There aren't too many commodities more leveraged to construction activity than cement, which is both good and bad news for Cemex (NYSE:CX). A major player in the cement and ready-mix concrete markets in the U.S., Mexico, and Europe, Cemex has been buffeted by the severe downturns in the U.S. and Europe. With a debt restructuring providing more breathing room and a focus on “value over volume” in the U.S., Cemex could have some room to trade higher on optimism about a U.S. housing recovery.
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The U.S. Is Improving, But Has A Ways To Go
Through mid-year, cement demand has already started picking up in critical Cemex markets like Florida, California, and Texas, and housing starts are starting to turn up. That's good news for Cemex and its approximately 17 million metric tons of cement capacity, and Cemex has already decided to add capacity in markets like Texas where both residential demand (housing) and industrial demand (energy) look to be improving.
A key feature of the Cemex story in the U.S. is a newfound focus on discipline. Management is looking to take a “value over volume” strategy, and so far it appears to be working, as both cement and ready-mix prices were up in the mid-single digits so far this year. Of course, this is not a solo effort and Cemex does need to see rivals like Holcim and Lafarge (OTC:LFRGY) behave responsibly with respect to price.
Certainly there's a question of how far this recovery will go, and how quickly it will happen. Even while building-sensitive companies like Weyehaeuser (NYSE:WY), Louisiana-Pacific (NYSE:LPX), and Cemex have already seen big moves up on the anticipated recovery, these are just the early days of what is likely to be a long (but maybe slow) recovery process. At the same time, civil construction activity has been slower to recover and the state of budgets at the federal and state levels may lead to a much slower (if longer) recovery here for cement companies like Cemex and aggregate companies like Vulcan Materials (NYSE:VMC) and Martin Marietta Materials (NYSE:MLM).
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How Much Turbulence Will There Will Be In Mexico?
While the U.S. market is starting to look better, the situation in Mexico is getting murkier. The economy in Mexico is starting to wobble, but the country is also dealing with a new set of infrastructure priorities with the change in government and new capacity coming on line in central Mexico.
At this point, it looks like energy and railroads are the major infrastructure priorities for the Mexican government, and that doesn't necessarily favor Cemex. At the same time, new capacity coming on from rivals is leading to basically no price leverage for Cemex in Mexico. With the largest part of its capacity and revenue generation in Mexico, these are not trivial concerns for Cemex today, even if the long-term outlook is positive.
Watch The Capacity
Investors won't have much difficult monitoring the trajectory of the U.S. housing/construction recovery, as it is quite likely to get major attention in the financial media. Just as important, though, will be the behavior of industry rivals with respect to capacity. To that end, investors may want to monitor a company like FLSmidth (OTC:FLIDY), one of the largest manufacturers and marketers of capital equipment used in the cement and concrete industries. If FLSmidth starts seeing a major increase in orders in markets like North America, Mexico, and South America, investors may have reason to worry about Cemex's ability to maintain strong pricing.
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The Bottom Line
With a huge debt load weighing on value, Cemex is an iffy stock from a pure valuation perspective. The company is likely to see its free cash flow margin rebound back into the double digits within five years, and that's going to be very good for the stock price. Likewise, the company is probably looking at some significant EBITDA improvement over the coming years. So while the stock does not look all that cheap from a long-term/full-cycle perspective, the reality is that the recovery story still has room to run and these shares can continue to perform up to the point where investors find themselves in the middle of a cement/concrete bull cycle, replete with analysts talking about how “it's different this time”.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.