Ambuja Cements’ premium valuation is at risk in the wake of dismal results

ACC Ltd’s dismal March quarter results perhaps set the tone of expectations from Ambuja Cements Ltd, both controlled by Lafarge Holcim Ltd. The Ambuja Cement stock traded in the red ahead of its earnings on Tuesday, mirroring the Street’s nervousness.

Ambuja, as feared, disappointed on most counts. Cement volumes grew 2.4% year-on-year (y-o-y) to 6.37 million tonnes for the quarter ending March 2019. This is nearly 50% lower than analysts’ 4-5% growth expectation. Though ACC’s 5% cement volume growth too was lower than estimates, it was well ahead of Ambuja’s. On the other side of the competition, Ultratech Cements Ltd outshone both these all-India cement makers with a 15% annual cement volume growth.

Growth in Ambuja’s realization was muted because of subdued cement prices in the key markets of the northern and western regions. Standalone net profit came in at ₹427 crore, beating Bloomberg’s analysts’ consensus estimate of ₹343.70 crore.

However, there’s a catch here as well. Analysts at IDBI Capital Markets and Securities Ltd said, “The company reported higher other income of ₹240 crore, up 374% y-o-y as it accounted for ₹132 cr dividend from ACC in the quarter. Moreover, there was a one-off tax provision reversal of ₹51.58 crore. Adjusted for this, profit after tax at ₹240 crore would have declined 10.4% y-o-y.”

Operating costs eased sequentially but were higher than the previous year. Also, ACC and Ultratech Cements have kept a better handle on costs. For instance, Ambuja’s power and fuel costs surged higher annually in the March quarter, while others reported a reduction.

It is already known that Ambuja’s medium-term growth is constrained by capacity expansion, the completion of which is still some quarters away. Therefore, improvement in earnings outlook depends on cost stabilization and an upswing in cement prices.

Petroleum coke and coal prices have started to ease, but the reduction seen in Ambuja’s operating expenses isn’t enough to beat the competition. Besides, analysts expect only marginal cost savings benefit from Ambuja’s master supply agreement with ACC. As for cement prices, while companies have struggled to keep prices up, the higher prices have failed to persist.

Despite these factors, surprisingly, shares of Ambuja trade at EV/Ebitda of 16 times for fiscal year 2020.

EV stands for enterprise value and Ebitda is short for earnings before interest, tax, depreciation, and amortization.

This valuation is higher than ACC’s EV/Ebitda of 11 times and Ultratech’s 15 times. After Ambuja’s disappointing earnings performance, this premium is unwarranted, and valuations should now shrink.