Think Concrete for Solid Returns?

Many analysts say Mexican cement giant Cemex stands to gain as a global recovery sparks a construction boom

By Eric Wahlgren

With the U.S. economy on the move again, it may be time to consider cement. Construction spending in September rose a surprisingly robust 6.5% over the same month last year. That signals greater demand for cement, the key ingredient in concrete used to build things like homes, dams, skyscrapers, and freeway overpasses.

Analysts say the building boom is likely to boost the biggest cement outfit in North America, a Mexican multinational with a reputation for solid management and technological innovation. Monterrey-based Cemex (CX ) pioneered the use of global positioning system locators on its ready-mix cement trucks to help drivers find the fastest routes to construction sites. (Cemex has since gone back to using two-way radios because they're still cheaper and easier to use. But it says it continually looks to technology to help it better serve customers.)

Cemex gets about 26% of annual revenues in the U.S., but investors have remained lukewarm on the stock despite increasingly positive reports on the economy. Its ADRs, which trade on the New York Stock Exchange, have more or less paced the market so far this year, rising 21%, to just under $25, as of Nov. 11, vs. a 19% year-to-date gain for the benchmark Standard & Poor's 500-stock index (the stock also trades in Mexico).


  So some bulls are urging investors to buy Cemex as the economic situation continues to improve in el Norte. "The timing of owning a stock like this is very good," says Jack Kasprzak, an analyst with BB&T Capital Markets in Richmond, Va., who has a strong-buy rating on Cemex. Over the next 12 months, Kasprzak sees the ADRs rising as high as $32, a 29% jump from current levels. (Neither Kasprzak nor his firm has any ties to Cemex.)

Others are a bit less enthusiastic about Cemex, mainly because they believe the stock is already near fair value. Daniel Altman, a Bear Stearns analyst in New York, sees many strengths, including its potential to benefit from a global economic recovery and its strong management team -- CEO Lorenzo Zambrano is a Stanford B-school grad. But these positives are already factored into the current price, he says.

"It's an interesting stock, but I don't think it's going to be a home run," says Altman, who rates Cemex a peer perform. "You would do [just] O.K. if you buy it here." Altman, who sees the stock at $27.75, or 12% higher, at the end of 2004, says he would buy it if the price dipped to the low-$20 range.


  It's possible that Altman is underestimating Cemex' prospects. After several quarters of disappointing results, it posted a 749% year-over-year increase in net income, to $140 million, on 7% higher sales of $1.83 billion in the third quarter ended Sept. 30. Earnings before interest, taxes, depreciation, and amortization (EBITDA) rose 13%, to $570 million.

Although the net-income figure fell short of analyst expectations, the EBITDA number bested Wall Street targets. The feat was achieved thanks in part to sales increases in countries including home market Mexico (36% of revenues) and No. 3 Spain (15% of revenues). It also helped that Cemex cut expenses 5% and booked gains in its securities portfolio.

In the U.S., Cemex' second-largest market, performance in the third quarter was mixed. Net sales dropped 1%, to $471 million, because of weak pricing. Ready-mix concrete (the kind delivered in cement trucks) volumes fell 1%. But the volume of cement sold in bags rose an encouraging 3%, partly because of some pent-up demand resulting from inclement weather earlier in the year.

Company officials say they see this spike as the beginning of an uptrend. "There are different infrastructure projects that might be coming in the following months, and the housing sector is active," says Cemex spokesman Javier Treviño. By Eric Wahlgren


  The long-term outlook business is very positive, analysts say. Cemex has been steadily paring its debt load, decreasing it 10 percentage points, to $5.68 billion, in the third quarter. Its ratio of net debt to EBITDA is now 2.8, nearly at its target of 2.7.

On the growth front, Cemex plans to boost revenues by taking share in existing markets and via acquisitions, Wall Streeters say. Its long-term annual top-line growth rate could range from 10% to 12% a year, including takeovers and market-share gains, Stephen Trent, a New York analyst with Smith Barney Citigroup, writes in a recent research note to investors. Trent rates Cemex a buy. (His firm has done banking with it.) He notes that Cemex' most recent acquisition -- the $84 million purchase of the Illinois-based Dixon-Marquette Cement plant -- was in an area in the U.S. where Cemex is seeing robust demand.

A focus on high-growth markets in the developing world, where margins tend to be fatter, gives Cemex an edge over rivals. It has operations in some 34 countries, including Egypt and Bangladesh, and its reach "should be a way to get faster growth," Kasprzak says. Cemex, the world's third-largest cement company, is more profitable than its bigger competitors, France's Lafarge (LR ) and Switzerland's Holcim, he adds.


  The global strategy has its drawbacks, though. "For more growth, you take on more political risk," Kasprzak adds. Cemex operations have been affected in Venezuela, where supporters of President Hugo Chavez have been involved in violent clashes with opponents. But Cemex says it has largely been able to mute the impact of business disruptions by exporting cement from Venezuela to other regions, including North America and the Caribbean.

Investors certainly court risks in owning this stock. As an international company, Cemex reports its financial results in U.S. dollars. But it prices its products in Mexican pesos in its largest market. Results can thus be dented if the peso weakens against the greenback, Altman says. Cemex' annual EBITDA can decline as much as $100 million for every five-percentage-point depreciation in the Mexican peso, he calculates.

Other possible negatives: "Pressure on cement prices and [a] lack of clarity on a sustainable rebound in the U.S. are the largest risks not only to the company's results, but also to [the] market perception [of Cemex]," Sebastian Luparia, a JP Morgan analyst in Buenos Aires, wrote in an Oct. 9 research note to investors. He rates the stock neutral. (JP Morgan does banking with Cemex.)


  Cemex counters that product pricing will be relatively stable in the future. On the issue of exchange rates, it says currency fluctuations can affect results in the short run. But Cemex adds that it has more than half of its operations outside of Mexico, lowering its vulnerability to exchange risks.

Treviño maintains that Cemex is a worthwhile investment. "Current demand for cement will grow, and new applications for cement -- cement siding and cement roofing for housing, for instance -- will grow," he says. "The economic recovery in the U.S. is going to trigger recovery in other regions."

Few doubt that growth is ahead for this ambitious global player, which got its start in 1906 when Zambrano's grandfather opened a cement plant in northern Mexico. The question for investors is whether Cemex' growth will be significant enough to warrant buying the stock at current prices. The answer depends largely on how much of a near-term jump investors are looking for. While the safest bet may be to wait for dips in the price, this is likely a solid long-term investment.

Wahlgren writes for BusinessWeek Online in New York

Edited by Beth Belton

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