October 12, 2009 - 12:37am EST by
2009 2010
Price: 41.53 EPS -$0.64 -$0.04
Shares Out. (in M): 28 P/E nmf nmf
Market Cap (in $M): 1,152 P/FCF nmf nmf
Net Debt (in $M): 516 EBIT 4 43
TEV ($): 1,618 TEV/EBIT 425.8x 38.0x
Borrow Cost: NA

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I am short Texas Industries.  The stock is at $41.53 and I believe it’s worth ~$31 ½ at the most, even with the stimulus.  If the current economic climate is in fact a “new normal”,

the shares could turn out to be worth considerably less than that.  I believe the potential upside from the current price is minimal.  


Quick overview of the idea

The stock has risen dramatically: ~3.3x off its low of $12.58

  • Because of the general recovery story and federal stimulus expectations
  • Because of an activist investor’s proxy context that will likely be successful
  • Because of hopes that the company will get sold
  • Management has been promoting fancy recovery earnings power numbers


  • Management’s earnings power numbers look unrealistic
  • The stock is already priced at a reasonable multiple on those earnings
  • The stock is priced at a bullish multiple on my optimistic 2011 earnings, which are substantially higher than Street consensus
  • The company’s credit posture has been weakening
  • Investors have more than priced in any benefits of a successful proxy contest
  • An acquisition is unlikely


There are numerous speculative companies with smaller market caps that have run harder than this one, but I realize that many of you are managing money for other

people so I wanted to write up a position with a market cap large enough that you could actually put money to work.  


Company Profile

TXI is primarily a cement company that also has aggregates and concrete operations.   LTM revenues were $767 million.

The geographic split is roughly 80/20 Texas/California.  The revenue split by product is:


  • Cement: 39%
  • Aggregates: 24%
  • Ready-mix: 37%

The company is based in Dallas.  It was founded in 1951 by Ralph Rogers.  His son Robert Rogers took over in 1970 and is the current chairman of the board.  

In 1973 the company started a steel mill (Chaparral) that was spun off to shareholders in 2005, and subsequently bought out by a Brazilian company in 2007at the peak

of the industrial frenzy.  


Product overview

Cement and aggregates are generally good businesses because they are essential products with no viable substitutes and barriers to entry.  They also benefit from a

high proportion of sales to public works projects, which historically have provided some cushion against the cyclical fluctuations of private sector demand.


Aggregates are the better business of the two because pricing and volumes are more stable, and demand for aggregates is relatively price inelastic; thus, the business

has better pricing power.  In the South, this industry may have as much pricing power as any industry in the entire country. 


A key difference between the two is the actual price – cement is more expensive.  For example, one ton of TXI’s aggregates was priced at $8.12 per ton vs. $85.70 for

cement in the most recent quarter.  So, transportation costs have less of an effect on the delivered cost of cement, thus expanding the distance over which competing sources

of supply can travel.  At times in past cycles the United States has been a dumping ground for low cost imports.  Not so for aggregates.


Another key difference is that the main obstacle to expanded cement production is the capacity of manufacturing equipment, whereas the main obstacle to expanded aggregates

production is permitted reserves.  In a nutshell, humans can build more cement capacity but “He” isn’t making any more rock reserves near population centers.  Therefore, capacity

utilization rates are a much more relevant concept to cement than aggregates.


Ready-mix concrete is a combination of cement and aggregates together.  Cement is the binder and aggregates are the filler.  This is not as good a business because it just

involves mixing the two together.  


To varying degrees these products serve the local markets in which they are produced.  Rock quarries in particular are like local monopolies or oligopolies only subject to limited

competition within their local markets. 


Financial results at the peak

The most TXI ever earned over four consecutive quarters was $241.6 million of EBITDA and $4.23 of fully diluted EPS in the four quarters ending February 28, 2007.  (TXI’s fiscal year ends in May.)  

Notice that the current stock price is ~10x peak EPS.  Historical multiples for the group are 14-15x forward EPS.  


During that time ROIC was 14.3% and operating margins were as follows.

  • Cement: 34.1%
  • Aggregates: 18.9%
  • Ready-mix: 2.8%
  • Consolidated: 12.6% 


Product operating margins don’t have unallocated corporate SG&A taken out of them pro-rata.  The consolidated operating margin number is net of unallocated corporate SG&A.  


What’s happened since the peak – bad capex decisions in a severe recession

LTM unit volumes as of August 2009 (fiscal 2010 Q1) are down substantially from LTM unit volumes at the February 2007 peak.

  • Cement: -27.4%
  • Aggregates: -36.5%
  • Ready-mix: -30.0%


Unit prices are holding up okay.  Cumulative changes since Feb 2007…

  • Cement: -12.3%
  • Aggregates: +11.2%
  • Ready-mix: +14.2%

LTM ROIC is 2.9% (adjusted for the 2009 Q4 goodwill impairment) and operating margins are…

  • Cement: 12.1% adjusted 
  • Aggregates: 14.6%
  • Ready-mix: 3.4%
  • Consolidated: 7.2%  after SG&A, also adjusted

LTM adjusted EBITDA stands at $125 million, down 52% from the peak of $241.6 million.  By and large those numbers are not out of line with their peer group.

But, management did something that has compounded the situation – they borrowed heavily to increase cement capacity in the face of decreasing demand and

decreasing utilization rates.  They have spent nearly $800 million, including capitalized interest, on projects designed to expand their cement capacity by 2.5 million tons,

focused on their plants in Oro Grande, CA (near Los Angeles) and Hunter, TX (near Austin).


To put the capex in perspective, since the February 2007 quarter the company cumulatively spent 29.7% of their revenues and 44.5% of their cash flow (operating cash

flow adjusted for changes in working capital) on capex.  


The company hasn’t been able to generate a return on that investment because the demand isn’t there.  


TXI’s credit profile has been weakening

Since the Feb 2007 quarter, primarily as a result of the above-mentioned capital spending, TXI has taken its debt load from $389.6 million up to $590.4 million at Aug 2009.  

(I am including accrued interest on the balance sheet in that number.)  The combination of an increased debt load being supported by a shrunken earnings base has had a severe

impact on TXI’s credit profile.


Interest coverage (Op. cash adjusted for w.c. changes + int. exp.) / int. exp.

  • Peak: 9.8x
  • LTM: 2.5x


Debt to EBITDA

  • Peak: 1.6x
  • LTM: 4.7x adjusted


Debt to capitalization was as low as 32.8% in the May 2008 quarter and now stands at 42.3%.  The Altman Z-score (measure of financial distress) has dropped from 5.2 to 2.1,

within the grey zone of 1.8 to 2.99, and just barely above the distress zone of 1.8.The S&P corporate credit rating has dropped from BB- with a positive outlook to B+ with a

negative outlook.  


Their CFO says that the current interest run rate is $52 million; compare that with LTM cash flow + interest expense of $96.9 million.  If the V-shaped recovery doesn’t materialize

it could be a serious problem.  Seeing how close they’re cutting it makes it especially hard to understand why management kept their foot on the gas with the capital spending. 


The bonds have a change in control put

They have two bonds outstanding, both from the same issue.  They are senior unsecured, come due on July 15, 2013, and have a 7 ¼% coupon.  $250 million face value was issued

on January 6, 2006 and the other $300 million was issued on August 18, 2008.  Bloomberg has them both marked in the high 90’s with YTMs of about 8 ½% for spreads of about 600 bps.  

They contain a change in control put at 101.  


The proxy contest is heating up, and will probably be successful

By almost any relevant performance metric TXI has lagged their peers for some time.  Nassef Sawiris (formerly of Orascom, current LaFarge board member) bought stock

a couple of years ago and approached management about opportunities for improvement and a board seat but he was rebuffed.


Shamrock Capital is Stan Gold’s private equity firm in Los Angeles that was originally seeded with Disney money.  It started an activist fund to look for opportunities in public equities and the

fund is now running a proxy contest against TXI’s insiders.  Shamrock owns 10%.  I won’t go over all of their arguments and proposals.  Their July presentation, which can be found on the

SEC’s website under TXI’s proxy materials, will give you a good summary.  


It looks like the proposals they’ve put forward and their 3 board nominees will probably be successful at the shareholders meeting on October 22.  Nassef Sawiris owns 15% of the stock and

Southeastern Asset Management owns 10%.  Both have said that they will vote in favor of Shamrock’s proposals, so between them and Shamrock, that covers 35% of the stock.  

Calpers only owns 30 bps, but since they have said that they will vote in favor of Shamrock’s proxy card that will probably influence other shareholders.  For what it’s worth, Shamrock’s

portfolio manager on the activist fund used to be at Calpers.


Management’s desperate response includes fancy estimates of recovery earnings potential

I think that management is in a situation they never expected to be in.  It seems like they’ve had a “clubby” culture and assumed they could swat away any outsiders like they did with Sawiris.  

Now they’re at risk of losing control of the company.  It is evident through their empty rebuttals to Shamrock’s arguments.  


Part of their response has been to put forward rosy estimates of recovery earnings potential, which in my view smacks of desperation.  

These estimates can be found on page 43 of their September 2, 2009 investor presentation.


In summary they project $383 million of EBITDA and $328 million of EBIT.  

I think those numbers are unrealistic for the following reasons.  

  • 7.9 million tons of cement production assumes their unfinished Hunter capacity expansion goes into service and their company-wide utilization rate returns to 100%+ of rated capacity 
  • 25 million tons of cement production would be a 70% increase over LTM levels.  For some perspective, the greatest increase in national consumption two years after a trough was 35.5% after the 1953 recession
  • “Normalized” cement operating margins of 30% are in excess of anything they’ve ever come close to sustaining, and would be on par with low-cost leader Eagle Materials 
  • “Normalized” aggregates operating margins of 20% would be several points above the company’s average margin of 17.3% over the last 5 fiscal years
  • $328 million of EBIT earnings potential would be the result of a 22.1% EBIT margin, whereas the company (or the materials division, back before the steel spinoff) only achieved that margin level 3 times in the last 20 years by my count

Ironically, one of Shamrock’s points is that management has a history of over-promising and under-delivering.

If you believe those numbers, then applying a mid-cycle multiple of 6.5x to the $383 million of EBITDA and adjusting for $516 million of net debt and 27.7 million shares outstanding,

you arrive at a share price of $71.25.


In that case the most you could lose on a short position relative to the current price would be 58%, and it would require a miraculous V-shaped economic recovery, significant operational improvement,

100%+ cement utilization rates, and continuing depressed prices for natural gas, diesel, and electricity (which would be unlikely in a V-shaped recovery).


Personally, I think that those are more like cyclical peak numbers, so a lower multiple would be appropriate.  The current share price implies a multiple of 4.6x on $383 million of EBITDA, which is not an

unreasonable multiple for peak earnings.  In that case, you would lose nothing. 


Since those numbers are already based on optimistic margin and volume assumptions, it’s hard to see how any operational improvements due to Shamrock’s or Sawiris’s increased involvement could

yield further incremental benefits, and create a riskier profile for a short position. I want to be clear that I have respect for Shamrock, Sawiris, and Southeastern.  It’s just that I think whatever they bring to

the table is already fully priced into the stock.  


Hopes for a sale are probably unrealistic

There is some talk that Shamrock will agitate to get the company sold.  Management is also accusing them of plotting for a quick sale.  I see several problems with an argument that they could

get bought for much of a premium to where the stock is already trading.  


It’s priced at a premium to historical deal multiples, even before factoring in any control premium.  J.P. Morgan’s global building materials summary published on September 8, 2009 has a

nice summary of historical cement deals and their LTM valuation multiples.


  • Median EV/Sales 1.7x TXI is at 2.3x 
  • Median EV/EBITDA 8.6x TXI is at 13.9x 
  • Median EV/EBIT 3.2x TXI is at 44.0x  

(Again, I’ve adjusted TXI’s EBITDA and EBIT for the goodwill impairment charge taken in Q4 of fiscal 2009.)


Granted, TXI’s multiple is expanded on trough earnings, but it exceeds those takeout multiples even on fiscal 2011 consensus estimates from Bloomberg.

  • EV/Sales: 2.3x
  • EV/EBITDA: 13.9x
  • EV/EBIT: 28.9x


I think other potential obstacles to a deal with a strategic buyer include the following:

  • Many are dealing with their own need to de-lever after expensive acquisitions towards the end of the cycle
  • It would probably have to be a stock deal, and only Vulcan Materials is trading at a higher multiple.  Vulcan is not a candidate because of their leverage from the Florida Rock deal in 2007 and possible antitrust overlap in Texas and California
  • Nobody has a credit rating higher than BBB+, and keeping an investment grade rating is a key part of the industry’s strategy of rolling up the smaller players or financing capital projects with the lowest possible cost of capital
  • The bonds’ change in control puts at 101 imply a YTM of about 6.9%, meaning a buyer would have to think they could refinance at about 450 bps over Treasuries

I suppose you could find an investment bank that would give a fairness opinion for a valuation built on management’s recovery earnings potential.  Stranger things have happened.  


“Doable” recovery earnings don’t get me to more than ~$31 ½  of value per share

I think TXI’s earnings power two years out is EBITDA of $210 million and EPS of $2.25.  Applying mid-cycle multiples of 6.5x and 14.5x gets me to share prices

of approximately ~$30 ½  and ~$32 ½ .  The average is ~$31 ½ . 


I get there by starting with a baseline of MRQ product prices per unit and costs per unit, as well as LTM sales volumes.  


I assume cement unit volumes grow by 17% cumulatively through 2011, consistent with the an 80/20 weighting of the Portland Cement Association’s forecast for Texas and Californi.  

I assume cement unit prices grow 10% compounded for 21% cumulative growth, consistent with Southdown’s experience coming out of the early 80’s recessions.  


I assume aggregates unit volumes growth 10% compounded for 21% cumulative growth.  That’s loosely based on comments MLM and VMC were making much earlier in the year.  

They’ve become less bullish for 2010, but I want to be conservative from a short perspective.  In that spirit, I assume aggregates prices increase by 5% compounded for 10.3% cumulative growth,

double the 20 year average pre-2005 MLM’s CEO Steve Zelnak says to expect for 2010. 


I assume ready-mix volumes grow at the same rate as cement, and prices grow at an 80/20 blended rate of aggregates (which make up about 80% of concrete) and cement.


For all three cost categories I assume just 3% unit cost growth per year for cumulative growth of 6.1%, again, to be conservative.  Given that electricity and gas/coal are each around 20% of the

cost per ton for cement, my 3% assumption would be highly unlikely in a V-shaped recovery scenario. 


Gross income of $219 million is the result.  Taking out $75 million of SG&A and $52 million of interest gets me to pre-tax income of $93.2 million.  Taxed at their historical tax rate of 33% and

divided over 27.7 million shares gets me to EPS of $2.23.


Adding back $66 million of DD&A (per management’s guidance) to EBIT of $144 million gets me to EBITDA of $210 million.


Compared with consensus EPS estimates for fiscal 2011 of $0.43 and EBITDA estimates of $130 million, I think I am being generous.  Granted, there are some timing differences here

due to calendar year vs. fiscal year comparisons, but it’s immaterial relative to the room for error in the bullishness of my estimates.  


New normal?

After the stimulus wears off coming out of 2010, if that elevated level of activity can’t be sustained and it turns out we have reset to a new and lower normal level of activity, then

what appear to be currently depressed earnings levels would have to be valued on a mid-cycle multiple, and the stock would be crushed.  



  • TXI’s stock is already priced at a level that discounts a huge V-shaped earnings recovery, and doesn’t leave you exposed to a lot of room to get hurt
  • Shamrock can’t do a whole lot to get the bulls any more excited
  • My generous earnings estimates give the stock downside of  ~25%
  • If the recovery is weak or unsustainable the downside could be much greater







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