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Monarch Cement: No Moat
Posted by: Mark Lin (IP Logged)
Date: December 5, 2012 09:33AM

This is one in a series of articles where I will be covering most of the "30 Obscure, Profitable Stocks" listed by Geoff Gannon on his blog on Nov. 29, 2012. Many thanks to Geoff Gannon for the wonderful list of interesting stock ideas.

The Monarch Cement Company (MCEM) is engaged in the manufacture and sale of portland cement. It owns
and operates quarries located near its Humboldt, Kansas plant, and its cement products are marketed under registered trademarks using the name “MONARCH.”

Valuation

MCEM is currently trading at a trailing twelve months P/E of 17.62 and a trailing 12 months EV/EBITDA of 4.82. Current P/E valuations are at parity with its five-year average P/E of 17.57. MCEM achieved a ROE of 5.3% for the trailing 12 months and a five-year average ROE of 6.4%.

Financial And Business Risks

MCEM has a low gross debt-to-equity ratio of 13.3% and a net gearing of 12.3%.

MCEM is heavily dependent upon the construction industry and the level of activity in the industry. In addition, construction activity is seasonal in nature. The summer season is more conducive for construction activities, since winds and warmer temperatures tend to dry the ground quicker creating fewer delays in construction projects. In contrast, During winter months, groundwork preparation cannot be completed, when the ground is frozen. As a result, MCEM's highest revenue and earnings historically occur in its second and third fiscal quarters, April through September. Moreover, any reduction in governmental funding and consequent reduction in public sector construction activity will hit MCEM badly.

The nature of MCEM's business requires it to invest a significant portion of its cash on inventories and capital expenditures. Since 2007, MCEM is averaging about three months in inventory days. In addition, the Environmental Protection Agency has published modifications to the National Emission Standard for Hazardous Air Pollutants regulation in the Federal Register, where all U.S. cement plants have to comply by Sept. 9, 2012. Additional pollution control equipment expenditures in its Cement Business are planned over the next few years to comply with these new regulations, since MCEM does not currently meet certain emission limitations included in latest regulations.

No single customer accounted for more than 10% of MCEM's net revenue during 2011, 2010 or 2009.

Business Quality and Capital Allocation

MCEM acknowledges that it is not a significant factor in the nationwide portland cement or ready-mixed concrete business but claims to constitute a significant market factor for cement in its market area. However, cement is essentially a commodity business, where MCEM and other competitors compete mainly on price and service. Cement is produced to meet standard specifications and there is little differentiation between the products sold by MCEM and its competitors. This is also reflected in falling margins since 2010.

MCEM has paid dividends in every single year in the past decade and currently sports a dividend yield of 4% with a dividend payout ratio of 70%.

Conclusion

I will consider only investing in a commodity-like business if it is supported by a strong dividend yield with undemanding valuations. MCEM still does not meet my two criteria in this case.

Disclosure

The author does not have a position in any of the stocks mentioned.


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Monarch Cement No Moat
Posted by: batbeer2 (IP Logged)
Date: December 5, 2012 12:31PM

>> However, cement is essentially a commodity business, where MCEM and other competitors compete mainly on price and service. Cement is produced to meet standard specifications and there is little differentiation between the products sold by MCEM and its competitors. This is also reflected in falling margins since 2010.

If there's no moat, why then have Chinese, Japanese, Korean, Greek, Australian or Vietnamese producers not figured out how to undercut American producers as they have with some other no-moat industries?

Hint: Humboldt is a small place. A railway line (BNSF), a river and highway run through this minute town. If you draw a circle with a radius of 500 km, you have an area including Kansas City, Oklahoma City, Omaha and st. Louis.

-EDIT-
Thanks to google, I just went there to take a look at that plant.
I know a moat when I see one.


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Monarch Cement No Moat
Posted by: marklin (IP Logged)
Date: December 5, 2012 11:32PM

Hi Batbeer2,

Thanks for your comments.

If I read you correctly, the moat you are referring to, looks like the efficient scale moat introduced by Paul Larson in 2011.

Efficient scale refers to a niche market efficiently served by one or a few companies enjoying outsized economic profits. The barrier to entry lies in the fact that the pie is too small to be shared, and new entrants will make it uneconomic for all participants. Efficient scale moat companies are either natural geographic monopolies like airports, telecoms, community newspapers and market leaders in niche markets like defense companies. MCEM claims to constitute a significant market factor for cement in its market area.

Personally, I do not consider efficient scale to be a true moat. My view is that it is not repeatable and is susceptible to irrational competitors introducing cut-throat price competition into the niche market. This is not likely, but not impossible. Also, I have a quantitative criterion for companies with moats - MCEM's ROE at 5% is too low.

I do agree that MCEM's market position in the area is defensible (except in the unlikely case of irrational competition), but I won't call it a moat. Thanks for sharing your insights, I always appreciate discussion and debate - I always learn something new!



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Monarch Cement No Moat
Posted by: batbeer2 (IP Logged)
Date: December 6, 2012 01:00AM

>> I do agree that MCEM's market position in the area is defensible (except in the unlikely case of irrational competition), but I won't call it a moat.

The barrier to entry is in the cost of transportation. Cement is cheap and heavy. It probably costs as much to transport the stuff 500 km as it does to produce it in the first place.

The reason the railway is there is to carry the cement from the plant to the city. In fact, you can see dozens of railway cars lined up on the premises if you look at the satellite pics.

It's a form of customer captivity. Customers can only go to another supplier at a very high cost.

To compete with this company you will need to build some serious infrastructure. At a very conservative $2 million per kilometer, a new entrant needs to bring $200 million to the table just to solve the problem of transportation.

In short, this is a $ 100 million company which, at first glance, has a moat worth $ 200 million.

[www.railway-technical.com]
[philippelasserre.net]


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Monarch Cement No Moat
Posted by: marklin (IP Logged)
Date: December 6, 2012 02:28AM


Thanks Batbeer2, I learned something new today.

I agree with you: it will take an irrational competitor to bring $200 million to the table just to solve the problem of transportation and then compete on price with MCEM.



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Re: Monarch Cement No Moat
Posted by: batbeer2 (IP Logged)
Date: December 6, 2012 02:53AM

>> I learned something new today.

So have I, thanks.

I didn't know of this one. Now it's on my radar. Should Omaha ever make a bid for the olympics, I'll know where to look for stock ideas ;-)


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