Do cement companies deserve such high valuations?
Commoditised businesses typically trade at less gravity-defying valuations, say, than a top-end carmaker. Besides the brand ‘aspect’ of commodities, the key reason for lower valuations is the theoretically low entry barrier, something that allows a new entrant to pose a stiff challenge to incumbents. India’s cement stocks, which have undergone multiple re-ratings in the past five years, are proving to be major exceptions.
Despite weak demand resulting in low pricing power, cement stocks are expensive, exceeding the typical valuation range within which analysts expect them to trade. The street ascribes EV/ EBIDTA multiple range of 10-15 to largesized cement manufacturers. But (based on FY18’s earnings), large cement companies are trading above this range. The average EV/EBIDTA multiple for largesized companies is 18.2.
Several analysts believe that peak valuations in a highly competitive industry such as cement are unjustifiable. They point out that most large-sized cement companies are operating at between 78% and 85% of their capacities. Since the headroom to enhance utilisation is minimal, the ability of companies to benefit from lower fixed cost per unitalso called operating leverage in technical parlance—will be lower. Hence, it will offer limited scope for any material surprise in projected earnings growth.