Rethink PE ratio valuation for high capex sectors like cement, specialty chemicals: Kotak analysts

Cement companies, for instance, will need high capital expenditure (capex) to increase volumes, resulting in FCF lagging behind PAT due to low fixed asset turnover (FATO). Although volume growth is driven by housing and infrastructure demand, large capex will be required to sustain this growth.

Another high capex driven sector like specialty chemicals will also face a similar problem. Typically, these companies have ambitious plans that would require higher capex, eventually resulting in low FCF in the medium-term. Historically, too, they have seen low FCF/PAT ratios.

ALSO READ: India’s capex cycle mirrors 2003-2007 boom period, only better this time: Morgan Stanley

"The current high P/E valuations of the sector are underpinned by expectations of strong FCF generation in the future, which may or not materialise once the growth phase is over due to the contractual nature of the business and increased competition over time," the analysts believe.

Apart from that, oil, gas, and consumable companies, especially PSUs that have invested in their core business will incur low FCF relative to their PAT. However, analysts believe that the return on these assets are questionable due to likely low returns from such projects, limited longevity, and doubtful terminal value of assets.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.