A cement company looks cheap on P/E against its peers but trades in line with them on EV/EBITDA, and it carries net debt of three times EBITDA. Which multiple should you trust, and why?

Trust EV/EBITDA to compare the businesses: at 6.0x, Amrevo is priced in line with its peers, not cheaply. Its P/E of 7.1x looks low only because Rs 3,000 crore of debt takes half the enterprise value while interest takes just 30% of earnings. Paying the peer P/E of 10x would value the whole business at 7.2x EBITDA. The low P/E is the price of leveraged equity, not a discount.

P/E prices the equity against the earnings left for shareholders after interest. EV/EBITDA prices the whole business, debt and equity together, against the profit before anyone is paid. EV multiples see through the funding; P/E is bent by it. Two identical shops, one bought with savings and one bought mostly with a loan, earn the same from customers. The owner with the loan has a smaller stake and smaller profit after the EMI, and a ratio of one to the other can come out almost anywhere.

Work Amrevo against an identical business with no debt. The debt-free version earns Rs 800 crore of operating profit, Rs 600 crore after tax, and is worth Rs 6,000 crore: 10.0x. Amrevo pays Rs 240 crore of interest, so it earns Rs 420 crore, but its equity is only Rs 3,000 crore. Debt halves the equity while cutting earnings by only 30%, so the P/E falls from 10.0x to 7.1x with no change in the business. That happens whenever the after-tax cost of debt, here 6%, is below the business's own earnings yieldAfter-tax operating profit divided by enterprise value, the inverse of an unlevered P/E. Here 600 / 6,000, or 10%. of 10%.

Suppose the market re-rated Amrevo to the peer P/E of 10.0x. Its equity would be worth Rs 4,200 crore, and adding back the debt, the business would be priced at Rs 7,200 crore, 7.2x EBITDA. Closing the P/E gap means paying 20% more than the peers for the same cement plants. There is also more risk per rupee of Amrevo's earnings: if EBITDA falls 10%, a debt-free peer's earnings fall 12.5% but Amrevo's fall 17.9%, because the interest bill does not shrink.

So the answer to the colleague is plain: use EV/EBITDA to compare cement companies with different balance sheets, and read Amrevo's low P/E as the price of more leveraged equity. Say the limit too. EV/EBITDA ignores differences in depreciation and capital intensity, so for peers with very different plant ages you would check EV/EBIT or cash flow multiples as well.