Dalal Street Investments

Cements Differntial Valuation – Small Cap Vs Large Cap

March 29, 2010

Small cap vs. large cap discounts in Indian Cement companies is at historical highs. The disconnect – Smaller companies pricing in near distress, while large companies pricing in upturn. The discount to replacement cost ranging between 20% and 60% and the discount to large-cap peers between 40% and 70%.

Looking at valuations over the last 10 years, the smaller names have traded at a significant discount to the larger names, which was driven by high leverage on balance sheets during the downturn, which meant valuations were more at distress levels. As of now, based on the latest reported data and Bloomberg consensus estimates wherever available, leverage across most of the small-/mid-sized names is low with four companies (Heidelberg Cement, Mangalam, Birla Corp and Prism Cement) being net cash positive.

Given lack of meaningful liquidity (most of the small names trade <$2MM daily) would likely result in a high entry/exit costs for institutional investors and trading in and out becomes difficult. However, for longer-term, patient investors, we think some of the smaller names with healthy balance sheets offer attractive opportunities but investors would need to hold names through the cycle. Alternatively, a sell-off there in large cap cement stocks could also result in a narrowing of the discount. What say ?


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