Looking for <br> solid value? </br>

It’s hard to find voices screaming ‘buy’ in the current market and you surely won’t find too many investors shopping for cement stocks. With the slowdown in real estate and other construction activity taking a toll on cement offtake, stock prices of cement companies have been in the dumps. While the worries are for real, stock prices being where they are, should you bottom-fish with an eye on couple of years down the road? After all, if you are bullish on the India story, then infrastructure can’t be ignored and cement companies will benefit.

Going by the valuations at which deals have been struck, cement stocks seem to be trading cheap. Since December last year, there have been three acquisitions with a total capacity of 23 million tonne, the lowest of which happened at an enterprise value of $124 per tonne. Even smaller deals like the acquisition of the one million-tonne BMM Cement by Hyderabad-based Sagar Cement in September 2014 happened at an enterprise value of about $90 million. Today, some companies like Heidelberg Cement, JK Lakshmi, JK Cement and Dalmia Bharat with capacity in the region of 5 million tonne-18 million tonne are trading at an enterprise value ranging from $83-99 per tonne.

Analysts suggest that setting up a cement plant today in the south could cost close to $90-110 per tonne whereas in the north it will be about $120-140 per tonne. While recent deal valuations and replacement costs may not be the best benchmark for valuing small and mid-sized players, analysts reckon that an enterprise value below $100 per tonne is cheap and should mean limited downside. "Cement stocks are cheap at this point, and risk-return ratio looks favourable,” says Nandan Chakraborty of Axis Capital.

If the demand cycle turns, players currently operating on low capacity utilisation particularly in the south will benefit from higher volumes. But players in the north may benefit more as price will inch up from considerably low levels. Currently, cement producers in the south enjoy a higher realisation per bag compared to their counterparts in the north, as the latter market is relatively more fragmented. Considering there is real stress in the construction industry with demand yet to take off, a turnaround will not happen quickly, which means, “one may not make returns in a hurry,” cautions Chakraborty.

Cementing the downside

More than wondering if cement prices will look up, as a potential investor, you are better off asking: What is the downside from here on? The fact is cement companies have seen much worse. After the 2008 crisis, some of the mid-caps traded at an enterprise value of $30-40 per tonne. But that should not scare investors away. While the worst could be an encore, practically there is very little to suggest a down market like 2008-09. “I don’t think we are going to drop to levels seen in 2008-09. We saw a global crisis then and one cannot take that as a base. You have to be reasonable, particularly today, as our economy is not in that situation," says Chakraborty.

Another analyst, Rashesh Shah of ICICI Securities says that if you consider the cost push over the past seven years, the cost of setting up a cement plant has gone up about 35%, which means the lowest end of valuation which stood at an enterprise value of $30-35 per tonne, today is about $47-55 per tonne. That is about 50% lower than the valuation some of these mid-cap companies command now. Theoretically, these companies can fall by another 50% in a ‘sky is falling’ scenario.’ But then, as Chakraborty says, that is not a reasonable assumption to make.

Since 2000, there have been only two occasions when cement dispatches actually fell due to a significant drop in economic activity. This was in FY03 when GDP growth rate fell to 3.8% and in FY09 when growth rate was 6.8%. After the 2008 crisis, India’s GDP growth had hit a low of 5.8% in Q4FY09 as against 9-10% in the earlier quarters. On an annual basis as well in FY09, GDP growth had hit a low of 6.8% compared to 9.3% in FY08. Gross fixed capital formation, a measure of physical assets built in the country, that year had tumbled to 3.5%, coming off from 16.2% in FY08. As opposed to that, in FY15, gross fixed capital formation grew at 4.6% and GDP grew in excess of 7%.

Over the next two years, the government is expected to step up its infra spending. Compared with last year, during April-July 2015, there was a 113% increase in spending by the Urban Development Ministry and a 249% increase in spending by the Ministry of Road Transport and Highways. That may not be enough to propel growth but it may just keep things from getting worse for cement companies.