Cement makers' valuations near replacement cost

The cement industry has shown yet another signal of correction with valuations (enterprise value/tonne) of the domestic cement giants inching closer to the replacement cost. During the last six months, since the cement market witnessed an unexpected surge in demand which later was followed by incessant rise in cement prices, the valuations have jumped by 48 per cent.

The replacement cost is the amount of capital needed to replace an old cement plant.

Back in October when over pessimism regarding the slowdown drastically affected the industry with fear of oversupply, companies valuations were at a discount of over 30 per cent against the average replacement cost of $120 per tonne. In some cases, it had fallen as much as 50 per cent.

The cement growth rate, since November, is consiste-ntly above 8 per cent while the prices increased Rs 12-15 a 50 kg bag of cement during the March quarter. Further, the decline in coal prices from as high as $160 a tonne to as low as $70 a tonne helped the industry come up with a good show in the March quarter results which is well reflected in the profitability of the cement producers.

“In the beginning of second half of last fiscal, there was a huge pessimism cement companies might start reporting losses and subsequently FY10 was perceived as a bad year. But, the scenario never played out, surprising analysts when demand poured in with an increase in profits and cement stocks moved up when other sectors were struggling,” said an analyst at a domestic brokerage firm. Moreover, in a recent report, J P Morgan lowered its expectations of price decline in FY10 to 5 per cent from the earlier projection of 10 per cent.

For instance, ACC — the largest domestic cement maker — is presently at a valuation of $100 per tonne, up 32 per cent against $76 per tonne in October. Similarly, enterprise value per tonne of Grasim and UltraTech jumped 48 per cent and 41 per cent to $98 per tonne and $86 per tonne, respectively. In case of Ambuja Cements, the company’s valuation is almost on a par with replacement cost at $118 per tonne.

Amrit Lal Kapur, managing director, Ambuja Cements, said, “The valuations will further move up if demand growth remains robust. Moreover, since cement units are now coming up with their captive power plants as well and there is a rise in infrastructure costs including land, replacement cost is somewhere in the range of $120-150 a tonne.”

When valuations dipped, it was anticipated that foreign cement players may take the opportunity and go for acquisitions as the domestic industry is still fragmented.

But cement players had ruled out any selling saying it made no economic sense to sell below $ 140 a tonne. However, the scenario has comparatively improved now.

Ashok Bhattacharjee, head of economic and sectoral analysis at ACC, said, “It may give some hope to potential sellers but who will buy during a cash-crunch. The last year has already seen significant reduction in mergers and acquisitions.”

The 212-million-tonne cement industry has seen major deals in the recent years at a valuation of as high as $235 a tonne paid by Irish firm CRH for My Home Industries in 2008. Portuguese player Cimpor paid $162 for Shree Digvijay Cement Company in 2007 while Holcim paid $200 for Ambuja Cements.

However, the latest deal in June, 2008 when French firm Vicat paid $100 a tonne for Sagar Cements, was the lowest in recent years of M&A activities in the cement sector before the valuations further plunged below the replacement cost.