BZZUY - CEMEX Still Has Operational Issues But Getting Dragged Higher On Sentiment

Summary

• CEMEX posted another mixed quarter, with a return to profit growth in Mexico, but weaker-than-expected EBITDA overall.
• Weaker volumes in 2023 don't surprise me, particularly given a weak U.S. housing outlook, but U.S. infrastructure projects and nearshoring in Mexico support a strong multiyear demand outlook.
• Structural cost issues will continue to dog CEMEX unless and until they reinvest the capital to upgrade their operations in the U.S., but liquidity and sentiment may limit management's options.
• CEMEX is not a top-notch operator, but it is still well-placed to benefit from a multiyear up-cycle in cement, and such swings often benefit less efficient producers more.

It has taken a while, but CEMEX ( CX ) has finally started catching up with better-performing comps in the cement and aggregates space, with the shares up about 15% over the last three months. The trailing one-year performance has still been relatively poor and well behind the likes of GCC ((GCC.MX)), Holcim ( HCMLY ), and Buzzi ( BZZUY ), but not out of line with Martin Marietta Materials ( MLM ) and perhaps not out of line with CEMEX's ongoing profitability challenges.

At this point, CEMEX is basically the opposite of a good house in a bad neighborhood - it's the fixer-upper in a nice neighborhood that the neighbors sorta wince at when they notice it. Cost issues here seem structural, and I think management needs to consider a more comprehensive plan to address them, though liquidity limits what they can do. I find myself wishing that CEMEX stock was better than it is, particularly as I see healthy multiyear drivers, and the valuation is still attractive, but I do think ongoing cost performance issues will be a long-term albatross around the company's neck.

A Pretty Typical CEMEX Quarter, With Cost Issues Still In Play

CEMEX reported 8% revenue growth in the fourth quarter (12% in constant currency), and that was good for an inline result relative to the Visible Alpha average estimate. Overall, the company reported a 6% year-over-year decline in cement volume, a 3% decline in ready-mix, and a 3% decline in aggregates, with various macro/price challenges in many markets.

Despite my commentary about elevated structural costs, CEMEX did show gross margin improvement in the quarter, with a 100bp yoy and 70bp qoq improvement to 31.2%, driven by a 160bp improvement in Mexico (to 45.6%) and a 420bp improvement in the U.S. (to 29.1%) as pricing and mix improved.

EBITDA declined 2% as reported and 1% in constant currency, missing by 3%, while margin declined 170bp to 16.3%. The miss was largely driven by corporate, though margins in the South, Central America, and Caribbean operations were well short of expectations.

Looking at some regional results, revenue in Mexico rose 13% in constant currency, beating by almost 8% with high-teens pricing only partly offset by weaker cement volumes (down 5%) and stronger ready-mix and aggregates volumes. Mexico underperformed industry volumes in the quarter but outperformed on pricing, and that's a trend we've seen before. EBITDA was up 4% in local currency, beating by more than 3%, and although margin was down 220bp to 26.7%, this was the first growth in over a year.

In the U.S., revenue rose 16%, missing by 3%, with 20%-plus pricing offset by 6%-7% declines in cement, ready-mix, and aggregates. EBITDA rose 16%, beating by more than 3%, with margin up 60bp to 16.5%.

Weaker Guidance For 2023 Isn't A Surprise To Me

Management guided for low-single-digit volume declines across its geographies in 2023. This doesn't surprise me, as I've been expecting weaker macro conditions in most of CEMEX's markets.

I've been more negative than most on the U.S. non-resi construction market, and while I do see an upside in infrastructure as federally-subsidized projects get moving, a weak housing market is going to offset some of that leverage. Mexico is a tougher call. Higher prices and the prospect of weaker remittances from the U.S. (as inflation bites into paychecks) will hurt the informal sector, but nearshoring is driving stronger demand and the Mexican government is throwing money at infrastructure projects (I'm sure it's only coincidence that 2024 is an election year…).

Management's call for low-single-digit EBITDA growth in FY'23 was a roughly 3% to 4% cut relative to sell-side expectations going into the quarter, but not much of a change compared to my expectations. Ironically, lower volumes could be good for margins in the U.S., as CEMEX has been having to rely more on large volumes of imported cement that carry low margins.

Beyond 2023, which has a lot of global macro challenges in it, I'm pretty bullish on the market drivers for CEMEX. I believe nearshoring will see billions spent on new facilities in Mexico's border states, and I expect to see more money going to badly-needed infrastructure projects as well. In the U.S., I expect tight capacity, growing infrastructure demand, and an eventual housing rebound to set the stage for very strong pricing and solid volumes for at least a few years.

Self-Improvement Options May Be Limited

I wish I could be more bullish on the likelihood of CEMEX closing its performance gap with its rivals in the U.S.

As I mentioned in my prior article on the company, CEMEX reliably produces weaker EBITDA/ton in the U.S. - about $10 to $20 below the average and more than $80 below the leaders. Elevated energy and maintenance costs are a notable part of this, and it looks like these issues are structural. Modernizing and improving the producing asset base could help, but CEMEX remains overleveraged and any talk of reinvesting in capex has generally been criticized pretty heavily by the Street.

Still, I'd like to see the company launch a more comprehensive program to tackle its U.S. margin issues. I don't know whether we're heading for a "super-cycle" in cement, but I do think there will be several good years on the way. It would be a shame for CEMEX to miss out because of an inferior asset base, assuming that reinvesting capex dollars can fix it (I don't have the information to speak with certainty on that), and I think the company could get a good return on dollars spent to improve the operating efficiency and capacity of these assets (particularly, if it has to keep relying on low-margin imports when demand reaccelerates).

The Outlook

I'm not making significant changes to my model at this point, as I had below-average numbers going into the quarter. I'm actually tempted to raise numbers a bit, but there's no rush at this point. I expect low-single-digit revenue growth in 2023, and I'm expecting a sharper correction in volumes in key markets. Over five years, the growth rate moves to 5% and over the long term, I'm looking for around 4% to 5% revenue growth.

Not surprisingly, I'm not so bullish on margins. I'm looking for around 16.75% EBITDA margin in FY'23 (down about half a point), but I do expect improvements in the coming years. At the free cash flow line, I expect free cash flow margins in the 5% to 6% through much of the bull cycle, and I expect long-term growth of around 4%.

I value CEMEX on discounted cash flow and a modified EV/EBITDA approach that mixes next year EBITDA with a longer-term "full-cycle" estimate. Cash flow gives me a fair value of around $7, while the EBITDA approach (using a 5.5x near-term and 6x long-term multiple) gives me $5.75.

The Bottom Line

If you want to own best-of-breed companies, I can't really recommend CEMEX to you, as it seems like this company always comes up short, whether it's with cash flow, liquidity improvement, margins, or what have you. I do think the potential is there to do a lot better, but I don't know if that potential can be unlocked. In any case, I do think CEMEX is "good enough" and I think there is still an attractive multiyear cycle on the way, so this is a name I'm still positive on from a tactical, if not qualitative, viewpoint.

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