Cement companies' valuation hits new peaks despite weak earnings

There has been a sharp slowdown in revenue and profit growth in the cement sector in recent quarters but it is yet to show in the share prices of cement companies.

On the contrary, there has been a rally in cement stocks and a re-rating of their equity valuation in the past three years despite an earnings contraction during the period.
 

The combined market capitalisation of 35 listed cement companies in the Business Standard sample was up 29 per cent between September 2021 and September 2024 despite a 29.1 per cent decline in these companies’ net profit on a trailing 12-month basis during the period.

Listed cement companies’ combined net profit (on a trailing 12-month basis) declined from a high of Rs 19,648 crore in the September quarter of 2021 to Rs 13,925 crore in the September 2024 quarter (Q2FY25). The Q2FY25 numbers include the updated earnings for only three companies; for others the Q1FY25 numbers have been extrapolated. The second quarter earnings are expected to decline further as only two major cement companies (UltraTech Cement and Dalmia Bharat) have declared their results and both reported a double-digit decline in net profit year-on-year.

As a result, the sector’s equity valuation measured by a trailing price-to-earnings multiple (P/E) had reached a record high of 57.4x at the end of September 2024 from 28.8x three years ago.
 

In comparison, the Sensex companies’ trailing P/E multiple declined by a fifth from around 31x at the end of September 2021 to 24.8x at the end of September this year. As a result, cement companies  went from being valued at a discount to the benchmark index to now trading at more than a 100 per cent premium to index valuation. There has been moderation in cement companies’ valuation in October and they are now trading at a trailing P/E of 52.3x but still at a 123 per cent premium to benchmark index’s valuation.
 

The BSE Sensex trailing P/E declined to 23.4x on Tuesday from 24.75x at the end of September.
 

Cement companies have also seen a steady slowdown in revenue and profit growth though their top line has done better than earnings in the last three years. This is attributed to a sharp decline in the industry’s earnings before interest, tax, depreciation, and amortisation, or operating margins, in the last three years from high energy prices and the firms’ inability to adequately increase prices owing to weak demand.
 

The cement companies’ combined net sales were down 4.1 per cent year-on-year in Q1FY25 , growing at the slowest pace in the last 16 quarters. The demand environment seems to have only worsened in the second quarter. For example, net sales of the market leader, Ultratech Cement, were down 2.4 per cent year-on-year in Q2FY25, which is its worst performance in the last 17 quarters.
 

A continued slowdown in revenue growth and the recent contraction in profit have created an imbalance between cement companies’ earnings fundamentals and market capitalisation.
 

Market capitalisation is up nearly 550 per cent since March 2011, compared to 185 per cent cumulative growth in net profit (on a trailing 12-month basis) and around 250 per cent cumulative growth in net sales during the period. Most of this gap between earnings and market capitalisation occurred after the June 2022 quarter.

This coincided with the Adani group entering the cement sector. The group acquired Ambuja Cement and ACC from the Holcim conglomerate in June 2022 for $6.4 billion. Subsequently, Ambuja Cement acquired three more cement companies in the country.
 

It has to be seen how cement makers continue to enjoy premium valuation, given a weak market and earnings slowdown in the sector.