We are simply amazed looking at enterprise level valuation of UltraTech Cement. It values the company at 26X FY 16 EBITDA. We gave SELL on UltraTech Cement at Rs. 3888/share.
Now lets buy an argument of the street that capacity utilization are at lows ~72-75% Even after considering capacity utilization at 85% and management guided volume growth rate of 6-8% CAGR, current valuation implies 14-16x FY18 EBITDA.
Now that’s really steep valuation for a company which is commodity in nature, with very high fixed cost structure and cyclical in nature. We believe that 8-10X EBITDA is a fair range of multiple depending on company’s competitive position, geographical dominance and operational excellence.
In Q1FY17, Ultratech reported volume growth in the domestic market moderating to 6% (from 15% YoY in 4QFY16) and some improvement in cement realizations. Declining power and fuel costs was the mainstay of earnings growth, a trend that will likely reverse in 2HFY17 based on spot prices of pet-coke. Recent acquisition will have dilutive impact which has further reduced valuation of the company. However, UltraTech continues to stay in overvalued zone.
Most of the cement companies trade in overvalued zone due to bet on accelerated infrastructure spend by the government. We are of opinion that since real estate formed major demand for Cement companies. Since its slowing down, we expect that the cement companies will have relatively lower realization growth benefit. Infra will partially support volume growth, albeit not as steep as market expects. We see that Bull Run in Cement companies is over. With no new capacities over next 3-4 years, the valuation is capped at current levels. Margins are at peak due to low petcoke prices. This will reverse or competition will put pressure. Hence, we generated SELL on most of the cement companies recently. Recently, Business Standard covered an article on euphoria in Cement Companies.
“Collectively, Indian cement makers are now valued at 48 times their net profit in the last financial year on average, nearly double the corresponding valuation ratio of Chinese firms. Globally, cement makers are now valued at 26x their latest annual earnings (net profit) and 1.6x their latest book value or net worth.
The analysis is based on the world's top 100 cement makers in terms of market capitalisation. The Bloomberg sample has 12 companies from India and 21 Chinese companies. Indian firms together account for 14 per cent of the sample's combined market capitalisation. Together, the sample firms are currently valued at $380 bn and they reported revenues and net profits of $250 bn and $10.5 bn, respectively, in the last financial year.
However, Indian companies are yet to catch up with their western and Chinese counterparts in terms of revenues. With revenues of $3.8 bn in FY16, UltraTech is the world's 14th biggest cement maker (excluding its parent Grasim Industries). In comparison, CRH plc, the world's top cement maker, reported revenues of $26.2 bn in the last financial year followed by Lafarge Cemex at $24.5 bn. In comparison, China's top cement maker China National Building Material Co reported revenues of $16 bn in FY16. China is the world's largest cement producer followed by India and the United States. In 2014, China produced 2,500 million tonnes (mt) of cement against India's 280 mt and US' 83 mt. This mismatch between the size of operations and market capitalisation has raised the possibility of an irrational exuberance in valuation of cement companies in India."
However, we do see some silver lining in companies whose plants are based out in states like MP, UP and Bihar. We expect most of housing and infra spending to take place in UP, MP and Bihar. Companies like Prism Cement, Heidelberg India Cement are based out in these regions. Their valuation are steep, we will recommend them once they get attractive. The management is conservative and capable. Prism Cement belongs to Rajan Raheja Group (Exide Industries) and Heidelberg India is part of German Company Heidelberg AG.
