Cemex CX
June 12, 2007 - 10:34am EST by
roger952
2007 2008
Price: 39.54 EPS
Shares Out. (in M): 0 P/E
Market Cap (in M): 29,452 P/FCF
Net Debt (in M): 0 EBIT 0 0
TEV: 0 TEV/EBIT

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Description

CX ($39.54) – Cemex (6/12/07)

 
Summary

 

Cemex is a combination of a good global business with great management and value (10% FCF yield, 27-52% upside). With the expiration of the tender offer for Rinker on June 22nd, restricted analysts (especially JP Morgan one) should resume coverage with a bullish tone. After the acquisition completion, the company should set up an Investors Annual Meeting and present higher targets for synergies at Rinker. Due to the strong reduction in imports and the oligopoly of the sector, there should be a sizable price increase in US cement in 2007 or maximum January 2008. This is not contemplated in the market expectations which focus on the weak US housing demand. Finally, the US comps will start to improve in the next few quarters and when the street start looking into 2008 they should see a good momentum picture (overly biased by US news) increasing the attractiveness of an already great  business, management and value story.

 

Business Analysis

 

The building materials sector has been consolidated into 3 major global cement players: Cemex (Mexican), Holcim (Swiss) and Lafarge (French). All 3 have global presence and present an organized oligopolistic behavior.

 

Cemex is present in 3 main businesses: cement, aggregates and ready-mix concrete. Cement and aggregates are inputs in the production process of ready-mix concrete.

 

Cement (72% of EBITDA pre Rinker, 57% after Rinker)

 

Cement is a low value-to-weight product at around $100/ton. Therefore competition and demand drivers are mainly local, generally restricted to 100-150 miles. It is hard to import/export cement because of transportation cost, humidity and the need of port infrastructure and grinding facilities (most imports are done through clinker which is grinded into cement at destination). As a consequence, global trading accounts for only 7% of consumption. The majors Cemex, Lafarge and Holcim control most of global trading, which is very important in the United States, where imports represented 24% of consumption in 2006.

 

In developed countries, it is very hard to expand supply due to difficulties in getting the environmental license and permits for new quarries and plants. Community resistance (NIMBY) is also strong. Holcim, for instance, gave up on a plant expansion in the US after many years of unfruitful efforts.

 

In developing countries, most of cement is consumed by the informal economy through the sales of bags (vs. bulk). Clients are very small and pulverized and distribution and brand become strong barriers to entry. Margins are higher than in developed countries.

 

In summary, the combination of high transportation cost, licensing/permits/NIMBY restrictions, pulverized distribution and oligopolistic behavior present strong barriers to competition in the cement business.

 

Aggregates (9% of EBITDA pre Rinker, 13% after Rinker)

 

Aggregates are even more expensive to transport ($10/ton). In the US, reserves are even scarcer and consolidation is creating a secular shift in pricing with margins expanding 200bps per year. This business should be as good as or even better than the cement business. The market currently trades pure US aggregates stocks at P/Es higher than 20x..

 

Ready mix concrete (15% of EBITDA pre Rinker, 20% after Rinker)

 

Contrary to cement and aggregates, ready-mix-concrete is a much less capital-intensive business. Barriers to entry are much smaller and profitability much more cyclical. Some exceptions happen in market where vertical integration is the norm, as Florida and California in the US. In these cases, it is harder for non-integrated players to compete because of the difficulties in guaranteeing supply of cement and aggregates. In these situations, margins may be more resilient and less cyclical.

 

Geographic Exposure

 

Cemex sometimes is excessively discounted for being listed in Mexico and for being exposed to US housing.

 

Mexico represented only  33% of EBITDA in 2006 (and this should fall to 24% after the acquisition of Rinker. They are truly as global as Holcim and Lafarge, but analysts generally attach a higher WACC for them because of its Mexican listing (and perhaps its name). The acquisition of Rinker may help change this risk perception.

 

Many American investors use Cemex as a vehicle to play US housing. However, US was only 29% of EBITDA in 2006. Moreover, most of cement sales are to infrastructure and non-residential construction. US housing probably represented less than 10% of EBITDA in 2006. With Rinker acquisition, this number should grow to a bit more than 15%. This misperception may help explain the stock being flat in the last 12 months. For example, in 1Q07 US EBITDA went down by 34% YoY (weather and housing effects), but total EBITDA was up 6%. Company guides a 5% growth in total EBITDA in 2007.

 

Management, Taxes and Acquisitions

 

Cemex has a great management, probably the best in this sector. They are also very aggressive and have almost eliminated its taxable income in Mexico. They benefit from loopholes in the Mexican tax system for multinationals. Many of their companies have R&D expenses paid to its Switzerland subsidiary, where R&D is not taxed. The overall effect is an accounting tax rate of 17% in 2007 of which only 11% are related to cash taxes.

 

Cemex tax rate should increase over time. A change in tax legislation in Mexico is reducing the alternative net asset tax rate but limiting the deduction used for net asset calculation. This should have a negative effect on Cemex. Over time as the company grows through acquisitions, it should be more difficult to maintain a low tax rate which has grown in the last 3 years.

 

The problem of having no taxable income in Mexico is that it makes no sense for them to pay dividends of make buy backs, since this would be taxed at full tax rate. Therefore Cemex is a cash flow machine which needs to use its cash in acquisitions to avoid worsening its capital structure and tax planning. The good thing is that management has created a lot of value in the acquisitions. They have a 10% ROCE target which needs to be achieved in 3 years after any acquisition. They also have a great experience in integration and the implementation of best practices across the organization. Cemex has historically presented a ROIC 200-300 bps above its WACC.

 

Rinker Acquisition

 

The most recent corporate event is the acquisition of Rinker, an Australian company with strong presence in the US markets (mainly Florida). The risk of overpaying has been a drag in the stock performance in the last 12 months. Cemex, however has recently obtained the support of Rinker’s management and last week the deal became a sure thing as Cemex achieved the 50% minium acceptance level in the tender offer. The tender offer expires on June 22nd.

 

Rinker is being acquired at a 5% FCF Yield (no leverage). With the announced operating sinergies of $100mm/year, this increases to 5.6%. If one assumes tax rate being reduced to 17%, FCF Yield becomes 7.1%.

 

The acquisition (US$14.3bi) is totally debt-financed at an estimated rate of Libor + 40bps. Therefore, I estimate that the new Cemex is trading at around 9.8-10.5% of Equity FCF Yield after maintenance capex (depending on tax savings potential). Even on an operating basis the FCF Yield would be 7.4-7.8%. Since this is a great business where WACC should be around 8%, it is easy to see that even by assuming CPI growth only the stock presents a substantial upside.

 

The conclusion of the Rinker acquisition should bring some positive triggers to the stock. Restricted brokers (UBS, JP Morgan and Citibank) should resume active coverage of the name with a bullish tone. Unfortunately, I was lazy in publishing this recommendation and Citigroup resumed coverage recently with a $42 target price ($56 on DCF) and the stock went up 10%. However, the most influential analyst in this sector is the one from JP Morgan who he should resume coverage only after the tender offer conclusion. Analysts as a whole should start making projections for the new company, probably with a lower WACC. The company should also set up its annual investors meeting, which should give the market more color on the acquisition, Mexican taxes and US market trends. After Rinker due diligence, they will probably announce a more aggressive target of synergies for the transaction.

 

US Market

 

The US cement market was definitely down in the last 12 months. As the table below shows, the housing slowdown which started in April/06 led to annual volume reduction of up to 8% YoY in 2006. The 1Q07 presented and even lower annual reduction of 16%, but this reflects the abnormal good weather presented in 1Q06. Since US housing permits are down 30% YoY and represent 30% of the market, it is expected that total market should be running at an 8% annual decline. Infrastructure and non-residential segments are growing.

 

Cement

Sales YoY

Import YoY

Import/Sales

Jan-06

27%

44%

24%

Feb-06

12%

33%

25%

Mar-06

8%

24%

25%

Apr-06

-4%

4%

25%

May-06

1%

11%

25%

Jun-06

0%

11%

25%

Jul-06

-2%

4%

25%

Aug-06

-4%

-2%

25%

Sep-06

-8%

-6%

25%

Oct-06

-3%

-4%

24%

Nov-06

-8%

-15%

23%

Dec-06

-6%

-16%

22%

Jan-07

-19%

-31%

21%

Feb-07

-18%

-27%

22%

Mar-07

-11%

-26%

20%

Source: USGS

 

The good side is that comps will start to improve in the 2Q07 and definitely should be much easier in the 2H07. Even more important is that the cement majors are implementing a substantial cut in import levels. As I said before, they control cement imports in the US. Imports are done through long term contracts, however, and could not be accommodated to the demand reduction at once. Throughout the year, however, the import reduction should become a fact as is evidenced by the 28% reduction rate of the 1Q07. As soon as they are able to reduce the excess supply through import reduction, there will be 2 major positive effects: (1) margins will improve with the shift from imported material to locally produced cement as imported cement has an almost neutral profit contribution and (2) the majors will implement substantial price increases even with the demand slow down. It is important to bear in mind that the cement players have been using their bargaining power to introduce price increases in the last few years, improving profitability. This process was only interrupted in 2007 because of a temporary adjustment of supply x demand, which depends only on the reduction of import contracts. The analysts are not counting with any cement price increases in the US for the near future and should be positively surprised with this move. I believe that such price increase will happen in 2H07 or at most in January 2008. Lafarge mentioned in its conference call that they expect a 6% average price increase in US in 2007 and that they reduced imports in 40% in 1Q07. Holcim mentioned that they will zero their US imports.

 

Valuation

 

The New Cemex is expected to generate an Equity FCF after maintenance capex of $3.0bi in 2007. This is comprised of $2,700mm from legacy Cemex, $700mm from Rinker, $675mm of additional after tax financial expenses, $85mm from after tax operating synergies and $214mm from potential tax synergies. This means $4.06 per share or 10.3% of yield based on current stock price. Even without tax synergies, there would be $2.8bi FCF ($3.77share) and 9.5% yield.

 

On an operating basis the FCF yield would be between 7.3% and 7.7% depending on taxes. Assuming a target 6% yield (8% WACC – 2% CPI growth), Cemex target price should be $55-60 (depending on taxes), giving an upside of 39-52%.

 

I also ran a DCF scenario where Cemex tax advantages are eliminated after a 5 year period. This leads to a target price of $50 or 27% above current level.

 

Cemex EV/EBITDA of 8.7 is slightly above those of its global peers Holcim (7.6) and Lafarge (7.7). However, this multiple does not capture Cemex higher FCF/EBITDA due to lower taxes and maintenance capex (which is now even lower due to a higher ready-mix-concrete in the mix).

 

Cemex P/E of 11.8 is substantially discounted to Holcim (14.5) and Lafarge (14.1). Their P/E is distorted because of Mexican GAAP which overstated depreciation and has a non-cash monetary correction line which overstates true earnings.  Besides, Cemex low effective tax rate may not be considered sustainable by some investors.

 

Therefore, the best way to look at Cemex is on a cash flow basis. My analysis shows an upside of at least 27% to $50 even assuming a phase out of tax advantages in 5 years. It is important to bear in mind that we are valuing the company on the trough of the US cycle whose reversion should not only bring momentum, but make the company even cheaper. I believe there are triggers in the short-medium term to help bring its valuation to a more appropriate level.

Catalyst

Conclusion of Rinker acquisition (June 22nd)
Resumption of coverage from restricted brokers. Citi has already resumed coverage this week which led the stock up 10%, but JP Morgan is the most respect analyst and should resume coverage together with UBS.
Reduction of US cement imports and consequent US price increases.
Improvement of comps (US housing started to fall in 2Q06, 1Q06 had extraordinarily good weather).
Cemex Investors Annual Meeting - higher synergy targets for Rinker.
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    Description

    CX ($39.54) – Cemex (6/12/07)

     
    Summary

     

    Cemex is a combination of a good global business with great management and value (10% FCF yield, 27-52% upside). With the expiration of the tender offer for Rinker on June 22nd, restricted analysts (especially JP Morgan one) should resume coverage with a bullish tone. After the acquisition completion, the company should set up an Investors Annual Meeting and present higher targets for synergies at Rinker. Due to the strong reduction in imports and the oligopoly of the sector, there should be a sizable price increase in US cement in 2007 or maximum January 2008. This is not contemplated in the market expectations which focus on the weak US housing demand. Finally, the US comps will start to improve in the next few quarters and when the street start looking into 2008 they should see a good momentum picture (overly biased by US news) increasing the attractiveness of an already great  business, management and value story.

     

    Business Analysis

     

    The building materials sector has been consolidated into 3 major global cement players: Cemex (Mexican), Holcim (Swiss) and Lafarge (French). All 3 have global presence and present an organized oligopolistic behavior.

     

    Cemex is present in 3 main businesses: cement, aggregates and ready-mix concrete. Cement and aggregates are inputs in the production process of ready-mix concrete.

     

    Cement (72% of EBITDA pre Rinker, 57% after Rinker)

     

    Cement is a low value-to-weight product at around $100/ton. Therefore competition and demand drivers are mainly local, generally restricted to 100-150 miles. It is hard to import/export cement because of transportation cost, humidity and the need of port infrastructure and grinding facilities (most imports are done through clinker which is grinded into cement at destination). As a consequence, global trading accounts for only 7% of consumption. The majors Cemex, Lafarge and Holcim control most of global trading, which is very important in the United States, where imports represented 24% of consumption in 2006.

     

    In developed countries, it is very hard to expand supply due to difficulties in getting the environmental license and permits for new quarries and plants. Community resistance (NIMBY) is also strong. Holcim, for instance, gave up on a plant expansion in the US after many years of unfruitful efforts.

     

    In developing countries, most of cement is consumed by the informal economy through the sales of bags (vs. bulk). Clients are very small and pulverized and distribution and brand become strong barriers to entry. Margins are higher than in developed countries.

     

    In summary, the combination of high transportation cost, licensing/permits/NIMBY restrictions, pulverized distribution and oligopolistic behavior present strong barriers to competition in the cement business.

     

    Aggregates (9% of EBITDA pre Rinker, 13% after Rinker)

     

    Aggregates are even more expensive to transport ($10/ton). In the US, reserves are even scarcer and consolidation is creating a secular shift in pricing with margins expanding 200bps per year. This business should be as good as or even better than the cement business. The market currently trades pure US aggregates stocks at P/Es higher than 20x..

     

    Ready mix concrete (15% of EBITDA pre Rinker, 20% after Rinker)

     

    Contrary to cement and aggregates, ready-mix-concrete is a much less capital-intensive business. Barriers to entry are much smaller and profitability much more cyclical. Some exceptions happen in market where vertical integration is the norm, as Florida and California in the US. In these cases, it is harder for non-integrated players to compete because of the difficulties in guaranteeing supply of cement and aggregates. In these situations, margins may be more resilient and less cyclical.

     

    Geographic Exposure

     

    Cemex sometimes is excessively discounted for being listed in Mexico and for being exposed to US housing.

     

    Mexico represented only  33% of EBITDA in 2006 (and this should fall to 24% after the acquisition of Rinker. They are truly as global as Holcim and Lafarge, but analysts generally attach a higher WACC for them because of its Mexican listing (and perhaps its name). The acquisition of Rinker may help change this risk perception.

     

    Many American investors use Cemex as a vehicle to play US housing. However, US was only 29% of EBITDA in 2006. Moreover, most of cement sales are to infrastructure and non-residential construction. US housing probably represented less than 10% of EBITDA in 2006. With Rinker acquisition, this number should grow to a bit more than 15%. This misperception may help explain the stock being flat in the last 12 months. For example, in 1Q07 US EBITDA went down by 34% YoY (weather and housing effects), but total EBITDA was up 6%. Company guides a 5% growth in total EBITDA in 2007.

     

    Management, Taxes and Acquisitions

     

    Cemex has a great management, probably the best in this sector. They are also very aggressive and have almost eliminated its taxable income in Mexico. They benefit from loopholes in the Mexican tax system for multinationals. Many of their companies have R&D expenses paid to its Switzerland subsidiary, where R&D is not taxed. The overall effect is an accounting tax rate of 17% in 2007 of which only 11% are related to cash taxes.

     

    Cemex tax rate should increase over time. A change in tax legislation in Mexico is reducing the alternative net asset tax rate but limiting the deduction used for net asset calculation. This should have a negative effect on Cemex. Over time as the company grows through acquisitions, it should be more difficult to maintain a low tax rate which has grown in the last 3 years.

     

    The problem of having no taxable income in Mexico is that it makes no sense for them to pay dividends of make buy backs, since this would be taxed at full tax rate. Therefore Cemex is a cash flow machine which needs to use its cash in acquisitions to avoid worsening its capital structure and tax planning. The good thing is that management has created a lot of value in the acquisitions. They have a 10% ROCE target which needs to be achieved in 3 years after any acquisition. They also have a great experience in integration and the implementation of best practices across the organization. Cemex has historically presented a ROIC 200-300 bps above its WACC.

     

    Rinker Acquisition

     

    The most recent corporate event is the acquisition of Rinker, an Australian company with strong presence in the US markets (mainly Florida). The risk of overpaying has been a drag in the stock performance in the last 12 months. Cemex, however has recently obtained the support of Rinker’s management and last week the deal became a sure thing as Cemex achieved the 50% minium acceptance level in the tender offer. The tender offer expires on June 22nd.

     

    Rinker is being acquired at a 5% FCF Yield (no leverage). With the announced operating sinergies of $100mm/year, this increases to 5.6%. If one assumes tax rate being reduced to 17%, FCF Yield becomes 7.1%.

     

    The acquisition (US$14.3bi) is totally debt-financed at an estimated rate of Libor + 40bps. Therefore, I estimate that the new Cemex is trading at around 9.8-10.5% of Equity FCF Yield after maintenance capex (depending on tax savings potential). Even on an operating basis the FCF Yield would be 7.4-7.8%. Since this is a great business where WACC should be around 8%, it is easy to see that even by assuming CPI growth only the stock presents a substantial upside.

     

    The conclusion of the Rinker acquisition should bring some positive triggers to the stock. Restricted brokers (UBS, JP Morgan and Citibank) should resume active coverage of the name with a bullish tone. Unfortunately, I was lazy in publishing this recommendation and Citigroup resumed coverage recently with a $42 target price ($56 on DCF) and the stock went up 10%. However, the most influential analyst in this sector is the one from JP Morgan who he should resume coverage only after the tender offer conclusion. Analysts as a whole should start making projections for the new company, probably with a lower WACC. The company should also set up its annual investors meeting, which should give the market more color on the acquisition, Mexican taxes and US market trends. After Rinker due diligence, they will probably announce a more aggressive target of synergies for the transaction.

     

    US Market

     

    The US cement market was definitely down in the last 12 months. As the table below shows, the housing slowdown which started in April/06 led to annual volume reduction of up to 8% YoY in 2006. The 1Q07 presented and even lower annual reduction of 16%, but this reflects the abnormal good weather presented in 1Q06. Since US housing permits are down 30% YoY and represent 30% of the market, it is expected that total market should be running at an 8% annual decline. Infrastructure and non-residential segments are growing.

     

    Cement

    Sales YoY

    Import YoY

    Import/Sales

    Jan-06

    27%

    44%

    24%

    Feb-06

    12%

    33%

    25%

    Mar-06

    8%

    24%

    25%

    Apr-06

    -4%

    4%

    25%

    May-06

    1%

    11%

    25%

    Jun-06

    0%

    11%

    25%

    Jul-06

    -2%

    4%

    25%

    Aug-06

    -4%

    -2%

    25%

    Sep-06

    -8%

    -6%

    25%

    Oct-06

    -3%

    -4%

    24%

    Nov-06

    -8%

    -15%

    23%

    Dec-06

    -6%

    -16%

    22%

    Jan-07

    -19%

    -31%

    21%

    Feb-07

    -18%

    -27%

    22%

    Mar-07

    -11%

    -26%

    20%

    Source: USGS

     

    The good side is that comps will start to improve in the 2Q07 and definitely should be much easier in the 2H07. Even more important is that the cement majors are implementing a substantial cut in import levels. As I said before, they control cement imports in the US. Imports are done through long term contracts, however, and could not be accommodated to the demand reduction at once. Throughout the year, however, the import reduction should become a fact as is evidenced by the 28% reduction rate of the 1Q07. As soon as they are able to reduce the excess supply through import reduction, there will be 2 major positive effects: (1) margins will improve with the shift from imported material to locally produced cement as imported cement has an almost neutral profit contribution and (2) the majors will implement substantial price increases even with the demand slow down. It is important to bear in mind that the cement players have been using their bargaining power to introduce price increases in the last few years, improving profitability. This process was only interrupted in 2007 because of a temporary adjustment of supply x demand, which depends only on the reduction of import contracts. The analysts are not counting with any cement price increases in the US for the near future and should be positively surprised with this move. I believe that such price increase will happen in 2H07 or at most in January 2008. Lafarge mentioned in its conference call that they expect a 6% average price increase in US in 2007 and that they reduced imports in 40% in 1Q07. Holcim mentioned that they will zero their US imports.

     

    Valuation

     

    The New Cemex is expected to generate an Equity FCF after maintenance capex of $3.0bi in 2007. This is comprised of $2,700mm from legacy Cemex, $700mm from Rinker, $675mm of additional after tax financial expenses, $85mm from after tax operating synergies and $214mm from potential tax synergies. This means $4.06 per share or 10.3% of yield based on current stock price. Even without tax synergies, there would be $2.8bi FCF ($3.77share) and 9.5% yield.

     

    On an operating basis the FCF yield would be between 7.3% and 7.7% depending on taxes. Assuming a target 6% yield (8% WACC – 2% CPI growth), Cemex target price should be $55-60 (depending on taxes), giving an upside of 39-52%.

     

    I also ran a DCF scenario where Cemex tax advantages are eliminated after a 5 year period. This leads to a target price of $50 or 27% above current level.

     

    Cemex EV/EBITDA of 8.7 is slightly above those of its global peers Holcim (7.6) and Lafarge (7.7). However, this multiple does not capture Cemex higher FCF/EBITDA due to lower taxes and maintenance capex (which is now even lower due to a higher ready-mix-concrete in the mix).

     

    Cemex P/E of 11.8 is substantially discounted to Holcim (14.5) and Lafarge (14.1). Their P/E is distorted because of Mexican GAAP which overstated depreciation and has a non-cash monetary correction line which overstates true earnings.  Besides, Cemex low effective tax rate may not be considered sustainable by some investors.

     

    Therefore, the best way to look at Cemex is on a cash flow basis. My analysis shows an upside of at least 27% to $50 even assuming a phase out of tax advantages in 5 years. It is important to bear in mind that we are valuing the company on the trough of the US cycle whose reversion should not only bring momentum, but make the company even cheaper. I believe there are triggers in the short-medium term to help bring its valuation to a more appropriate level.

    Catalyst

    Conclusion of Rinker acquisition (June 22nd)
    Resumption of coverage from restricted brokers. Citi has already resumed coverage this week which led the stock up 10%, but JP Morgan is the most respect analyst and should resume coverage together with UBS.
    Reduction of US cement imports and consequent US price increases.
    Improvement of comps (US housing started to fall in 2Q06, 1Q06 had extraordinarily good weather).
    Cemex Investors Annual Meeting - higher synergy targets for Rinker.

    Messages


    SubjectComments
    Entry06/12/2007 01:58 PM
    Memberalex981
    Like the company and management, but here are my issues with the thesis:

    Developing country margins / ROE: I know the party line is that the share of consumption from individuals is what accounts for the high margins in developing countries, but I don't quite buy it. My recollection is that cement prices in Mexico were something on the order of 2x those in the US, in spite of the fact that Mexico was an exporter of cement. In fact, I believe there was an NYT article some years ago on the issue, claiming that you could buy a bag of cement from a store in Texas for cheaper than you could across the border in Mexico. There was even a Jordanian trader who tried to import Russian cement into Mexico (it's not too expensive to ship cement by sea), but was blocked by the Mexican government. My point here is that I believe some of the developing country margins are unsustainable, and I believe margins in Mexico have been declining over the past few years. I don't think it's realistic to expect governments in developing countries to protect producers at the expense of consumers forever, which is what I think has been happening, especially in Mexico. Given the high share of EBITDA from developing countries, I think that presents a risk for Cemex.

    Tax issue: You bring it up, but I think you significantly understate the issue. There is a finite number of cement capacity in the world, and a very finite amount not owned by one of the majors. Returns on acquisitions have been great historically, but recall that historical multiples are much lower. Just look at what Rinker was at two or three years ago when it was written up on this board, and what Cemex paid for it. The only way to get around returning cash to shareholders is to buy more businesses and hope the tax law changes in the meantime. At the rate Cemex gushes cash, the necessary size of acquisitions will grow exponentially (look at the progression from Valenciana to Southdown to RMC to Rinker), and that would almost certainly mean straying from their core competency. At the end of the day, taxes will catch up to them, and they'll have to pay them like everyone else.

    Valuation: I think this thesis hinges on current earnings being below normalized earnings, which I don't think is the case given historical cement prices / margins. Don't forget that despite the high capital costs, this is still a commodity business with relatively free entry, and commodity prices generally go down (or at least don't go up) over the long term. I don't see why it makes sense to pay a 12x multiple for Cemex given these issues when you can get, say, Wal-Mart for 13x-14x 08 earnings.

    I'd be interested to hear your thoughts - as you might be able to tell, I haven't closely followed the company for a couple of years, so I might be a bit off base here.

    Subjectwsj article
    Entry06/12/2007 02:21 PM
    Memberalex981
    some shot excerpts from a wsj piece on the importation incident in 04:

    Ship Endures Troubled Waters in Mexico --- Saga of the Mary Nour, a Vessel Carrying Cement, Illustrates Barriers to Competition

    14 December 2004

    ...

    Cement, however, is serious business in Mexico. Two giants, Cemex SA and Holcim Apasco, the local unit of Zurich-based Holcim Ltd., dominate the market, where a metric ton of bagged cement often sells for more than in the U.S., and twice the price in China. As the saga of the Mary Nour shows, Mexico doesn't exactly roll out the red carpet when a rival steps on the turf of one of its most powerful firms.

    Over the years, Monterrey-based Cemex has benefited from high prices at home to help fund an acquisition spree that turned a provincial producer into the biggest single cement maker in the U.S. Cemex recently agreed to pay $4.1 billion to buy the world's biggest concrete maker, Britain's RMC PLC.

    Cemex is also aggressively seeking to export abroad. In the U.S., Cemex must pay steep "dumping" charges because domestic producers have persuaded the U.S. government that Cemex sells at below-market prices.

    For Capt. Dahl, the Mary Nour's journey has provided a painful lesson about Latin America's biggest economy. Despite Mexico's many free-trade agreements, a chaotic legal system and weak institutions pose informal barriers to competition in key industries. Take telecommunications: Despite six years of deregulation, Mexico's Telefonos de Mexico SA still controls 95% of domestic phone lines and charges more per call than counterparts in the U.S. and Brazil. Two Mexican brewers control 98% of the domestic beer market.

    ....

    The Mary Nour's troubled voyage began after CTI Group, a cement-trading company based in Amman, Jordan, paired up with former Cemex employees in Spain and Mexico to buy cheap cement and sell it in Mexico.

    From the beginning, the group ran into trouble. The Mary Nour spent the first weeks of May meandering in the South China Sea as Indonesian and Taiwanese cement suppliers pulled out of deals to sell cement. Then, the Swiss cement broker that CTI had contracted to supply the ship with cement backed out, complaining of Cemex influence.

    "We have been clearly advised" that the root cause for the refusal of suppliers in Indonesia and Taiwan to load the ship is "the intervention of Cemex," Transclear SA, the broker, informed CTI in a May 19 memo. Transclear officials confirmed the authenticity of the memo but declined to comment further. Cemex denies exerting influence to block the sales.

    Meanwhile CTI's Mexican partners encountered roadblocks at home. In February, the Mexican cement producers' association -- dominated by Cemex and Holcim-Apasco -- refused to endorse their application for a cement importation license. So the group paid $90,000 to buy a small trucking company in northern Mexico that had such a license.



    SubjectTaxation on Dividends
    Entry06/15/2007 02:28 PM
    Memberroger952
    Thanks for the interest.

    In Mexico you need to accumulate some "fiscal currency", similar to an "earnings reserve" in order to pay dividends or make buy backs. This is an off-balance sheet calculation. If you run out of this "reserve/currency" you are actually taxed at the marginal income tax rate when paying dividends or making buy backs.

    Let me know if this did not clarify your doubts.

    SubjectSome answers/comments
    Entry06/15/2007 05:04 PM
    Memberroger952
    Thanks for the comments. Many of your points are very well taken, though I have a different view on others. You seem to be as knowlegdeable (if not more) on the subject.

    Developing markets: WSJ article is very interesting and of course these oligopolistic players use all their influence to try to impair competition. I believe price difference between Mexico and US may have reduced over the last few years as a consequence of (i) cement repricing in the US due to oligopolistic forces and difficulties to expand supply and (ii) expansion of Mexican formal consumption with the development of housing financing. I understand however, that many of the higher returns in Mexico are related to the market structure. Consumers there are more pulverized and weaker, they buy cement in bags (not bulk). In this type of market brand is very important and leads to higher pricing. Cemex also has its own stores of construction material – Construrama, whose brand they have offered to some of their distributors. Construrama had 2100 stores in 2005. This is an evidence of the distribution power that Cemex has in Mexico, and as I said distribution is very relevant in this market. Bear in mind that Mexican mountains make cement distribution more difficult. My opinion is that the higher margins in developing countries are mostly a consequence of their market structure and not of government protection.

    Tax issue: I agree with you. I would not be very surprised, however, if Cemex in the next 5 years ends up buying a company like Lafarge and create a lot of value by reducing their inefficiencies (not sure about anti-trust issues). I think Lafarge is also concerned about becoming a takeover target in the medium/long term. No surprise there is some speculation that they could merge with Saint-Gobain (perhaps protecting 2 French companies by combining them). Anyway, my DCF exercise assuming the end of fiscal advantages in 5 years leads to a $50/share and it could be conservative as I will mention in the Valuation topic. Also, bear in mind that such change in fiscal advantage would be a catalyst for a strong buy back program.

    Valuation: My $50-60 target price does not assume any upward correction in earnings. It assumes only 2% annual nominal growth in operating cash flow without capital reinvestment, which is equivalent to inflation. The same effect (or better) could be obtained by reinvesting capital at a 2% spread to WACC (which is credible). Any upward normalization of earnings would add to this valuation exercise. Any increase in Rinker operating synergies would increase this target price. Any fiscal synergy obtained at Rinker would also add to the $50-55 target price (though it will be hard to get fiscal synergies without 90% acceptance of the bid).
    I actually believe that US prices may still go up (and margins) as I mentioned in my investment idea. And I definitely don’t see this business as a commodity business. It is very hard to expand supply in the US (permits, NYMBY, environmental issues) and imports are concentrated in the major oligopolistic players (as your WSJ shows). Independent importers are opportunistic and not a permanent source of materials. If you are a client that shifts purchases to independent importers, when they stop supplying the US market you will get into the end of the line of the local producers. And this is a global organized oligopoly, where the major players protect each other, by coordinating price increases, import reduction and even price reductions (against the entrance of a new competitor).
    I am not very knowledgeable on Wal-Mart, but I would say that Cemex P/E is probably around 10x if adjusted for maintenance capex (not sure how Wal-Mart would be on the same adjustments). I have the perception that WMT’s capex has also lower return than Cemex one. On the other hand I think Cemex earnings benefit from higher leverage than WMT, which is a negative. Any way, WMT could also be a good investment. This would not change my opinion on the attractiveness of Cemex, though.

    Thanks for your comments again. I am more than glad to continue discussing and getting a better view on the strengths and weaknesses of the case.

    Subjectre: answers/comments
    Entry06/15/2007 07:43 PM
    Memberalex981
    A couple of more points...

    Developing markets: I agree that the organization of the structure of the market in Mexico should lead to somewhat higher returns / margins, but there's no way it accounts for that much of the price differential. Other developing markets such as China and India have prices that are half or less as those in Mexico. There was a WSJ article (cover story on Cemex in 02) where one producer commented that there was a fair amount of interest at the time in importing cement from the US, which is a ridiculous notion if you consider that production costs are higher in the US, and transporting cement is expensive.

    My fear with Cemex is that a populist leader in one of these Latin American countries will realize that there is political mileage in targeting cement producers with antitrust action/price controls, since cement prices are visible to consumers, and there will be no problem with supply since prices were artificially high anyway. Even in the best case scenario, consumption gets more concentrated as the country develops, reducing pricing power. No matter what happens, there really is no scenario where the Mexico/developing markets business doesn't decline.

    Taxes: I recall seeing a research report sometime back saying that a merger between any of the majors would be an antitrust nightmare which would require a ton of divestitures, because of all of the overlap.

    Valuation: As I believe you mentioned, US prices spiked something like 20%-30% a couple of years ago, which was really unprecedented in recent history. I think a key cause for this was an increase in shipping rates from Asia (where most US imports originate), brought on by the shortage in transport capacity brought on by higher exports from China. I believe shipping rates are coming down to normal, and last I checked, planned new cement capacity worldwide was soaring. Since it's not typically too expensive to ship cement from China, I think this will eventually bring prices down to more normalized levels, once the capacity comes in. Yes, there is a NIMBY factor limiting US cement capacity, but cement is more readily importable than you might think.

    I think the concentration of supply in the hands of a few prodcers will improve the rationality of the market, but I don't think they'll get to the level of being a cartel, as you suggest, if only because that might attract the attention of the DOJ or equivalent (at least in developed countries).


    As always, further comments are welcome.

    Subjectre: answers/comments
    Entry06/17/2007 08:11 PM
    Memberroger952
    I might be worth to try to get some empirical international prices to get a more accurate and update view on relative prices (US x Mexico x China). This would help the discussion.

    I agree that Mexican margins should trend downwards, but volumes would trend upwards. Some other emerging markets may face the same problem (declining profitability). Many, however present huge opportunities. China, India and Brazil should see prices going up substantially over time. Cemex is not very active there, but they are in Eastern Europe which is showing a phenomenal momentum of volumes and pricing. And I think that Cemex is present in so many countries and regions that one specific government action should not be able to cause a major impact in the company, except for the US and Mexican governments.

    I think the major divergence we have (based on relevance for valuation and stock prices) is the matter of import availability vs. pricing power of local US producers (oligopoly). I think this is an issue that we will need to wait and see the actual data of imports and US prices to verify which side was closer to reality. I believe stock price will move accordingly. And this is definitely one of the pillars of my investment thesis.

    SubjectAggregates
    Entry06/24/2007 06:06 PM
    Memberroger952
    MLM - Martin Marietta and VMC - Vulcan Materials are the main stocks for you to get exposure to US aggregates. They trade at high P/Es because it is anticipated that their operating margins should go from 20% to 30% in 5 years (in case of MLM) . Basically the industry consolidated, aggregates is a scarce resource and much more expensive to travel than cement ($10/ton vs $100/ton). It is very hard to expand quarries and if you exhaust a local quarry, the price of aggregates may double as you bring it from a more remote one. The major cement players bought companies in this area. As a consequence, the pricing of this product initiated in 2005 a structural shift from a "production cost" to "replacement cost" pricing. Prices should go up every year 200bps higher than cost, causing the margin expansion I mentioned. They have some fixed cost, but volumes are not growing, price has been the main driver in the recent past. I owned Martin Marietta until recently (it was the investment idea I used to apply for VIC membership), but I think stock price now reflects most of its fundamental value (it went from $80 in Sep/06 to $160 in Jun/07).

    SubjectEdward comments, Fiscal Reform
    Entry08/01/2007 10:04 AM
    Memberroger952
    Thanks Edward for your supportive and enriching comments.

    I would add on some of your notes:

    Citi is the broker that follows Mexican prices. They have today P$98 for a 50kg bag, which implies US$255/ton given current stronger peso-dollar rate. However, as you said, average cement prices in Mexico is $123 against $111 in the US.

    Also, according to a report by Citi, other avg cement prices in 2Q07 are US$127 for Spain, US$152 in the UK, US$115 in South/Central America ex Mexico and US$59 in Africa/Middle East.

    The relevance about vertical integration depends on the specifics of each market and how their players are structured. In Florida, for instance, where Cemex-Rinker have a relevant exposure, the market is very integrated. The concrete business helps protect the cement business, but brings more ciclicality to the business. Most of Cemex drop in US EBITDA and margins in the 2Q07 came from ready-mix concrete.

    About "ridiculous" imports, I would just note that I understand Alex was referring to Mexico imports of US cement and not the opposite.

    Adding on my previous comments, the initial draft of Mexican tax reform was released weeks ago. I have done a good work there and am very comfortable it will not have a meaningful effect in my projections (I used 18% cash tax rate).

    Basically, the new tax (CETU) is bad for Cemex as it does not consider interest expenses, but good because it considers capex instead of depreciation. Labor expenses are not included but labor taxes can be used as credit which is equivalent to labor being deductible. Cemex released in the 20F the taxes they are paying for their Mexican operation (universe for the fiscal reform). If anyone has interest, I would be glad to share my numbers on this issue.

    And finally, I think the macro environment and US housing new data points have not been good news for the stock which pulled back from $40 to $33. I just wanted to remind us that most of the housing uncertainty is on the short term (supply-demand adjustment), but long term level for annual residential building in the US is not that uncertain. Morgan Stanley has a "neutral" on the stock and just released its forecasts for the Cemex-Rinker company. They have a $3.1bi FCF after maintenance capex for 2008, which implies a 12.5% FCF Yield based on CX current price of $33.
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