recommend a long position in Lafarge (Bloomberg: LG FP, €21.3bn equity, €34bn
EV) on the back of its transformational acquisition of Orascom Cement for
(1) Acquisition of Orascom
Cement is a transformational deal in an attractive sector
(2) Lafarge is a derivative
play on emerging market construction spend (est’d 65% '08 EBITDA)
(3) Current equity value is
at a discount to deal terms where Sawiris family buys ~11% stake
(4) Also, parri passu with Baron
Albert Frere/Groupe Bruxelles Lambert’s ~16% stake
(5) Company is growing, cash
generative, defensive with > 20% IRR on two-year view
is the world’s largest cement manufacturer; EBITA is split between cement
(75%), concrete and aggregates (20%) and gypsum (5%); geographically, Western
Europe accounts for 30%, North America 15% and
emerging markets 55%. In 2008e, and in
line with consensus and excluding the acquisition of Orascom Cement, we expect
the company to generate €18.2bn revenues, €4.4bn EBITDA, €3.4bn EBITA,
€10.7/share EPS, €14/share FCFF and €11.8/share FCFE (cash flows based on
maintenance capex); the equity is valued at €122/share, we estimate net financial
debt, pensions, provisions and minorities of €72/share and an enterprise value
of €195/share. To capture the
transformational nature of Orascom Cement and Lafarge’s growth profile we
believe this opportunity must be evaluated on a multi-year view.
purpose in this post is to highlight Lafarge’s transformation as a function of
the recently announced acquisition of Orascom Cement. By way of background, we would only point out
that we rate highly the European cement space.
Specifically, we view selected companies within the universe as
derivative plays on emerging market growth and infrastructure spend (e.g., Holcim,
65% EBITDA), view them as less cyclical than perhaps one would assume at first
glance (e.g., since 1992, Holcim has only posted two years of negative organic
growth), and in many ways a consolidating sector where companies are beginning
to impose price and volume discipline.
Further, we would caveat that as the deal was announced on December 9th,
we have only had the chance to meet management once, but are familiar and
comfortable with the asset; we felt it would be more important to highlight
this opportunity in a timely and actionable manner.
December 9th, Lafarge announced the acquisition of Orascom Cement for €8.8bn
and the assumption of €1.4bn net debt. This
transaction will be financed with €6bn debt and 22.5mm new Lafarge shares
issued to the Sawiris family (Orascom’s principal shareholders) at €125/share, i.e.,
the Sawiris are effectively purchasing an 11.4% stake in Lafarge and a board
seat at a 2.5% premium to where the equity is currently valued. In addition, they will become the second
largest shareholder in Lafarge, after investor Baron Albert Frere’s GBL amassed
16%. In acquiring Orascom, Lafarge paid
11.5x ’08e EBITDA, 10.3x ’09e EBITDA post synergies of €150mm, but more
importantly the transaction is value accretive in year one (ROCE ~8% >
WACC). It adds 15% to Lafarge’s EBITDA
in ‘08, rising to 25% in ‘10 as Orascom delivers on its growth.
Cement has a leading position in the Middle East and Mediterranean Basin
and is a growth story fuelled by booming fundamentals and capacity. Management guides
revenues to grow from $2.6bn to $3.5bn, and EBITDA to grow from $1.3bn to
$1.7bn, from 2008 to 2010 as new capacity comes online and benefits from the
region’s compelling dynamics.
Specifically, we expect > 90% cash conversion as Orascom has a
particularly favourable tax rate of 4-5%, rising to 16% by 2012, and as
maintenance capex will be below $50mm at these brand new facilities.
continue to work on the impact of this new capacity on pricing and therefore
guidance but at the same time remain confident of supply/demand dynamics in the
key end markets of Egypt, Algeria, Northern Iraq, U.A.E., Saudi Arabia and Syria. For example, 5mt of Orascom’s 35mt capacity
in ‘08 is in Iraq
which is expected to have 40% p.a. demand growth through ‘10.
view Lafarge’s acquisition of Orascom Cement as both financially and
strategically material. In one
value-accretive move, management accomplishes its goal of increasing emerging
market exposure to 65% of EBITDA from 55% (i.e., it will be on par with Holcim
in diversifying out of mature, developed markets and into fast growing emerging
ones). Lafarge’s guidance pro forma for
Orascom is EPS of > €15/share by 2010, free cash flows of > €3.5bn and
ROCE exceeding 12%. To put management
targets into a valuation context, €3.5bn of free cash flows is net of interest,
cash taxes and maintenance capex; with 196mm shares pro forma for the 22.5mm
issued to the Sawiris family, this translates into €18/share FCFE in 2010;
i.e., Lafarge is trading at 6.8x FCFE in 2010 or a 15% free cash flow yield for
diversified and tailwind growth.
financial projections are close in line with consensus estimates to which we
add Orascom projections reflecting demand dynamics in the Middle
East. On this basis, we
arrive very close to management guidance at the income statement level, but are
more conservative on cash flows, and on 2010 estimates expect €22.8bn revenues,
€6.4bn EBITDA, €5.0bn EBITA, €15/share EPS, €19.7/share FCFF and €16.5/share
FCFE (all cash flows based on maintenance capex), i.e., our valuation is based
on FCFE’s ~8% lower than guidance. On
this basis, we have the company trading on 8.2x forward PE or 13.4% forward FCFE
in ‘09; we view this as excessive and believe the company should trade on 9-10%
FCFE yields (9.3% cost of equity, implies 11.5x PE in line with 1-year forward
peer comparables); on a midpoint of 9.5% FCFE yield we get a price target of
€175/share or >40% upside on a two year view. Including cash dividends during this time,
this would yield ~21% IRR over a two year period. Alternatively, if we discount the end-2009
price target at Lafarge’s cost of equity we get 25% upside to the end of 2008. We feel this multi-year approach is correct as
otherwise we miss the growth and cash generation.
another perspective, we know that in 2010 Lafarge’s EBITDA will be comprised of
Orascom €1.1bn, Other Emerging Markets €3.0bn and Developed Markets €2.3bn for
a total of €6.5bn. We value Orascom at
10x EBITDA (excludes synergies, is high ROCE and high growth, current deal
values business on 10.3x ‘09e EBITDA including synergies), we value Other
Emerging Markets at 8x EBITDA (high ROE and fundamental growth, peer emerging
market plays); on this basis, at today’s share price, we would be purchasing
the Developed Market assets for 2.7x EBITDA which we believe is a material undervaluation. At our fair price target, the Developed Market
assets would be valued at 7x EBITDA which we view as appropriate.
factors: Lafarge has diversified end-markets which offset one another; i.e.
growth in one is offset by declines in another (e.g., Holcim, above). Additionally, only 50% of cement is used for
buildings and the balance is used for infrastructure, where government fiscal
stimuli during downturns increases spend and hence cement demand. Nonetheless, a global recession with a
simultaneous slowdown in all end markets will inevitably have an impact. On a near term basis, North American
construction poses a risk although here we would highlight that consensus estimates do
incorporate a decline and that North America (including Canada ops) accounts for less than 20% of profits.
Closing of Orascom Cement transaction in March 2008; discussion of further cost-cuts at the Lafarge level in 2008; integration and delivery of merger synergies, continued growth across diversified portfolio, continued delivery on strong free cash flow generation.