The cement industry is perhaps the best example of consolidation in India, and Holcim’s move to increase its stake in Ambuja Cements Ltd is just an extension of the consolidation process. Holcim already controlled Ambuja Cements with a 32.35% stake, but the move to raise its stake further would lead to a larger share of the earnings pie. Moreover, Ambuja Cements is among the most profitable businesses run by Holcim worldwide, but its numbers aren’t included in Holcim’s consolidated results on a line-by-line basis. It can do that only when its ownership exceeds 51%.
The company is allowed to purchase up to 5% of outstanding shares from the open market every fiscal, but if only that route was adopted it wouldn’t be until financial year 2011-12 that Holcim would reach the desired ownership. (Holcim was smart to exhaust most of the 5% limit for this financial year, buying those shares at an average price of Rs110-115 in the June quarter). It then purchased a 3.94% stake from the former promoters of the company at Rs154 per share, taking its purchases this fiscal beyond the allowed 5% mark. This, in turn, triggered the 20% open offer to minority shareholders, which fits well with Holcim’s plans of raising its stake beyond 51%.
From a minority shareholder’s perspective, the offer is at an excellent price of Rs154 per share, as it values the company at a CY08 PE (price equity multiple in calendar year 2008) of over 13 times. Barring ACC, which trades at about 10 times CY08 earnings, cement stocks trade at single-digit PE multiples. But since minority shareholding in Ambuja Cements is at a high 62.9%, the acceptance ratio in the offer will just be one out of three shares. After accounting for the fact that sale of shares in the open offer would attract higher capital gains tax, it makes more sense for shareholders to offload their shares at current prices in the open market.
That’s unless they believe that Ambuja’s share price will stabilize above the Rs130 levels after the open offer.
But that’s a highly unlikely outcome. Analysts say that Holcim’s open offer now and its market purchases earlier provided a floor for Ambuja’s share price. This wouldn’t continue once Holcim crosses its desired 51% stake. Besides, there are better opportunities in the cement space. Ambuja is facing cost pressures because of its high exposure to imported coal. But there haven’t been commensurate price increases in the Western India market, where it operates. Companies in South India are much better placed—they have effected a net price increase of Rs9 per tonne just this month. Prabhudas Lilladher estimates that earnings of India Cements Ltd (based in South India) are expected to jump 56% this fiscal, while those of Ambuja Cements are expected to rise just 3%.
The recent sell-off in the stock market has so far been one of the mildest corrections in the four-year-long bull run. That’s best seen in the historical price-earnings multiple for the Sensex, which has come down from 22.4 on 24 July, when the Sensex made a new high, to 18.94 on 22 August. It’s true that the PE multiple for the Sensex was higher in January this year and it has since come down in spite of the run-up in the index, thanks to higher earnings growth. But contrast what happened during the correction of May 2006, when the PE multiple for the Sensex slipped from 22.7 on 10 May to a nadir of 16.29 by 14 June. This time, in spite of widespread predictions of doom and gloom, the damage has so far been comparatively mild.
Similarly, the PE multiple for the CNX Nifty index was down to 18.79 on 22 August from a high of 22.01 on 24 July—in contrast, the damage done during the little pullback in February/March this year was more, with the Nifty PE falling to 17.2 on 5 March. During the major correction in May/June 2006, the Nifty PE had fallen to as low as 14.92.
Midcap stocks have held up relatively well this time, for the simple reason that their valuations were comparatively low. The PE multiple for the CNX Midcap index dropped from 18.8 on 24 July to 16.10 on 22 August. In May 2006, before the correction that multiple was as high as 25.8 and it was no surprise that mid-cap stocks got butchered then, with the PE for the CNX Midcap index falling to 14.3 in June 2006.
The fact that PEs have not corrected substantially so far is surprising, given that previous global corrections were not accompanied by bank bailouts or a freeze-up of credit markets. It’s also surprising as last-quarter corporate results have shown, earnings growth is slowing down, while the political impasse adds to the uncertainty. All this raises the probability of more pain ahead.
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