A cement company has 30 million tonnes of capacity at 68% utilisation and trades at an EV of Rs 9,500 per tonne against a replacement cost of Rs 7,000. Is it cheap or expensive, and what utilisation justifies the price?

Expensive on today's numbers, and priced for utilisation of about 84% with no fall in cement prices. At 68% utilisation the company earns Rs 1,836 crore, so Rs 9,500 a tonne is 15.5 times EBITDA against peers at 11. The 36% premium to replacement cost is a bet that volumes fill the plant before anyone builds a new one. If utilisation rises to 84% with prices held, 11 times EBITDA supports the price; if prices slip Rs 150 a tonne, it needs about 92%.

If a second-hand car sells for more than a new one, either the buyers know something about delivery delays or they are overpaying. A cement plant valued above the cost of building one is the same signal: the market is paying for the three or four years a rival would need to add capacity, and for the earnings in between. Kharagiri at Rs 9,500 a tonne is 36% above replacement cost of Rs 7,000. That is not automatically wrong; the question is what earnings the premium assumes, which is where the utilisation comes in.

Translate the per-tonne price into a multiple. Enterprise value is Rs 28,500 crore and EBITDA is Rs 1,836 crore, so the stock trades at 15.5 times, against established peers at 11. On today's volumes, the market is paying about 41% more per rupee of EBITDA than for peers, and the only reason to do that is a belief that EBITDA will rise faster. In cement the two ways it rises are more tonnes through the same plant and a higher price per tonne. The case needs you to separate them.

Model the plant's operating leverageThe way profit rises faster than volume when a business has large fixed costs, because each extra unit adds revenue without adding to those costs.. Each tonne sold brings Rs 5,500 of revenue and Rs 3,900 of variable cost, a contribution of Rs 1,600. At 20.4 million tonnes that is Rs 3,264 crore, and since EBITDA was Rs 1,836 crore, fixed costs are about Rs 1,428 crore. For 11 times EBITDA to equal Rs 28,500 crore, EBITDA must reach Rs 2,591 crore, which needs about 25.1 million tonnes, 84% utilisation, with prices unchanged. At that volume EBITDA per tonne rises to about Rs 1,031, which is the operating leverage the price is counting on.

Expensive unless you hold two beliefs at once. First, that demand in its region grows enough to lift utilisation from 68% to about 84%, roughly 23% more volume, before rivals add capacity. Second, that prices hold while that happens, which is the harder one, because a 36% premium to replacement cost is a public invitation to build a new plant. If prices slip by Rs 150 a tonne, the utilisation the price needs rises to about 92%, and a plant that full in a region with new capacity coming is rare. Say the limit of the method: replacement cost ignores limestone reserves, location and the brand premium, all of which can justify some premium. The view is: a good asset at a price that already assumes the recovery, so pass, and name the utilisation print that would change your mind.