Cement firms have solid foundations

Nevertheless, all four firms have good prospects. The most exciting opportunities are in the U.S., says Joe D’Angelo, portfolio manager with Signature Global Advisors, a division of CI Financial Corp. in Toronto. Not only is the U.S. housing market recovering from a very low base, but there are new environmental emissions standards coming in for 2015, which will require at least 10% of existing buildings to be retrofitted. North America accounts for about 25% of sales for Cemex, Heidelberg and Lafarge. Only Holcim’s share of revenue is significantly lower, at 15%.

Given the good prospects in the U.S., Charles Burbeck, co-head of global equities portfolios with UBS Global Asset Management (U.K.) Ltd. in London, says it’s hard to choose among the four cement companies. He has a slight preference for Cemex and Heidelberg, but considers all of them to be well-managed and their stocks to be reasonably priced.

In the short term, analysts with J.P. Morgan Securities LLC (JPM) also prefer Cemex and Heidelberg, on which they have “overweight” recommendations. They rate Lafarge “neutral” and suggest “underweighting” Holcim.

But D’Angelo prefers Lafarge, which has the most exposure to Africa and its potential industrialization. He says Cemex is a “big worry” because it has a significant amount of debt, and he’s shying away from Heidelberg because “supply is catching up with demand” in Indonesia. He isn’t enthusiastic about Holcim because it needs stronger growth in India for healthy earnings growth.

The four cement firms have done a great job on consolidation, adds D’Angelo, as they bought up local firms over the past 10 years.

This includes Cemex, which, as Burbeck points out, is a rare example of an emerging-market company that’s aggressively making acquisitions in the industrialized world.

Local production is a necessity in this industry because cement is so heavy that it isn’t moved further than it has to be. Furthermore, cement deteriorates quickly (within a matter of hours) when mixed.

There are advantages for local operations being part of large companies, says Burbeck. The subsidiaries will have access to better technology than other local players and also may be able to negotiate better prices for energy, a major input for the product.

There also is an advantage in having a well-known brand, says D’Angelo. In emerging countries, consumers mostly do their own renovations and will go for packaging they recognize – particularly if they’ve been burned previously in buying a cheaper brand that didn’t hold up well. (Cement has a short shelf life that’s measured in hours, he explains.)

However, large companies can be hurt if politics come into play. Producing cement requires a licence, and if governments want local companies to produce the cement, those firms will get the licences even if the larger players are willing to pay more for the licences. In fact, Burbeck notes, in some parts of the world, local companies don’t necessarily operate as a profit-making entities.

Here is a closer look at the four companies:

– CEMEX SAB DE CV. Burbeck has a “marginal” preference for it because he likes Cemex’s large exposure to the U.S. and considers the economy of its home base of Mexico to be “relatively strong.”

That said, D’Angelo is worried about the company’s debt levels: long-term debt was US$13.8 billion, or 116% of stockholders’ equity, as of Sept. 30. D’Angelo admits that if global growth picks up, the stock is likely to do better than others. But if global growth remains weak, it’s the most exposed.

There also has been a pause in infrastructure spending in Mexico after the new government came to power late last year. But, D’Angelo says, there are signs that it is picking up again.

Nevertheless, a recent JPM report notes that a continued pause in domestic infrastructure spending, along with the possibility of higher taxes in Mexico, are downside risks to its “overweight” recommendation on the stock.

Cemex had a loss of US$512 million on net sales of US$11.4 billion in the nine months ended Sept. 30 vs a loss of US$411 million on net sales of US$11.3 billion in the corresponding period in 2012.

The losses were due to the firm’s high debt and heavy financing expenses. Operating earnings before interest, taxes, depreciation and amortization in the nine months ended Sept. 30 was US$2 billion, unchanged from a year earlier.

The JPM report has a price target of US$14 on Cemex stock. The shares closed at US$10.58 each on Nov. 18.

– HEIDELBERG CEMENT AG. D’Angelo is “shying away” from this stock because of Heidelberg’s large exposure to Indonesia.

But a recent report from analysts with J.P. Morgan Cazenove (JPMC) in London has an “overweight” recommendation on the stock, noting that Heidelberg “has implemented price increases in Indonesia and expects weaker margin trends to improve in Q4 2013 [ending Dec. 31].”

Net income was 912 million euros ($1.3 billion) on revenue of 10.4 billion euros ($14.5 billion) for the nine months ended Sept. 30 vs net income of 403 million euros ($510 million) on revenue of 10.5 billion euros ($13.3 billion) in the corresponding period in 2012.

The JPMC report’s price target is 63 euros ($89). The shares closed at 55.97 ($78.90) euros each on Nov. 18.

– Holcim Ltd. There isn’t much enthusiasm for this stock among stock analysts. In particular, D’Angelo says the company needs to have good demand in India, where the economy has been struggling.

A recent JPMC report notes that Mexico also is important to Holcim and points out that management’s commentary around the 2014 outlook for Mexico, as well as India, was “lacklustre.” The report also notes that although Holcim has increased its prices in the U.S., the JPMC analysts remain “skeptical of passing price increases in Mexico.”

Holcim had net income of 1.3 billion Swiss francs ($1.5 billion) on net sales of 14.9 billion francs ($17 billion) in the nine months ended Sept. 30 vs net income of 1.1 billion francs ($1.2 billion) on net sales of 15.9 billion francs ($16.6 billion) in the corresponding period in 2012.

The JPMC report suggests “underweighting” the stock, with a price target of 58 Swiss francs ($66). The shares closed at 66.80 francs ($76.36) each on Nov. 18.

– LAFARGE SA is “structurally a very good operator,” says D’Angelo, who likes the firm’s exposure to the African market. Africa is the last major part of the world waiting to be industrialized. Africa and the Middle East account for about one-third of Lafarge’s sales. The only downside is political risk in Africa, a very volatile part of the world.

Net income was 515 million euros ($717 million) on revenue of 11.5 billion euros ($16 billion) in the nine months ended Sept. 30 vs net income of 432 million euros ($546 million) on revenue of 12 billion euros ($15 billion) in the corresponding period in 2012.

A JPMC report has a “neutral” rating on the stock, with a price target of 48 euros ($67.66). The shares closed at 52.67 euros ($74.24) apiece on Nov. 18.

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