2023-12-11 01:10:53 ET
Summary
- Cementos Pacasmayo is a major cement producer in Peru with a quasi-monopoly in the northern region.
- The company is expected to grow alongside the Peruvian economy and offer a dividend with a good yield.
- However, in a few years, the company may require better financing and should avoid excessive leverage.
- Further, the dividend is potentially at risk in the short-term, which could make the company's stock price volatile.
Cementos Pacasmayo ( CPAC ) is one of the three cement producers in Peru and holds a quasi-monopoly in the country's northern region.
I wrote about CPAC in June 2021 , May 2022 , and November 2022 . Those articles contain more detailed descriptions of the company's operations. CPAC is very stable across the Peruvian cycle but has some potential if the Peruvian economy enters a new growth stage. I also believe that the company has to manage its leverage levels carefully.
In this article, I review the latest 9M23 results, plus the financial condition of the company. I believe that the company is at risk of decreasing its dividend and that it is difficult to estimate if the market already discounts this. For that reason, I prefer to wait until FY24 is more advanced, and operating income is better understood, before purchasing CPAC for dividend income.
Peru's downward portion of the cycle
The Peruvian economy grew strongly in 2021 and 2022 thanks to the income effects of the COVID stimulus, plus the betterment of its trading terms via better export commodity prices.
The construction segment was particularly benefitted, with a 30% expansion in 2021 compared to pre-pandemic levels. At that time, I recommended avoiding CPAC as the company was being priced as if those cement consumption levels were permanent.
The data for 2023 above shows that the cycle turned as expected and that now the consumption of cement stays at a midpoint between pre-pandemic and 2021 levels, which I believe are probably more sustainable.
The latest report from Peru's Central Bank shows that the cycle is probably stabilizing by the second half of 2023.
In the case of CPAC, the cycle is not as marked. I believe one of the reasons is the high investment in inventories during 2022, which kept the plants at high occupation, which means fixed costs were spread over more inventory. Those inventories were sold during 2023 (the turnover is close to 0.5, so it takes about 2 years to clear inventories), which means an improvement in margins, especially if you have some inflation like Peru does. I would expect CPAC gross margins going forward to decrease.
In my opinion, the decrease in margins and relatively stable revenues should cause CPAC's operating income to cycle lagged to the Peruvian economy in the following quarters. It's probably that the stable level is closer to $80 million than to $90 today.
Leverage, maturities, and return on assets
CPAC has been consistently leveraging for the past few years, via the payments of dividends a little above EPS.
This was a good policy, given that CPAC's interest cost was well below its ROCE (operating income over total assets, chart below). For example, in 2019, CPAC got PEN 600 million (~$200 million) with maturities of 10 and 15 years at rates close to 7%. In 2021, it got PEN 860 million (close to $300 million) in a 9-year maturity paying only 5.82%. If you can leverage at long rates below your return on capital employed, then you can increase leverage for equity sustainably.
However, the company has reached a limit in this respect, but it keeps investing and decreasing its cash holdings. It has recently financed PEN 60 million at 9.5%, above its long-term ROCE. Further, the fixed investments in kilns will increase depreciation and, therefore, decrease ROCE for a given output level.
The company is financially sustainable, given that most of the debts above mature after 2030. However, management should stop leveraging at this point and wait for a potential decrease in interest rates to refinance the convenient rates it has locked in.
The dividend is not sustainable
CPAC's current dividend of about $0.55 per year per ADR is unsustainable even if we assume a stable operating income level of around $90 million (current level), plus interest expenses of $35 million going forward (7% rate on its PEN 1.5 billion and stable PEN/USD exchange rate of 3).
That leaves $55 million pre-tax or $37.5 million after a 32% effective tax rate. Divide that by 85 million ADR equivalents (420 million shares at 5:1 ADR ratio) to get $0.44 of EPS per ADR.
I guess the market expects the current 11% dividend yield (given the yearly dividend of $0.54 announced a few weeks ago), to decrease to 9.2% or lower, given the sustainable rate of income. Take into account that the above EPS was based on a relatively optimistic $90 million in operating income, which I expect to be lower given the cyclicality of the Peruvian economy in general.
If, as I expect, operating income moves to the $80 million territory due to cyclicality, then EPS per ADR would be $0.36, which, if fully paid as a dividend would imply a dividend yield of 7.5%.
If the dividend was maintained without a corresponding increase in earnings, then it should come from leveraging, which is unadvisable at these rates.
Conclusion
Even with lower operating income, a 7.5% dividend yield of a stable and financially sustainable company is enticing. However, it is difficult to predict what could be the market effect of a decrease in the expected dividend rate. I fear that if EPS lowers the price of the stock falls to keep the dividend yield at a 10%+ level, and therefore the positive effects of the yield are offset by the fall in price.
For that reason, if the goal of owning CPAC is dividend income, I would wait a few months into 2024 to understand better the company's operating income dynamics and how the market reacts to that. This year's dividend has already been announced and the ex-dividend date has already passed, so there is no cost in waiting.
For further details see:
Cementos Pacasmayo Dividend Might Be At Risk (Rating Downgrade)