The cement industry is nothing if not cyclical. US consumption this year could be barely 50 per cent of its 2007 peak of 113Mt, with similar percentage declines in Spain, Eastern Europe and Russia. The possibility of a double-dip recession following what has already been a devastating construction boom and bust has inevitably made investors in the world’s biggest suppliers nervous. Shares in Holcim Ltd, Cemex SA, HeidelbergCement AG and Lafarge SA are down between 21 and 33 per cent this year.
But is the selloff overdone? The US and Europe may avoid recession in the quarters ahead though growth could slow to a crawl. Lafarge, HeidelbergCement and Cemex are cutting costs and lowering debt after gearing up to make top-of-the-cycle acquisitions. Activity in developing countries remains buoyant; Holcim derived 73 per cent of first-half operating earnings from emerging markets.
True, for all their international reach, the main players have little pricing power. The big four supply only 16 per cent of the world’s cement, well below the concentration in markets for other raw materials like iron ore. Pricing is unpredictable because cement isn’t internationally traded. It is too heavy to transport profitably over long distances and hard to store. Returns on capital-intensive quarries, kilns and silos depend on mastering local market conditions. Indeed, in markets where ownership is concentrated, producers are persistently suspected of price-fixing. Exiting countries, as Lafarge has done in Turkey and Holcim in South Africa, can be as important as entering them.
Even so, investors have reckoned on too much growth this year but likely too little in 2011 and beyond. At enterprise value multiples of six to seven times 2011 earnings before interest, taxes, depreciation and amortisation, share prices don’t reflect that fact the cement industry hit bottom this year. The sector should trade more in line with historic mid-cycle multiples of seven to eight times, according to broker Cheuvreux. Assume higher volumes in emerging markets and a slight recovery in the U.S. and Europe next year, then Ebitda could also grow about 10 per cent in 2011. That leaves 17, 43 and 17 per cent upside respectively for share prices in Holcim, HeidelbergCement, and Lafarge, Cheuvreux says. Cyclical, but oversold.