Hello Sir,

Hope you are doing well.

In this mail, we will briefly discuss how to value cement companies based on the replacement cost method.

Basically, highly cyclical businesses like Metals, Cement, etc can deliver excellent returns if bought during cyclical lows.

To determine if the sector is going through cyclical low or not, you could look at operating performance of several companies in the sector. If they are reporting lower utilization levels, lower gross and operating margins than historical average, the sector might be going through a bad phase and could throw up good investment opportunities assuming there’s a turnaround in the next 2-3 years.

Another way one could determine if the sector is going through a bad phase is by comparing the current valuations of the companies against their replacement cost. This is most common in the case of Cement sector.

Here, it’s important to know that markets ascribe different valuations to different companies within the same sector depending on the size, efficiency, profitability and the growth outlook.

So, when comparing the current valuations with the replacement cost, it’s important to look at the historical valuations range of a particular company. Now, let's look at how to use replacement cost method.

 

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How to use Replacement cost method?

I will explain this using example of Anjani Portland Cement Ltd (APCL). We recommended this stock in May’19 as we found the stock to be quite cheap on replacement cost valuation method.

Note: We have already closed the coverage on APCL and currently, we don’t have any recommendation on Anjani Portland and this is only being used as an example to understand the concept.

So, back in May’19, APCL had 1.16 MTPA (million tonnes per annum) integrated cement unit, backed by limestone reserves and 16 MW captive power plant.

The market cap of the company was Rs 390 crore. The company was debt free with surplus cash of around Rs 20-25 crore and therefore the enterprise value was Rs 370 crore.

We decided to check as to how much it costs to set up a greenfield 1 MTPA integrated cement plant and found the following details:

 

From the above data, it was clear that setting up a greenfield 1 MTPA integrated cement unit costs around Rs 800-900 crore.

While in the case of APCL, we were getting 1.16 MTPA integrated cement unit, backed by limestone reserves and 16 MW captive power plant for Rs 370 crore, i.e., around 0.35 times the replacement cost.

We thought that 0.35 times was quite low and during an upturn in the sector, it could trade at 0.7-0.8 times.

We had also shared the following table with Premium Members detailing Enterprise Value/MTPA for different cement companies in May’19.

 

As mentioned above, market ascribes different valuations to different companies based on a variety of factors and therefore it becomes important to check historical valuations of each company.

Recently, we were again looking at current costing for setting up integrated 1 MTPA cement plant and for most of the companies it is in the range of Rs 900-1,000 crore.

(End)

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Disclaimer: This is not a recommendation to buy/sell Anjani Portland Cement. It has been used as an example to understand the concept of replacement cost valuation method.

 

Best Regards,

Ekansh Mittal
Research Analyst
Web: https://www.katalystwealth.com/

 

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Name: Ekansh Mittal     Email Id: [email protected]    Ph: +91 727 5050062

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