The US and Global markets remain in free fall mode. Rather than panic, the savvy investor needs to focus his/her search for buying opportunities that may not come along again. These kind of market conditions tend to weed out competition with weaker balance sheets and poor management strategies. When the market eventually cycles back (however long that takes), the strong, well managed company emerges with a greater market share and is positioned to take advantage of the rebound in growth and investor confidence.
I've been a fan of CX for some time. It's hardly an "unknown" company but I do believe it has been unfairly discounted by the housing debacle. Investors have taken an indiscriminate flight away from any stock that has the word "housing" associated with it.
I started buying CX at $31 and have bought stocks in small quantities all the way down to $25. As I free up some more cash, I intend to add to my position gradually. I hope it drops to the low 20's!
An extensive and well-thought out analysis below from ACMPartnersip (sic), a CAPS member on the Motley Fool:
At today's prices CX offers incredible value, with a forward earnings yield of roughly 13%. CX's global reach, best in class management team, strong free cash flow generation, high quality assets, and low cost structure should represent just a few of the reasons why shares' today represent considerable opportunity. Current concerns relating to the U.S. housing slowdown (for some reason U.S. investors use CX as a vehicle to play U.S. housing even though U.S.Housing probably represents less than 10% of 2006 EBITDA), as well as the fact that it is domiciled in Mexico (CX appears to be excessively discounted do to this) have unfairly punished the stock over the last few months. Cemex has a long-running record of using the steady and substantial cash flows from its mexican operations to support the cheap debt necessary to opportunistically aquire competitors around the globe. With Mexican population centers largely landlocked, CX has captured 50% of the market. And becasue self construction is so prevalent, the brand has developed a substantial brand and distribution advantage, which allows for prolific margins on bagged cement. This outsized profitability, coupled with the increasingly oligopolistic nature of the industry should lead CX shareholders to market smashing returns for years to come. My estimate of intrinsic value, sits conservatively 40% above today's prices with additional upside likely as uncertainty over various issues (such as the recent Rinker aquisition) begins to disappear over the next few quarters.
Company Overview, History, Industry and Management Analysis:
CX's world class management team, highly profitable domestic market, and it's ability to generate strong amounts of free cash, has allowed the company to build itself from a small domestic player into a global powerhouse (currently the third largest player in the global cement industry). CX's assets would be nearly impossible to replicate for a variety of reasons, and its outsized profits are protected from significant competitive threats due to poweful barriers to entry fundamental to the industry itself. Reason's include...
Transport costs act as a significant barrier to entry in the cement industy, especially for incumbents in geographically protected markets. Cement is a low value to weight product, 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. As a consequence, global trading accounts for only 7% of consumption worldwide.
The majors...Cemex, La Farge, and Holcim control most of the global trading, which is important in the U.S where imports represented 24% of consumption in 2006. Waterborne transportation remains the cheapest way to transport cement, but with tight ship supply and escalating fuel costs, this source has become considerably less profitable in recent years...and due to CX's proximity to the U.S., this trend has and will continue to improve their competitive position vs. their primary rivals who suffer a distinct disadvantage in serving the world's most lucrative market.
In the cement industry, the cost structure at both the cement plant as well as the distribution level is vitally important, and CX is a leader in both thanks to its flexible energy strategy and advanced logistical capabilities. Their flexible energy strategy and logistic capabilities determine their baseline economics (ex. If production costs are lower in another region, and assuming transport costs don't chew up the difference, the disparity can be profitably arbitraged).
An example of Cemex's savvy management as well as one of its unique competitive advantages can be seen in its use of petroleum coke. Energy accounts for close to half of cement production costs. CX reduces its oil and gas exposure (i.e. its risk) by substituting petroleum coke, a lower cost and less volatile source of fuel. Therefore CX, on top of its geographic proximity to the United States, has yet another strategic advantage concerning the global cement trade...it not only has to spend less on fuel (simply because it doesn't have to travel nearly as far as its competitors), it's fuel is actually cheaper and more efficient than its rivals.
Another barrier to trade involves government intervention, often in the form of quotas or tariffs. In fact, currently CX is a prime beneficiary of the unwinding of one such situation. The U.S. and Mexican governments negotiated a reduction and eventual elimination of long-standing limits on Mexican cement imports. Because U.S. demand has long outstripped domestic supply, Asian and other plants have filled the gap (another reason why trade is disproportionately important in the U.S.). If CX is successful in supplanting a portion of this business from its Asian competition with mexican cement, the additional volume and attendant operating leverage could yield quite a significant windfall not included in my fair value estimation.
Essentially, in developed countries, it has been very difficult to expand supply due to the difficulty in getting the environmental license and permits for new quarries and plants. Holcim, for example, gave up on a plant expansion in the U.S. after many years of unfruitful efforts. In developing countries, most cement is consumed by the informal economy through the sale of bags (vs. bulk). Clients are generally very small and distribution and brand become strong barriers to entry (commonsensically, margins are typically higher in developed countries). In summary, the combination of high transportation costs, licensing/permit restrictions, pulverized distribution and oligopilistic behavior present strong barriers to competition in the cement business.
Additional Pertinent Points:
Cemex is diversified across geographies and up and down the value chain, selling cement, aggregates, and concrete
Rapid infrastructure investments in developing countries have soaked up industry supply and created a favorable supply/demand environment
Repeat-buyer programs, online ordering, and a flexible, one time concrete delivery network (all aimed at increasing reocurring revenue as well as "stickyness") are just a few examples of Cemex's unrivaled service, for which customers are often willing to pay a premium
International expansion has been the hallmark of Cemex's strategy for decades: By employing centralized thinking (the Cemex way!), and leveraging operational practices across all markets, CX has been able to quickly implement "best practices" within newly aquired companies. Historically, this has lead to an immediate improvement in the newly aquired company's operations, leading to increased profitability, and substantial cost savings over time as they benifit from CX's scale and expertise.
CX management has an outstanding record of intelligently allocating capital, and is not hesitant to make big up-front investments that may hurt near term results, but will add value over the long term. Management also has a stellar record of talent development (providing a deep bench). Additionally, similar to many legendary companies such as WMT, management places a large premium on information flow: an intranet connects all offices and plants for real time data sharing
CX benefits from significant tax advantages as well. Loopholes in the mexican tax system (which have in some respects been eliminated recently) for multinational corporations have benefited CX to a meaningful degree over its history. An example of this is that many of their international companies have R&D expenses paid to its Switzerland subsidiary, where R&D is not taxed. The overall effect can be seen in their accounting tax rate of 17% in 2007 of which only 11% are related to cash taxes.
Although such tax advantages may seem like a win-win situation, it actually presents a few problems for the company... primarily being that as things currently stand it makes no sense for management to pay dividends or buy back stock, since this would be taxed at a full tax rate. This underlying truth goes along way in explaining why CX, a cash flow machine, needs to use its cash in aquisitions to avoid worsening its capital structure and tax planning. The good thing is, and in contrast to most companies over time, management has created significant value in each of their major aquisitions. There ability to integrate and implement their best practices quickly and effectively across newly aquired organizations has typically resulted in results (ROIC) of 200-300bps above its cost of capital. Pretty impressive....
Catalysts:
The first likely catalyst is Increasing pricing power due to the strong reduction in imports and the oligopolistic nature of the sector. The recent and sizable price increase in U.S.cement should start to land on Wall Streets radar within the next few quarters...
Cost cutting and stable/improving pricing has mitigated much of the downward earnings pressure from recent volume declines within the U.S. market. Even with today's incredibly poor demand environment, it is worth noting that CX's U.S. operating margin was still a very respectable 17%. While I expect further declines within the U.S. market in the short term, this should be offset by higher prices for cement and aggregates coupled with yet to be realized synergies from the Rinker aquisition (in this unique case, CX management's past track record of success gives me confidence in their ability to deliver exactly what they say they will)...propping up U.S. earnings. Cemex's global diversification is also critical at this juncture, as Cemex has recently (as of last quarter) increased operating profits in all of its other markets outside of the U.S. and U.K.
Another likely catalyst...current negotiations with CRH regarding the divestiture of certain assets in the U.S.
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