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The curious case of the Indian cement sector (revisited)

We continue to be baffled by (1) the market’s perennial hopes about meaningfully higher profitability for the cement sector despite large earnings downgrades every year; FY2024 saw an EPS change of +4-(-)68%% from the beginning of FY2024 and (2) the Street’s continued usage of ‘incorrect’ valuation multiples and desire to use ‘high’ multiples in the face of incontrovertible facts about the capex-intensive, commodity nature of the cement business.

FY2024 has turned out to be no different from previous years

FY2024 was another ‘routine’ year of sharp earnings downgrades for the cement sector, with large EPS cuts in several companies since the start of FY2024 (see Exhibit 1). As such, FY2024 was no different from the previous years (see Exhibit 2). We note that earnings downgrades also have the unintended consequence of ‘inflated’ valuations, based on actual reported earnings versus estimated earnings, becoming the benchmark for target multiples.

FY2025 starting with renewed hopes

FY2025E consensus estimates show a sharp increase in EPS versus FY2024 estimates (see Exhibit 3). We are not sure about the reasons for the optimism other than conditioned behavior, fed by perennial optimism. It is perhaps time for the Street to adopt a more realistic approach to the sector. The oft-repeated argument about ‘price discipline’ resulting in higher profitability seems rather tedious and is dubious anyway, as hopes of ‘cartel’ pricing (whether or not) should not be a basis for any rational investment thesis, especially in light of the continued large supply-demand imbalance in the sector through FY2026E (see Exhibit 4). We note that our profitability assumptions translate into reasonably healthy CRoCI for the companies (see Exhibit 5).

Cement is and will be a capex-intensive, commodity business

We see a large disconnect between (1) the Street’s approach and (2) our valuation approach to the valuation of cement stocks, which takes cognizance of the capex-intensive, commodity nature of the business. The Street seems singularly obsessed with earnings growth and is willing to ascribe high P/E multiples for volume-led growth (assuming stable and reasonable profitability). However, the very nature of the business should lead to lower FCF relative to PAT; any incremental volume will require additional capex. The sector’s FCF-toPAT ratio has been expectedly on the lower side (see Exhibit 6).

Multiples of cement stocks should be about half on a ‘first-principle’ basis

In our view, the multiples of the cement stocks should be about half of their current multiples on a ‘first-principle’ basis. We note that the sector has a very low asset turnover ratio (around 1X for expansion projects, lower for greenfield projects), which should automatically cap their valuations. However, most cement stocks trade at 2.5-5X FY2025E BV, which is clearly very high in the context of the low-to-mid-teens RoEs of the companies (see Exhibit 7) despite our assumptions of reasonably high profitability and CRoCI.

Several cement companies saw downgrades in consensus earnings in the past year

Exhbit 1: FY2024E consensus EPS movement for cement companies (Rs)

Earnings downgrades have been the norm for cement companies over FY2016-23

Exhbit 2: Actual versus 1-year prior consensus EPS estimates for cement companies, March fiscal year-ends, 2016-23 (Rs)

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