Cemex Still Undervalued - And Somewhat Underwhelming

Sep. 17, 2018 1:17 PM ETCEMEX, S.A.B. de C.V. (CX)BZZUY, CPAC, HCMLY, VMC
Stephen Simpson profile picture
Stephen Simpson
17.64K Followers

Summary

  • Cemex shares have done alright during the summer, even though sluggish volumes in Mexico and Latin America remain a challenge to operating leverage.
  • Management is targeting a new round of asset sales, debt repayment, and cost reductions, as well as a dividend for shareholders in 2019.
  • Cemex shares look undervalued below $9, but the company really needs construction/infrastructure activity to pick up in Mexico and Colombia, and for the U.S. construction sector to remain healthy.

Although Cemex (NYSE:CX) shares have done pretty well since my last update, rising more than 15% and outperforming peers like Vulcan (VMC), LafargeHolcim (OTCPK:HCMLY), Buzzi (OTCPK:BZZUY), and Cementos Pacasmayos (CPAC), the absolute returns over the past couple of years still haven’t been all that impressive, and the company continues to see only modest growth in EBITDA. Now the company is launching another program of value-creation focused on asset sales, deleveraging, and cost cuts that should produce some incremental, but not transformational, value for shareholders.

The volume situation is frustrating, but I still see value in this company as it continues to reduce debt and starts to return capital to shareholders (likely next year). Asset sales could add a little value and there’s still a credible story here for volume acceleration in the U.S. and Mexico over the next couple of years. Below $8.50 to $9, I’d still say there’s more room for these shares to head higher.

A Three-Pronged Value-Creation Idea

I’m not a big fan of gimmicks, but I do see some potential for Cemex management to create value from its new “A Stronger Cemex” plan. Management is looking to generate $1.5 billion to $2.0 billion from asset sales, pay down another $3.5 billion in debt, and pull another $150 million or so out of operating costs by year-end 2019.

Asset sales have been a part of the Cemex story for a while now, and it remains to be seen what, if anything, the company actually will do. Some have agitated for Cemex to sell itself down to the point where it’s just a Western Hemisphere company, but management has always sounded fairly bullish on the long-term prospects for markets like the Philippines and Egypt. On the other hand, the company’s European operations would seem to be a natural target – they’re low-margin and low-return for Cemex (and not coincidentally have the lowest mix of cement as a percent of sales) and could be more valuable as part of a company with more substantial European assets. I don’t believe a complete sale of the European business is especially likely, but selling even half of the business could get the company to that target range of asset sale proceeds.

Deleveraging is much more straightforward, with the company looking to reallocate free cash flow and asset sale proceeds towards greater debt reduction. Management is still targeting an eventual investment-grade rating and is getting close to a point where debt covenants won’t block returns of capital to shareholders.

The cost savings program may actually be the easiest part of the company’s new plan, particularly given a respectable recent track record of cost savings. The targeted $150 million in cost costs represent only a little more than 1% of total costs (COGS + SG&A), and I think there are opportunities in Europe, the U.S., and Asia/Mideast/Africa to drive efficiency gains. On the other hand, the headwinds in the U.S. market may make that a tougher goal than it first appears – in addition to higher energy costs, Cemex (as well as other operations in the U.S. like Buzzi, Vulcan, and LafargeHolcim) are looking at higher labor costs and higher distribution costs (higher trucking costs/wages, etc.).

Still Waiting For The Big Turns In Volume

Cemex hasn’t established the best reputation lately for hitting its own volume targets. The second quarter did see a good pick-up in volume (over 4% growth in cement volumes after 2% growth in Q1’18), with 9% growth in the U.S. and 5% growth in Europe, but just 2% growth in Central/South America and 3% growth in Mexico. Within the South America geography, Colombia remains quite weak, with a 9% year-over-year decline in volume.

A significant part of the bull story for Cemex has revolved around improving volumes in Mexico and the U.S. driving significant operating leverage. The U.S. side of the story is cooperating, as Cemex is benefiting from a strong construction market (especially residential) that has more room to run. In Mexico, though, infrastructure and construction activity remains relatively lackluster. With significant unused/under-used capacity, this has remained an ongoing drag on the bull-case scenario materializing for Cemex.

Just how much Mexico improves remains a key unknown. The incoming administration has certainly talked up its desire/intention to renew and expand Mexico’s infrastructure, and the country most certainly needs that. On the other hand, the administration got itself elected in no small part on an anti-corruption platform and that may end up slowing the permitting process for new infrastructure projects – wherever you look around the world, where there’s corruption, it’s often found in the construction sector and most especially in public works projects.

On a brighter note, volumes were higher in the Philippines (up 8% yoy) and Egypt (up 7%) this past quarter. What’s more, Colombia may at last be bottoming out as the government puts new policies in place that should benefit the construction sector.

The Opportunity

I still believe 3% to 4% long-term revenue growth is a reasonable expectation for Cemex. While it is getting late in the cycle, I don’t think volumes at Cemex are as much at risk as some bears seem to think; the U.S. construction market (both non-residential and residential) still seems to have legs long term, Mexico has been soft for a while, and markets like Colombia should turn.

I’ve likewise made no major changes to my margin or FCF assumptions; I do think the company’s cost-cutting program should succeed, but it’s not especially material to my margin assumptions (I had already assumed some incremental improvements). I continue, then, to look for mid-single-digit FCF growth, supporting a fair value in the neighborhood of $9.

Valuing Cemex on an EV/EBITDA basis is a little trickier. Sector-wide valuations have come down some, and my prior target of 8.5x doesn’t exactly look conservative next to current forward multiples of 8 for LafargeHolcim, 7 for Heidelberg, or 7 for CRH, though U.S. operators (Vulcan, Martin Marietta Materials (MLM), and Eagle (EXP) trade at more robust multiples). What’s more, there’s not much rhyme or reason to forward multiples in the cement space – there’s minimal correlation to margins, returns on capital, or revenue growth, though attractive end-market exposures (cement, in growing markets) does seem to matter. I’m sticking with my 8.5x multiple for now, though, and that supports a mid-$8 fair value.

The Bottom Line

Cemex has been a patience-testing stock for a while now, and I don’t expect that to change immediately. Good conditions in the U.S. are certainly a positive, but I’d really like to see that coupled with improvements in Colombia and a real pick-up in demand in Mexico. If Cemex can execute some attractive asset sales and finally drive some of the waited-for leverage in Mexico (and Colombia), more of that underlying fair value could be realized in the next year or two.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

This article was written by

Stephen Simpson profile picture
17.64K Followers
Stephen Simpson is a freelance financial writer and investor. Spent close to 15 years on the Street (sell-side, buy-side, equities, bonds); now a semi-retired raccoon rancher. That last part isn't entirely true. Probably.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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