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Value Research on Demand: Lafarge

March 20, 2011 | About:
Lafarge (PAR: LG, PINX: LFRGY), driven by housing and infrastructure demand, is one of the world’s largest building groups with operations in 78 countries. It is the world’s largest cement manufacturer by mass. Its headquarters are based in Paris, France and the CEO is Bruno Lafont, whom was appointed on 1st January, 2006.


The company was founded in 1833 to exploit a limestone quarry. Lafarge signed its first international order in 1864 for the delivery of 110,000 tonnes of lime.


At a global level Lafarge is number one in cement, number two in aggregates, number three in concrete and number three in gypsum. The business is roughly spread at 60% cement, 32% aggregates and concrete and 8% Gypsum.


Operationally Lafarge operates in a cyclical industry and an obvious investment technique would be to invest during the low cycle and sell out during the high cycle. Capital expenditure costs are high in this industry and large asset investment would be needed in order to substantially increase sales.


Sales: At the end of 2009 sales were divided as follows:




Geographic Area


Percent


Western Europe


29.3%


North America


19.1%


Africa & Middle East


25.3%


Central & Eastern Europe


6.0%


Latin America


5.0%


Asia


14.7%





See the table at end of report for a detailed breakdown of cement plant, grinding plant, capacity and market share per country.


Global cement ‘hotspots’ include China, India, Turkey and South Africa. Brazil, too, is experiencing fast paced growth with cement sales more than doubling since 2007.


Special mention must be made regarding China whose market alone consumes more than half of the worlds cement consumption. It is also the world’s second largest plasterboard market. At the end of 2009 Lafarge was a top ten player in China and had facilities consisting of 28 cement manufacturing sites, 5 concrete batching plants and 4 plasterboard plants. Lafarge has an ambitious target of growing capacity to 50m/t per annum by 2012/2013. Given that the Chinese government is closing down smaller rural and inefficient plants Lafarge just may reach their target. Lafarge entered China in 1994.


Earnings


Historical and forecasted revenue, pre-tax profits, EPS and dividends paid are as follows:




Year End


Revenue ( Euro bn )


PTP ( Euro bn )


EPS ( Euro Cent )


Dividend ( Euro Cent )












Dec - 2005


15.97


1.85


913.64


364.60


Dec - 2006


16.91


2.22


565.80


216.23


Dec - 2007


17.61


2.76


796.46


288.31


Dec - 2008


19.03


2.42


702.11


169.80


Dec - 2009


15.88


1.31


277.00


200.00


Dec - 2010


16.17


-


289.00


100.00


Dec - 2011


17.08


1.80


366.27


142.86


Dec - 2012


18.17


2.25


469.76


174.65




As can be seen earnings are somewhat erratic with return on retained earnings being negative over any substantial period of time. This is due to the company operating in a very cyclical sector and is typical for the industry. CRH and Holcim etc all have similar figures.


The current market capitalisation for Lafarge is around Euro 11.8bn.


Finances


For the year 2010 Lafarge generated Euro 2.2bn in free cash flows though net debt increased by 1% to Euro 13.99bn. ROCE came in at 5.8%. Net income increased by 12% and represented a net margin of around 5%. The operating margin came in at 15.1% a fall of 50 basis points from 2009.


The company successfully refinanced Euro 2.7bn during 2010 with an average interest cost of 4.5% and an average maturity of 6.5 years. Cash and equivalents plus unused lines of credit are sufficient to cover short-term obligations.


‘Strict Working Capital in Days of Sales’ has been reduced from 53 days in 2007 to only 30 days in 2010. This reduction has resulted in more than Euro 350 additional cash flows in 2010.


Lafarge has cash and cash equivalents of Euro 3.3bn and no financial covenants on any credit facility.


Costs


Two of the largest operating costs for the sector are electricity and cement. Electricity prices will vary according to regulation allowances in the areas that the company operates but Lafarge is forecasting an 8% increase in electricity costs for 2011 which is equivalent to 1 Euro per tonne.


Gross cost of debt is forecasted to be 5.7% and the tax rate is estimated to come in at 26%.


Capital expenditure is forecasted to come in at Euro 1bn split into 50/50 between expansionary and maintenance capex.


The group exceeded its cost cutting target for 2010.


It is important to note that inventory loss is usually small for the sector as cement, if stored properly, will hold its value as cement prices are usually stable over time.


Pricing Power and Competitive Advantage


Building companies typically have little pricing power although they can raise prices in order to combat inflation which is what Lafarge is planning during 2011. Although price rises may not offset inflation combined with cost cutting is provides a satisfactory form of protection.


Cement and aggregates are a commodity product therefore there is no pricing power, under normal production costs, which can gain market share when increasing prices beyond that of competitors.


Lafarge’s competitive advantage lies in economies of scale. Other competitive advantages are best viewed from a local perspective. Those plants situated very near lime quarries save on transport costs. A strong advantage also is if a plant is situated in a monopoly area such as a location that is surrounded by a mountain range and makes transportation costs for competitors unviable.


The Board of Directors


The Board consists of 18 members, 11 of whom are independent. The position of Vice-president of the Board is reserved for an independent director. Directors are appointed for a period of 4 years.


Management remuneration is in-line with the industry. Bonuses are awarded for a combination of corporate, environmental and social targets.


Some Characteristics of the Cement Industry


The cost of building cement plants is often higher than $220m per million tonnes of annual capacity. Usually such a plant is akin to 3 years worth of revenue. Plant modifications are very expensive too thus the cement industry is one of the most capital intensive industries that one can find.


Around 60 -120 kilograms of fossil fuel is required in order to produce one tonne of cement as well as 105KWh of electricity.


The industry features low labour intensity due to the advent of process machinery.


Globalisation has benefitted the cement industry, or more specifically, bulk shipping has. It is now cheaper to ship 25,000 tonnes of cement across the Atlantic Ocean than it is to drive it 400 kilometres.


Risks


The company lists the following risks: market risks, interest rate risk, commodity risk, exchange rate risk, counterparty risk for operations, liquidity risk and equity risk. Since these risks are standard for most multinationals I will not go into them in detail here.


Egypt


Egypt represented 4% of company turnover in 2010. At the 18th, February, 2011 Lafarge’s operations in Egypt had 7 days of sales disruption in total. Sales have resumed since February, 5th, and are back to normal levels (this information was accurate at the 18th of February). The long term potential of Egypt is very important as it’s the largest growing population in the Middle East thus there is significant demand for housing and infrastructure.


Joint Venture


Lafarge has created a joint venture with Tarmac (Anglo American) to form a group with combined revenues of Euro 1.5bn and EBITDA of Euro 235m. The 50/50 cash neutral deal features a wider range of products for customers including larger ranges of cement, aggregates, ready-mix concrete and asphalt & paving. The JV should generate Euro 70m worth of annual synergies and is accreditive to Lafarge shareholders.


Outlook


The group is aiming to accelerate deleveraging and to reduce debt by at least Euro 2bn during 2011. Cement volumes increased during Q4, 2010 and this trend looks set to continue with cement demand in its markets forecasted to grow by between 3 – 6% compared to 2010. The two regions expected to post the largest growth are Latin America (forecasted to grow by between 7 – 10%) and Asia (with 5 - 8 %.)The main drivers of growth are the emerging markets with developed markets expected to recover slowly. Overall pricing is expected to move higher although this will vary by market.


The Latest News


Revenues surged for Lafarge Zimbabwe for the year ending 31 December, 2010 due to a strengthening economy. However profits remained flat due to payment of a large once-off tax payment.


Valuation


At the time of writing Lafarge’s share price was Euro 41.42. On this basis, working from the forecasts tabled above, Lafarge is trading on a multiple of 11.3 with a dividend yield of 3.4%. Sector comparisons include CRH (multiple 17.2, dividend 4.2%), Heidelberg (multiple 12.2, dividend 1.5%) and Anhui Conch (multiple 15.8, dividend 1.3%) amongst others. Therefore Lafarge looks somewhat attractive against the peers listed in this regard with a nice dividend to boost.


The company ended 2008 on a multiple of 5.2 (dividend yield of 5.2%) and the year 2005 on a multiple of 7.1 (dividend yield of 4.6%). These figures show that there is significant downside risk with only moderate upside reward.


In the authors opinion it is better to invest in a cement play with major competitive advantages such as the company listed in the paragraph below.


A Different Option than Lafarge


An undervalued Chinese cement company is West China Cement (HK: 2233) listed on the Hong Kong stock exchange. The company is expanding nicely, financed by an IPO on the Hong Kong market after delisting from London’s AIM market where management felt the company was undervalued. Further capital was raised in a recent bond offering.


Operationally West China Cement benefits from the competitive advantages listed in the article above – mines surrounded by mountain ranges creating a monopoly situation, lower transport costs than competitors resulting in higher margins. There are expansion plans to which should see annual capacity more than double.


The company is trading on a single digit multiple versus double digit multiples from its peers yet, West China has greater margins and much higher growth. For further research the company website is here: http://www.westchinacement.com/eng/global/home.htm




Lafarge: A Breakdown per country of cement plants, grinding plants, capacity and market share:







Country


Cement Plants


Grinding Plants


Cement capacity


( m/t )


Approx. Market share


France


10


1


9.5


34


UK


6


-


5.9


40


Greece


3


-


9.8


50


Spain


3


-


7.3


10


Germany


3


-


3.4


10


Austria


2


-


2.0


32


US


12


-


14.8


13


Canada


7


-


6.4


33


Poland


2


-


4.8


20


Romania


2


-


4.9


31


Russia


2


-


4.1


7


Moldavia


1


-


1.4


62


Ukraine


1


-


1.3


12


Serbia


1


-


2.0


45


Slovenia


1


-


0.6


38


Czech Republic


1


-


1.2


9


Morocco


3


-


6.8


43


Nigeria


3


-


3.5


32


Algeria


2


-


8.6


36


Iraq


2


-


4.8


21


Jordan


2


-


4.8


94


Zambia


2


-


1.3


75


Egypt


1


-


10.0


20


United Arab Emirates


1


-


3.0


6


South Africa


1


2


3.6


17


Tanzania


1


-


0.3


22


Kenya


1


1


2.0


48


Uganda


1


-


0.4


62


Cameroon


1


1


1.7


92


Benin


1


-


0.7


37


Malawi


-


1


0.2


76


Brazil


4


1


4.0


7


Mexico


2


-


0.8


NS


Ecuador


1


-


1.4


20


Honduras


1


1


1.3


55


French West Indies / Guyana


-


3


1.0


100


China


18


10


24.3


6-22 (b)


Philippines


6


1


6.5


33


Malaysia


3


1


12.5


37


South Korea


2


1


9.6


13


India


2


2


6.5


24 (c)


Pakistan


1


-


2.1


6


Indonesia


1


-


0.0 (a)


4


Bangladesh


-


1


0.5


1


Vietnam


1


-


1.6


15




(a) The Indonesian plant was damaged during the 2004 Tsunami and is under reconstruction.


(b) Depending on region


(c) For the North East region




Value investing is my hobby as well as my vocation. I am a director at www.shareladder.com and have written a value based newsletter for the site since May, 2010. The portfolio based on my newsletter is up just under 40% during that time.

About the author:

Liarspoker
Stockbroker @ www.market-swings.com

Visit Liarspoker's Website


Rating: 3.6/5 (16 votes)

Comments

kfh227
Kfh227 premium member - 3 years ago


I'd almost liek a write up on West China cement.

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