CPAC - Cementos Pacasmayo Is Trading At Historically Low Prices

Summary

• CPAC is a cement manufacturer with a virtual monopoly in Peru's northern regions.
• The company has been posting record earnings fueled by record cement demand.
• Although macroeconomic risks are significant, the company is now trading at a much cheaper valuation than it did a year ago.
• Additionally, CPAC announced an extraordinary dividend that reduces the purchase price by another 10%.
• The company now trades at its cheapest valuation since it went public, despite generating record earnings.

Cementos Pacasmayo ( CPAC ) is a Peruvian cement manufacturer with a virtual monopoly in the country's northern region.

This is a recurring coverage article on the company's financials and stock price. For a more detailed review, please read my coverage initiation article from June 2021 and my latest update from May 2022 .

In my latest update, I found that the company had produced record earnings fueled by record cement demand in Peru. I was afraid that demand would not be sustainable. That situation has not changed much, CPAC has continued producing record earnings, and cement demand has not fallen.

However, although the risk of cement demand falling still exists, CPAC is now trading at a cheaper valuation, which reduces the risks associated with a decrease in demand. The company's stock is now trading at a valuation 35% cheaper than one year ago. Additionally, the company announced a one-time extraordinary dividend of S/2 ~ $0.5 per ADS, which reduces the purchase price by another 9%.

With this valuation (an after dividend adjusted market cap of $440 million) CPAC is trading closer to its historic earnings generation capacity (10-year average net income of $43 million). It is also trading at its lowest historic P/E ratio, probably motivated by political developments in Peru.

I believe CPAC now presents a more compelling opportunity to benefit from Peruvian economic growth and a recovery in the market P/E ratios. It is more protected from negative macroeconomic factors by a lower price.

Note: Unless otherwise stated, all information has been obtained from CPAC's filings with the SEC .

Company overview

As mentioned, for a more detailed description of CPAC's business and financial structure, please visit the initiation coverage from June 2021 .

CPAC is the only cement manufacturer in Peru's northern region, an area concentrating approximately 25% of the country's demand for cement. Because of the country's extension, geography, and the logistic costs of transporting cement, CPAC enjoys a virtual monopoly in the region.

In terms of competition, CPAC is also benefited by an interesting bargaining power position with its sales channel downstream. Most of its sales are conducted through small-scale distributors that in turn sell directly to families, because most construction in Peru is done by families themselves (a phenomenon known as self-construction or auto-construcción). This allows CPAC to grab more value downstream than other cement manufacturers that tend to depend on wholesaling operations. Like most cement manufacturers, CPAC is also integrated upstream, operating the mines from where it obtains raw materials like limestone.

The company has sufficient spare capacity, with three plants operating at a combined utilization rate of 70%, according to the latest earnings' presentation for 3Q22 . Its cost structure is relatively variable. Both SG&A and depreciation represent less than 20% of the company's costs. This means the company does not suffer from excessive operational leverage. Lack of operational leverage is a protection when demand falls but can also become a drag to profitability when revenues are growing.

On the negative side, CPAC's sales are tied to Peru's economic growth. For example, between 2008 and 2013, CPAC's sales doubled, in line with Peru's GDP. However, as the country's economy slowed, so did CPAC's revenues, which remained stagnant until 2020.

Finally, CPAC is relatively leveraged financially. The company currently has about $375 million in debts that mature between 2026 and 2029, compared to cash reserves of $50 million as of 3Q22, and an average yearly net income of $43 million for the past 10 years. This is probably the most negative aspect of CPAC's finances. Fortunately, Peru is one of the best rated credit markets in Latin America, and CPAC's debt pays a fixed 4.5%.

Latest business developments

For the last two years, Peru's cement industry has been burgeoning. As the chart below, from the Peruvian Cement Manufacturers Association , shows, cement dispatches for 2021 and 2022 are significantly above the 2017-2019 average. This elevated demand is consistent with the country's economic recovery since the pandemic.

Also of importance, CPAC has been able to increase prices above inflation, 9% YoY for the 3rd quarter and 12% YoY for the 9M22 period. The combined effect of higher volumes and higher prices, albeit damaged by higher costs and a relatively non-leveraged operational cost structure, has been a fast recovery in operating profits and net income.

Price considerations

But the situation above has not changed much from the one I described in my latest article from May 2022 , when I recommended a hold rating for CPAC.

The main difference now is not operations or macroeconomic context but price. CPAC's ADS is now trading more than 30% cheaper than one year ago and 10% cheaper than six months ago. The company has also announced a one-time extraordinary dividend of S/2 (~$0.5) per ADS, which drives the purchase price down another 10%. The ex-dividend register date is November 17, 2022.

Considering this, CPAC's ADS now trades at an after-dividend price of $4.9, or a market cap of $440 million. It is the company's lowest since it went public as an ADS. The stock's P/E ratio is also at a historic low. This is consistent with Peru's stock market trading at historically low prices too .

What are the potential benefits of this investment?

If the Peruvian economy remains at this level, then an 11% earnings yield on the current purchase price. If the Peruvian economy continues to grow, then an increase in earnings generation capacity, coupled with the possibility of P/E ratio recovery. Economic growth will translate to cement demand because 30% of Peru's population lives with less than $6 a day , 30% of the urban population lives in slums , and in the northern regions, more than 50% of houses are not made of brick and cement.

In terms of risks, the main one is a decrease in cement demand, particularly to 2013 to 2018 levels. As the cement association chart showed, current demand is as much as 30% higher than during the 2013-2018 period.

How was CPAC's profitability during that period? As the chart below shows, the company's average net income was still sufficient to cover an interesting return compared to the company's current market cap.

For this reason, I believe CPAC now represents a more compelling story than it did one year or six months ago. It still has a speculative component, but now more protected. The upside has increased too.

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