BalkansCat/iStock Editorial via Getty Images

BalkansCat/iStock Editorial via Getty Images

I looked at HeidelbergCement (OTCPK:HDELY). Now I'm going to look at Holcim (OTCPK:HCMLY). This is a swiss company, and one at a very appealing valuation. Like HeidelbergCement, it has problems related to the current environment of carbon costs and the specifics of its operations - but it also has a number of potential upsides.

Overall, I believe that concrete is a good place to be, regardless of the challenges.

That's why I own a bit of Holcim - and why I'm going to probably buy more at some point in the near future.

Let's look at what Holcim gives us.

Like HeidelbergCement, Holcim is a multinational concrete/aggregate company. It has tens of thousands of employees and presences around the globe - scale is the only way to make this sort of thing work.

Holcim is what became of LafargeHolcim, a company that resulted from a merger of Lafarge and Holcim back in 2015. This combined merger at this time was one of the largest in cement ever. The company later changed its name to Holcim Limited.

It has annual sales revenues of 26B CHF and a market capitalization of around 29B CHF. Its dividend is typically between a 3-5% yield, depending on where in the valuation cycle you buy it - and like its peers, it's a very cyclical sort of business with plenty of ups and downs.

LafargeHolcim Stock history (Google Finance)

LafargeHolcim Stock history (Google Finance)

Any successful Cement/Aggregate company is typically going to be an integrated sort of business, on a vertical basis. The only exception in the value chain here is the use of energy/electricity, which no cement company can really integrate given their massive use.

However, Holcim has a high degree of vertical integration on a global scale, and has recently added Chinese cement OEM Huaxin. This integration does give Holcim some cost and scale advantage, due to proximity and cost advantages in emerging markets. Also, on a high level, Holcim differs slightly from its competition because it focuses on a retail/distributor sort of sales model, as opposed to the wholesale model used by most peers.

As I mentioned in my earlier articles, Cement/Concrete is a type of commodity that isn't made for long-distance shipping. It weighs too much and costs too little (generally speaking). As a result, companies typically want distribution networks of plants around cement factories and near pockets of demand. It's often profitable to build new plants to meet expected amounts of heightened demand in areas.

Keep this in mind. The market for building materials is local - fundamentally. It's not a market where you'll see extensive amounts of shipping due to logistical costs.

However, because of the immense volatility of demand and pricing, as well as geographies, these companies have incredibly cyclical trends. Holcim is no different. It needs to find a balance between stability and growth. And this is hard to do.

On a high level, it can be said that demand from legacy markets is relatively recurring, while emerging market demand is extremely volatile, but also much more profitable. An interesting dynamic.

All cement/concrete companies have been value-destructive for the past few years.

What do I mean by this? I mean that on a ROCE (NOPAT+lease exp*(1-tax)/ net capital employed percentage) basis, the company is below its weighted average cost of capital (WACC) of around an average of 7.5-8%. ROCE is lower than 6% and has only recently climbed up closer toward the WACC, compressing the spread.

This is not unique. HeidelbergCement faces exactly the same issue. However, it's also an implication for investment. I won't invest in a cement company when ROCE is above WACC because it implies we're in a asset high-utilization portion of the cycle. The resulting implication is that when things turn back down, the stock will fall - and your returns go south.

The right time to invest, therefore, is exactly when ROCE is at its lowest in terms of WACC, but make sure that the companies you invest in are actually stable. Because, and again, write this down - the ROCE/WACC spread implies the utilization rate for the assets, and as such implies where we're in the cycle.

It's a bit more complex on a granular level, of course. We need to consider that replacement values for the plants that Holcim - and HeidelbergCement - operates are actually higher than the current company share price.

In order for a peer to generate similar levels of production or revenues, they'd have to invest more than the company's NAV currently is. This ratio is trackable.

Alpha Value - Holcim Asset replacement value/NAV (Alpha Value)

Alpha Value - Holcim Asset replacement value/NAV (Alpha Value)

Company sales are fairly balanced, with Europe, NA, and APAC being the primary sales regions and LATAM/Africa the smaller ones. However, as I said before, margins in emerging markets are far better, which creates a dynamic where the European EBIT margin is only 13.1% for 2020, but 31.3% for LATAM and 21% for APAC.

The purchase of a ~42% stake in Huaxin cements the company's long-term strategy in place. This strategy includes:

Results in 2021 have been superb. Holcim is ahead of its long-term plan, with double-digit sales and EBIT growth, high conversion rates, and good ROIC with good, sub-2X leverage. The company is investment-grade rated, of course.

Sales saw significant expansion in the aforementioned Solutions & Products segment, reaching 13% of overall sales, in line to its 30% 2025E sales target, lowering the basic cement segment to less than 50%.

A crucial part for Holcim will be its green expansion, due to the heavy use of energy and generation of waste or a concrete company. The company expects to double its waste recycling by 2030. However, I view it as more important to look at things like the expansion to non-core product segments, continued margin stability, and keeping operations lean. Cement/Aggregate will always be an energy-heavy sort of business, and I see little changing this. The energy dependence and volatility need to be taken into account as a standard sort of factor, as I see it.

2021 was excellent - and 2022 is expected, at least initially, to provide similar earnings. I have yet to fully calculate the impact of the geopolitical situation as we're experiencing it now, so expect my targets for Holcim and how they're calculated to potentially change depending on how the situation changes.

For now, I expect continued near-double-digit 8.5% EPS growth in 2022, and stable 5-6% in 2023.

I highly doubt we'll see any adjustment in the dividend. Holcim is extremely conservative and stable about its dividend, and it hasn't been adjusted in some time.

Holcim Dividend (S&P Global/TIKR)

Holcim Dividend (S&P Global/TIKR)

I, therefore, do not model for a dividend increase trajectory according to what S&P Global expects. The 2 CHF dividend is what we're getting, and at good valuations, that's "good" enough for me.

On a high level, Holcim is far more of a play towards light-side materials since its M&A of Firestone - and this trajectory is expected to continue. HeidelbergCement does some of the same, but Holcim is ahead here. If one believes this is a good development as opposed to more of a legacy focus, then Holcim is the way to go between the two peers, as I see it.

However, please realize that any current expectation about a concrete/cement company has to take into consideration its potential carbon pricing provisions/expenses. These are rapidly rising, and therefore even under good circumstances, company growth in terms of profits and margins might be hampered.

Let's look at some risks.

No company is without risk. Holcim has several.

Previous/partially current management were positive about their Lafarge/Holcim M&A. This proved to be flawed, on several levels. The comparative lower margins and profits at Lafarge, coupled with higher leverage as well, proved to be one of the most value-destructive mergers in the sub-sector ever recorded. The combined company has been at a disadvantage because of this. Furthermore, initial management targets of cost-savings, cumulative FCF, and CapEx as well as supposed high dividend increases over time proved to be little more than dreams. Management didn't account for downside risk. They changed these targets in 2018 - but these were, according to many analysts, still too optimistic. Lafarge itself had, before this deal, also been known to be a very poor M&A'er, with attempts such as Blue Circle Industries, Redland, Orascom, and others - resulting in a 2008-2010 increase of debt the company could ill afford.

Most analysts forecasted an EBITDA CHF500M-900M lower than management did. So, this company has a 2015-2019 history of being perhaps a tad optimistic as to what they're able to achieve. While 2021 has been nothing short of excellent, there's still a lot of this history baked into the current valuation.

Holcim is also dependent on Emerging markets, and this is always a risk during times of the expected FED tapering. In addition, there are cost items such as carbon pricing that could turn out to really dial down the profit margins over the coming years.

Its reliance on electricity/energy is also a heavy risk given the current geopolitical situation. The problem is that much of the company's EBITDA margin growth is exactly because of the low energy prices. The fact that we're now looking at exactly the opposite means that it will take a miracle for the company to not only maintain but to grow EBITDA margins or any margins further.

The company's new CEO, Jan Jenish, has really been a blessing for the business. Much of the record levels have been arriving under his tenure, and implications are that much of the leaner structure and management more in-line with company ambitions is a result of his leadership as well as his changes. It's a clear case of "management" being a good thing here.

However, these are some of the risks that impact the company.

Valuing Holcim is similar to valuing HeidelbergCement. I'm applying a sales growth rate of close to GDP with EBITDA heavily impacted by increased CapEx due to things like Carbon costs (they're up 200% in 2021 alone), and energy costs rising, it's not fair or accurate (in my mind) to expect a whole lot of growth out of Holcim.

On the DCF side, I'm modeling a 1-2% sales growth and 1.5-2% EBITDA growth range. I'm bumping CapEx to 2.5-3% of sales. This is a massive increase to most analysts, who stick to 1.8-2.2% to more accurately reflect history. But as I've said earlier, I go for the conservative - and I believe the recent year increases of some of these cost items will continue. if not - great. If they do, well, at least I did some due diligence.

S&P Global calls for valuation ranges of 43 CHF up to 74 CHF, coming to a current average of 60 CHF. The low end of that assumes basically very little growth or extreme costs, whereas the high end assumes the higher end of sales growth, with the lower end of CapEx to sales, if we look at it through the lens of DCF.

I apply a 10% discount to Holcim for some of the risks mentioned here, but I still consider weighting these at fairly heavy amounts.

With a weighting where I favor DCF above all at a conservative part of the range, I reach an average weighted share price target of 60 CHF. This might be low in your eyes - and indeed, many analysts would agree, but it's a result of much of the discounting I've mentioned here, and I believe it fair.

Alpha Value holds an average target of 68 CHF per share for the business, as sees a significant, 45% upside here. Mine is lower.

There is no doubt that there are plenty of catalysts for a positive long-term trend here, however. A quick look at the momentum as well as knowing conservative valuations tells us that we're looking at a very cheap price for what is essentially a very well-performing cement company.

We're essentially back to early 2021 levels. The upside potential here is nothing short of 'significant'.

While there are clear risks and downsides here, I firmly believe that these are very much second to what are sector-high sort of upsides even to my extremely conservative valuation for the company.

That is why I view Holcim as a "BUY" here with a 60 CHF price target.

Remember the high level you should be looking at here. Any Cement company such as this is a play on Urbanization. The fundamental trends ongoing around the world speak in the long-term favor of companies like Holcim - and that's why I invest in them. Very long term, just making sure that I'm buying them in the "right" time of the cycle.

It's my argument that this time is now.

The relevant ADR for Holcim is HCMLY. It's a 0.2X ADR, but unfortunately, it doesn't have that much liquidity. I'd recommend going for the native Swiss listing, but this might be hard to get to, especially if you're in Europe. I would frequent brokers that allow trading the native if you want Holcim - though the ADR is of course, technically, an option.

Still - the low debt, the fundamental upside, the credit rating, the yield, the valuation - it all speaks in favor of this Swiss company.

I have a small number of shares, and following this drop, I'm definitely looking to expand my ownership in Holcim.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

The company discussed in this article is only one potential investment in the sector. Members of iREIT on Alpha get access to investment ideas with upsides that I view as significantly higher/better than this one. Consider subscribing and learning more here.

This article was written by

36 year old DGI investor/senior analyst in private portfolio management for a select number of clients in Sweden. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.

I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.

Disclosure: I/we have a beneficial long position in the shares of HDELY, VVCTY, HCMLY either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. The author's intent is never to give personalized financial advice, and publications are to be viewed as research and company interest pieces. The author owns the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in the articles. The author owns the Canadian tickers of all Canadian stocks written about.