CX - Loma Negra's Executing Very Well But The Macro Backdrop Is Awful

2023-03-07 18:02:17 ET

Summary

• Loma Negra's fourth quarter results should show still-healthy volumes, effective pricing actions, and EBITDA/ton in the low-$30s, but the weak macro environment in Argentina is going to weigh on 2023.
• Management has effectively leveraged improved volumes and pricing to drive better margins, as well as plant modernization and cost/logistics optimization.
• Further margin improvement is likely more dependent upon capex (plant modernization) and a better macro environment, including lower energy prices.
• The fate of Loma Negra's rail concession is still somewhat in doubt, particularly with respect to how efficiently the rail lines will operate after the concession ends.
• Loma Negra could be significantly undervalued if Argentina's economy improves, but that's a risky bet and it's tough for a good company to win out over a weak macro.

I’ve used the “good house in a bad neighborhood” analogy many times over the years, but I’m not sure if that quite captures the dichotomy I see with Loma Negra ( LOMA ) and its home economy. Loma Negra is a high-quality operator in the cement industry, with EBITDA per ton that would slot in reasonably well with U.S. producers, but the Argentine economy is basically a dumpster fire now, with high inflation, weak real growth, a central bank with basically no forex reserves, and little likelihood of change ahead of elections later in 2023.

Despite this, Loma Negra is the “little engine that could” and continues to chug along. If the company can generate core long-term revenue growth in the mid-single-digits, the margins I expect would support a fair value around $8. Unfortunately, the economic situation in Argentina makes any and all projections highly suspect, and investors have to consider the very real risk that further erosion in the value of the Argentine peso will limit (if not seriously undermine) the benefits to holders of the ADRs.

Gearing Up For Q4’22 Results

Loma Negra is a late reporter in the cycle, but fourth quarter earnings are due to be reported after the close on March 8, with a conference call the following day.

At this point I expect to see adjusted revenue growth of around 10% year over year, or $206M in U.S. dollar terms. Given persistent cost inflation across the operation, I expect EBITDA to decline by around 9% to $57M, leading to an adjusted EBITDA margin of around 27.5%, or down about a point from the prior quarter. If those numbers prove accurate, EBITDA per cement ton would work out to about $32.50 or so.

Given the lack of major ongoing capex programs, I would expect to see another decent dividend, as well as progress with the buyback program. Given the weakness in the Argentine peso (down 16% versus the dollar in the fourth quarter and down another 10% or so since the start of the year), I don’t expect the same level of dividend payout in dollars; simply maintaining the prior quarter dividend in A$ terms would mean a roughly 36% cut in U.S. dollars at current exchange rates.

I do expect healthy underlying fundamentals, though, including healthy volumes and price realizations. Management has done a good job of passing on costs through prices, and while I do think that 2023 will be a more challenging year, I do think there will be enough demand tailwind to drive volumes in Q4’22.

Loma Negra Needs A Better Economy

Since 2016 Loma Negra has come close to doubling its EBITDA per ton and has significantly closed the gap with regional peers. Improved volume and pricing has helped, but so too have efficiency initiatives. The recent expansion of L’Amali has made this leading plant more efficient and management has likewise turned to areas like supply and logistics to drive further cost improvement.

Further progress is not entirely within management’s control. The first phase of the Kirchner pipeline should be complete around midyear, and if that completes on schedule and runs as expected, Loma Negra should benefit from lower natural gas prices. A healthier economy with less punishing inflation would be an even bigger boon to Loma Negra, but I don’t expect that there will be any meaningful announcements until after the first round of elections in October of this year. Even then it remains to be seen if the government post-elections will have a strong enough mandate to push through meaningful economic reforms.

Given that, I do believe volume will weaken in 2023. Longer term, though, cement consumption in Argentina and Buenos Aires in particular is well below average – Argentina’s per-capita consumption has ranged from around 250kg to 300kg over the last decade, well below the averages in Chile (378kg), Ecuador (374), Peru (366), Mexico (326), and Colombia (275), and depending upon your definition of comparable cities, consumption in Buenos Aires is 50% or more below average.

Argentina definitely needs more infrastructure investment, but whether or not the government (whomever that includes post-elections) has the capability of stabilizing the economy such that those investments can be made remains to be seen. Along those lines, the company will have to surrender its rail concession in 2023, and having its plants linked by rail lines it controlled was a positive for the operating efficiency of the company. There’s still uncertainty about what exactly the government will do with the Ferrosur Roca network, but I do have some concerns that operating efficiency and service quality will deteriorate under the control of someone other than Loma Negra.

A better macro would be the best outcome for Loma Negra , as the market is quite consolidated (Loma Negra has around 43%-44% share, with the top three controlling about 95% of the market) and the leading companies generally act responsibly. Moreover, over time there could also be opportunities to use more efficient on-site generation (like renewables) to reduce operating costs, and I would like see the company reinvest in plant modernization to drive further cost reductions, even if that comes at the cost of dividends in the short term.

The Outlook

Modeling always involves guesswork, but in the case of Loma Negra it’s even more speculative given the impact that government policies can have on the economy and the currency exchange rate. Given the core fundamentals of the economy (the population, the size of the economy, the need for infrastructure, et al), I believe Loma Negra could easily generate mid-single-digit core revenue growth on a long-term basis, and that’s likely a material underestimation of the actual potential growth if Argentina really got itself into shape.

On the margin side, I believe Loma Negra could get to $40 EBITDA/ton with just some moderation in hyperinflation – EBITDA per ton was $39 earlier this year, and that was still under less-than-ideal circumstances. Given core profitability and the relative lack of need of major capex in the near term (though I’d like to see more discretionary capex to make the older plants more efficient), I believe FCF margins could come in at the mid-teens for a couple years, and I think a low double-digit FCF margin would be sustainable on a long-term basis.

Even with a 13% discount rate, that supports a fair value of around $8 today. Likewise, I believe EBITDA supports the shares. A 4.5x multiple to my 2023 EBITDA estimate gives me a fair value of almost $7.50, and 4.5x is a 20% discount to the short-term multiple I use for Cemex ( CX ) – a company that operates in far more attractive macro environments (largely Mexico and the U.S.), but has struggled to match Loma Negra’s operational efficiency.

The Bottom Line

Loma Negra does look undervalued, and potentially meaningfully undervalued. If the government of Argentina can fix the country’s current economic woes, there’s tremendous potential for a cement company that has already shown it can operate effectively and efficiently under trying circumstances. Even so, I won’t be buying the shares – I don’t the risk and aggravation that comes with shaky macro situations. I have no doubt there are more aggressive investors who see Argentina as a prime opportunity, though, and I think Loma Negra is a good name to consider for that thesis.

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