Description
Cemex produces and sells cement. CX trades at approximately 1x book value, 7x free cash flow, 10.5x 02 E, 7x 03 E and 7x EBITDA. CX has a great balance sheet with 3x debt to EBITDA, 5x interest coverage, and 30-33% margins. The company has a 4.7% dividend yield. Its 3 biggest markets are Mexico, the US and Spain.
DESCRIPTION -- (from Yahoo, a longer description is given at the end of the report)
Cemex S.A. de C.V. is a holding company engaged, through its operating subsidiaries, primarily in the production, distribution, marketing and sale of cement, ready-mix concrete and clinker. The Company is a global cement manufacturer with operations in North, Central and South America, Europe, the Caribbean, Asia and Africa. As of December 31, 2001, Cemex S.A.'s main cement production facilities were located in Mexico, the United States, Spain, Venezuela, Colombia, Egypt, the Philippines, Thailand, Panama, the Dominican Republic and Costa Rica. The Company's Mexican operations, through CEMEX Mexico, represented approximately 35% of net sales in 2001. Its United States operations, through CEMEX, Inc., represented approximately 26% of net sales in 2001. The Company's Spanish operations, representing approximately 10% of net sales, are conducted through Compania Valenciana de Cementos Portland, S.A. Please see CX’s full description plus history at the end of the report.
A GROWTH COMPANY IN A STABLE INDUSTRY -- Over the last 10 years CX has grown free cash flow approximately 18%. Going forward, the company’s growth is split 50/50 in organic growth and external growth. Long term organic growth going forward should be 5-6% driven by 2% price increases and 3-4% volume growth. External growth is driven by CX’s $1 billion free cash flow (CX has an equity market cap of $ 7 billion), which the company has been using for acquisitions but also to pay off debt (Over the last seven years CX has brought down its debt to EBITDA from 5.5x to 3x.) and buy back stock. This results in 10-12% top-line growth and a little better free cash flow growth due to leverage. The cement business is currently more stable than it used to be due to 1) a lack of price competition due to the recent consolidation in the industry, 2) capacity constrains of cement plants in developed markets because of not in my back yard and better financial discipline of the big players, 3) construction activity has less of a boom-bust character than in the past due to slightly better financial market discipline and anti cyclical government spending, and 4) a less cyclical residential housing market has stabilized the market. While the cement business in the developed markets is consolidating, in the emerging markets cement is more of a growth business albeit also more risky and cyclical. However CX is well positioned in the emerging markets because it is diversified, has critical mass, and has a great balance sheet.
GOOD RISK REWARD CHARACTERISTICS -- CX’s proven track record as a growth company through consolidation and exposure to emerging markets combined with the more stable nature of CX’s business warrants long term multiple expansion, especially if one compares CX’s returns on capital with current interest rates. However, even without long term multiple expansion CX is still a low risk cyclical play on the economic recovery. When the economy had a false start in 1q02 the stock went from $20 just after 9/11 to $33 and in a real economic recovery the stock could go higher. However if the economy does not recover or gets worse there is some good downside protection. In contrast to some other companies in more competitive industries, CX is doing just fine in the current economic weakness generating $1 billion of free cash flow/year. The stock low points in recent market lows has been around 20 (“the old economy is dead”, 9/11, and recent lows). Thus with the stock at 21.70 it has good risk reward characteristics.
CATALYSTS -- Buying back stock; Paying off debt; Mexican institutions being able to buy Mexican stocks; An improving economy -- If the stock stays low enough CX may also buy back stock as it has done many times before. -- The company wants its debt to EBITDA at 2.7x or lower before making any acquisitions thus its plans to pay off up to $1 billion of debt in 2003. -- In addition, currently Mexican institutions such as pension funds cannot buy Mexican stocks. Although a proposal to change this was defeated recently people believe that this will eventually change, which would by a huge benefit to CX as one of the few Mexican blue chips. -- There is additional upside in the stock if the US economy recovers and grows 3-4%+ because the Mexico economy, being leveraged to the US economy, should the grow 6%+ which should grow the cement business in both pricing (2-3%) and volume (3-4%+) after a standstill in the last two years. Given CX’s huge profitability and free cash flow a stronger economy is not necessary but the company is certainly leveraged to it. Finally, the company’s numbers are helped in 03 because CX had been expensing $100 million of efficiency initiatives, a program which is being concluded, which reduces CX’s costs next year.
RISKS – Acquisitions; the company has been active recently acquiring other cement companies all over the world and will probably resume its acquisition program when its debt to EBITDA is below 2.7x. While CX’s track record with its acquisitions has been OK, some acquisitions were better then others (the acquisition in the Philippines was an outright failure). CX being a sophisticated cement company certainly can acquire and improve cement companies at 10%+ yields, but against the company’s owns free cash flow yield of 14% it might be better off buying back its own stock and paying off debt. The company’s responds to such a question is that sometimes it has to by active in the acquisition markets as a defensive measure, to make sure the company has the wherewithal in its competitors’ markets to respond to price decreases. In the consolidating cement industry the companies do not compete on price and want to keep it that way. One way do control competition is to make sure that you have the wherewithal to buy into a competitors market as retaliation to a competitors’ price decrease in one of your own markets. While CX’s business would not be a great one without the lack of price competition, it comes at a price; the need to sometimes acquire other cement companies, which poses the inherent risks.
Derivatives; The company uses three types of derivatives: 1) swapping floating rate debt to fixed, 2) managing currency exposure and 3) entering into forward equity contracts to buy back shares issued to cover option programs. Swapping floating rate debt to fixed is plain vanilla and poses no risk other than non cash write offs if the hedge loses its value (but that money is earned back in on the interest payments, though the timing of charges poses some headline risk). Managing currency exposure is somewhat more complex and requires trust in management that it is done in a prudent fashion which I have but there is some risk nonetheless. The worst case in the forward equity contracts is that the stock goes down a lot and the employee options expire worthless but the company has to buy back some stock anyway at prices in the mid 20’s (which is the average price of the forward equity contracts). If one believes that the company is conservatively managed so that there would be enough liquidity to buy back to stock this is not a huge risk, however in extremely difficult times (I can hardly imagine the company’s free cash flow to completely dry up but you never know) this liability represents additional risk.
BACKGROUND INFORMATION -- Cemex S.A. de C.V., incorporated in 1906, is a holding company engaged, through its operating subsidiaries, primarily in the production, distribution, marketing and sale of cement, ready-mix concrete and clinker. The Company is a global cement manufacturer with operations in North, Central and South America, Europe, the Caribbean, Asia and Africa. As of December 31, 2001, Cemex' main cement production facilities were located in Mexico, the United States, Spain, Venezuela, Colombia, Egypt, the Philippines, Thailand, Panama, the Dominican Republic and Costa Rica. The Company's Mexican operations, through CEMEX Mexico, represented approximately 35% of net sales in 2001. Its United States operations, through CEMEX, Inc., represented approximately 26% of net sales in 2001. The Company's Spanish operations, representing approximately 10% of net sales, are conducted through Compania Valenciana de Cementos Portland, S.A. In July 2002, the Company acquired Puerto Rican Cement Company, Inc.
As of December 31, 2001, the Company's main cement production facilities were located in Mexico, Spain, Venezuela, Colombia, the United States, Egypt, the Philippines, Thailand, Panama, the Dominican Republic and Costa Rica. Cemex manufactures cement through a closely controlled chemical process, which begins with the mining and crushing of limestone and clay, and, in some instances, other raw materials. The clay is then pre-homogenized, a process which consists of combining different types of clay in different proportions in a large storage area. The clay is usually dried by the application of heat in order to remove humidity acquired in the quarry. The crushed raw materials are fed in pre-established proportions, which vary depending on the type of cement to be produced, into a grinding process, which mixes the various materials more thoroughly and reduces them further in size in preparation for the kiln. In the kiln, the raw materials are calcined or processed at a very high temperature to produce clinker. Clinker is the intermediate product used in the manufacture of cement obtained from the mixture of limestone and clay with iron oxide.
There are two primary processes used to manufacture cement, the dry process and the wet process. The dry process is more fuel efficient. As of December 31, 2001, 45 of the Company's 51 majority-owned operating production plants used the dry process, four used the wet process and two used both processes. Three of the six production plants that use the wet process are located in Venezuela, where fuel costs are substantially lower than in the other countries in which Cemex operates. The remaining three production plants that use the wet process are located in Colombia and the Philippines. In the wet process, the raw materials are mixed with water to form slurry, which is fed into the kiln. Fuel costs are greater in the wet process than in the dry process because the water that is added to the raw materials to form slurry must be evaporated during the clinker manufacturing process. In the dry process, the addition of water and the formation of slurry are eliminated, and clinker is formed by calcining the dry raw materials. In the most modern applications of this technology, the raw materials are first blended in a homogenizing silo and processed through a pre-heater tower that utilizes exhaust heat generated by the kiln to pre-calcine the raw materials before they are calcined to produce clinker.
Mexico
Cemex' Mexican operations represented approximately 35% of its net sales in 2001. At December 31, 2001, the Company owned or had economic rights to 100% of the outstanding capital stock of Cemex Mexico, including a 2% interest held by a Mexican trust for Cemex' benefit. Cemex Mexico is a direct subsidiary of the Company and is both a holding company for some of Cemex' operating companies in Mexico and an operating company involved in the manufacturing and marketing of cement, plaster, gypsum, groundstone and other construction materials and cement by-products in Mexico. Cemex Mexico is now also the holding company for all of the Company's international operations.
As of December 31, 2001, the Company operated 15 wholly owned cement plants located throughout Mexico, with a total installed capacity of 27.2 million tons per year. Cemex' Mexican operations' most significant gray cement plants are the Huichapan, Tepeaca and Banientos plants, which serve the central region of Mexico; the Monterrey, Valles and Torreon plants, which serve the northern region of Mexico, and the Guadalajara and Yaqui plants, which serve the Pacific region of Mexico. The Company has exclusive access to limestone quarries and clay reserves near each of its plant sites in Mexico. As of December 31, 2001, all its production plants in Mexico utilized the dry process.
United States
As of December 31, 2001, Cemex operated a geographically diverse base of 12 cement plants located in Alabama, California, Colorado, Florida, Georgia, Kentucky, Michigan, Ohio, Pennsylvania, Tennessee and Texas. As of that date, the Company also had 51 rail or water served active distribution terminals in the United States and one in Canada. It also markets ready-mix concrete products in four of its largest cement markets, which include California, Arizona, Texas and Florida. In addition, Cemex mines, processes and sells construction aggregates in California, Arizona, Texas and Florida, and specialty mineral products throughout the eastern half of the United States. During the first quarter of 2001, in connection with Cemex, Inc.'s post-merger integration process related to the acquisition of Southdown in the fourth quarter of 2000, production operations at the Pittsburgh cement plant were shut down. The plant is being used as a cement distribution center, and the Pittsburgh cement production was reassigned to the Louisville cement plant. In December 2001, the Company sold its construction aggregates operations in Kentucky and Missouri. consisting of four quarries in Kentucky (Bowling Green North, Bowling Green South, Hartford and Bardstown) and one quarry in Missouri (Columbia).
Europe, Asia and Africa
The Company's Spanish operations represented approximately 10% of its net sales in 2001. Cemex conducts its Spanish operations through its operating subsidiary, Compania Valenciana de Cementos Portland, S.A. (Valenciana), which is also a holding company for its international operations. The Company's cement activities are conducted by Valenciana and Cementos Especiales, and its ready-mix concrete activities are conducted by Hormicemex, S.A.
Cemex' Philippine operations represented approximately 2% of its net sales in 2001. The Company owns a 70% economic interest in Rizal, which has two cement plants with a total installed capacity of 2.6 million tons. It also owns a 99.9% economic interest in APO, which has one cement plant with an installed capacity of 3.2 million tons.
In October 1998, the Company purchased from the Indonesian government a 14% interest in Gresik, an Indonesian cement producer. As part of the agreement, the Indonesian government had a right to require Cemex to purchase up to its remaining 51% stake in Gresik, and, in 1999, the Company increased its interest in Gresik to approximately 25.5%.
In May 2001, Cemex acquired a 100% economic interest in Saraburi Cement Company in Thailand. The Company's economic interest in Saraburi is approximately 77.4%. In addition, Cemex has operations in Egypt through Assuit, which has an installed capacity of approximately 4.5 million tons, as well as in Colombia, Venezuala, Panama, the Dominican Republic and Costa Rica.
Catalyst
Buying back stock; Paying off debt; Mexican institutions being able to buy Mexican stocks; An improving economy -- If the stock stays low enough CX may also buy back stock as it has done many times before. -- The company wants its debt to EBITDA at 2.7x or lower before making any acquisitions thus its plans to pay off up to $1 billion of debt in 2003. -- In addition, currently Mexican institutions such as pension funds cannot buy Mexican stocks. Although a proposal to change this was defeated recently people believe that this will eventually change, which would by a huge benefit to CX as one of the few Mexican blue chips. -- There is additional upside in the stock if the US economy recovers and grows 3-4%+ because the Mexico economy, being leveraged to the US economy, should the grow 6%+ which should grow the cement business in both pricing (2-3%) and volume (3-4%+) after a standstill in the last two years. Given CX’s huge profitability and free cash flow a stronger economy is not necessary (as opposed to some other companies in more competitive sectors) but the company is certainly leveraged to it. Finally, the company’s numbers are helped in 03 because it had been expensing $100 million of efficiency initiatives, a program which is being concluded, which reduces CX’s costs next year. In the false start of the economic recovery in 1Q02 the stock went from $20 around 9/11 to $33 in April 02, the stock could go higher if there is a real economic recovery.