduced by combining sales and distribution with Grasim. The Birla team, of course, thinks it was just doing the usual thing. K.C. Birla says, “Financial prudence and better working capital management is central to all our group companies and UltraTech is no exception.” The company continued to focus on improving internal cash generation and retention even if it meant keeping dividend payment to a minimum and reducing the need for working capital.

In the last three years, UltraTech has distributed just 8% of net profit as dividend, compared to ACC’s 42% and Ambuja Cement’s 36%, according to Capitaline database. “Why would a shareholder want cash when his money is being re-invested in growth?” asks K.C. Birla. The conservative approach has ensured the company remains virtually debt-free despite investing over Rs 4,500 crore since 2005.

UltraTech has been one of the top performing stocks in the last 12 months, having appreciated by 50% in a flat market. Grasim’s investment in UltraTech has jumped 10 times in value. Grasim’s current 60.3% stake is now valued at over Rs 25,000 crore against investment cost of Rs 2,636 crore. This translates into an annualised return of 25% for Grasim shareholders. UltraTech’s turnaround also allows Grasim to focus on its viscose staple fibre (VSF) business, its bread and butter.

Not surprisingly, Dalal Street is upbeat on the company’s long-term prospects. “UltraTech is likely to gain the most from the next up cycle in cement, expected in 2014. While the small Indian firms lack the financial firepower to expand fast enough, the MNC-owned companies are hamstrung by their need to pay hefty dividends to their parent,” says Vineet Hetamsaria, head of research, PINC Research, a Mumbai-based brokerage and research firm.

That shows. ACC and Ambuja have been slow in capacity addition though they have generated an equal amount of cash. Currently, Switzerland-based Holcim group, through its subsidiaries ACC and Ambuja Cement, leads the league table with an installed capacity of 55 million tonnes as against UltraTech’s 49 million tonnes. But Hetamsaria expects UltraTech to pip Holcim to the post by 2015 with 62 million tonnes against Holcim’s 60 million tonnes. Rajesh Kumar Ravi, senior analyst at Karvy Stock Broking, a financial services firm, says there’s plenty of headroom for further rise in cement consumption here and UltraTech is best placed to seize the opportunity.

China with a comparable scale of population produced 2 billion tonnes of cement last year, seven times more than India. Growth in infrastructure and urbanisation in India will see cement demand rising further.

NOW, WITH THE BASICS IN PLACE, UltraTech has set its sights on the next frontier: It plans to become the most preferred and premium brand in cement. In FY11, it spent Rs 300 crore on an aggressive advertising and brand-building exercise, thrice that of ACC, the second-biggest spender. UltraTech plans to continue that momentum.

“Branding is a strategic decision. We want UltraTech to be the most premium brand, so that customers are willing to pay Rs 2 to Rs 3 more per bag. Our premium positioning has already begun to show in some markets in the country,” says Puranmalka. Some competitors agree. “UltraTech has managed to do that but the challenge will be to maintain the premium it commands and increase it further. There is a limit to that though,” says a senior executive with South India-based cement maker.

Though commodity manufacturers don’t have a say in retail prices beyond a point, branding does help in fetching a premium and improving operating margins. Harish Bijoor, a brand consultant, gives a thumbs up to UltraTech’s strategy: “Branding is essential for commodity companies as there are few other differentiating factors.”

Sample the math. Last year, the company sold around 33 million tonnes of cement—nearly 1,650 million bags. Since around 65% of the cement in India is bought by individual homeowners who have brand preferences, it could well translate into additional revenues of at least Rs 215 crore. The gains from branding will grow even larger as it raises production capacity.

But then, UltraTech’s branding strategy is long-term and goes beyond the price of cement bags. It wants to be a one-stop shop for the construction industry at a time when customers are no longer happy with just a strong structure—they are fussy about the fittings and the finish too.

“Homeowners are more involved today, from the design stage and material selection to the finishing and final looks. Success in this new environment requires increased interaction with customers. We can’t afford to stay just another cement maker and leave everything else to the trade,” Puranmalka says.

That means making UltraTech the most visible brand. “We are increasing our presence by launching related products such as waterproofing solutions, grouting cement, sealants, and jointing mortars,” says Kumar N. Pillay, vice president and head of marketing services, UltraTech.

The minor revolution taking place on the environmental front bodes well for UltraTech as well. Courts and public authorities are taking serious cognisance of environmental destruction caused by the unorganised sector during stone quarrying and aggregate production. Restrictions have been imposed on sand mining and stone quarrying in many states. This allows corporate houses the possibility of introducing scientific and environmental-friendly practices.

“It would fit perfectly with our ready-mix concrete business. We currently buy stone and sand from local suppliers,” says Puranmalka. “There is an opportunity to become an end-to-end supplier of building solutions eight to 10 years from now. So, we have to establish a strong brand equity.”

This move is winning UltraTech the praise of analysts. “Their strategy to go beyond cement is a smart move because interior budgets now are as big as the structure itself. It will help UltraTech grow faster than the cement industry,” says Hetamsaria. It will also increase loyalty to UltraTech among dealers, as they will make additional revenue without any significant increase in investments, he adds.

Already, some analysts see UltraTech increasingly playing the role TCS did in the Tata Group—a source of stability and cash profits even in times of economic volatility. “Hindalco’s fortune is tied to the international prices of aluminium and copper, and Grasim’s main VSF business is dependent on cotton prices. Idea operates amid regulatory uncertainty and falling margins. UltraTech, on the other hand, continues to grow steadily, facing no such risks,” says Ravi.

UltraTech has a simple philosophy: that it should be “the last man standing” in the industry. This is driving a great deal of vigilance regarding operational efficiency and cash flow maximisation—not just accounting profits. It also means rigorous, long-range planning on capacity expansion instead of meeting short-term targets.

“The chairman hasn’t given us any lofty goals to scale. Only that when big companies begin to tumble in a bad economic environment, UltraTech should be the last to fail in the industry,” says K.C. Birla.