Summary
- Cementos Pacasmayo is a Peruvian cement company with almost 65 years of operating history.
- Under normal conditions, I believe that Cementos Pacasmayo management will enjoy revenue growth and profitability from investments made by public institutions.
- In the Board of Directors, I find a former President of the Lima Stock Exchange, a former CEO of Banco de Credito del Peru.
Cementos Pacasmayo S.A.A. ( CPAC ) expects to profit significantly from the increase in infrastructure investments in Peru. The company also appears to have good connections with relevant key individuals in the Peruvian building industry and efficient facilities. In my view, even considering inflation risks, potential corruption scandals, and supply chain risks, the stock price is too low. Under the results obtained in my discounted cash flow models, I believe that seeing the stock price creeping up soon is likely.
Business Model And Ties With Public Institutions In Peru
Cementos Pacasmayo is a Peruvian cement company with almost 65 years of operating history. In my view, there are two main reasons to have a look at CPAC. First, management will most likely benefit from investments in infrastructure in Peru, where there are significant infrastructure needs. The company discussed massive figures, close to $160 billion, in a recent presentation.
Presentation To Investors
Besides, it is worth considering that CPAC has many ties with relevant key members in the building industry in Peru and the banking industry. In the Board of Directors, I could find a former President of the Lima Stock Exchange, a former CEO of Banco de Credito del Peru, and a former Chairman of Fondo Mi Vivienda. I believe that these individuals may have sufficient connections to bring new projects to CPAC as well as financing.
Presentation To Investors
I believe that most investors are quite optimistic about CPAC. They expect sales growth for the next three years, a stable EBITDA margin close to 23%-25%, and positive net income.
MarketScreener.com
It is also quite impressive that CPAC is expected to deliver FCF/Sales between 39% and 21% with only a small increase in capital expenditures. These numbers made me design my own financial models about CPAC.
MarketScreener.com
Under Conservative But Optimistic Conditions, I Obtained A Fair Price Of $6.7 Per Share
Assuming normal conditions, I believe that management will enjoy revenue growth and profitability from investments made by public institutions. Payments from local governments, regional governments, and other public initiatives are expected in Peru:
Presentation To Investors
I also believe that CPAC already owns efficient facilities, which will likely be sufficient to sell products to regions in most parts of Peru. With that, perhaps the utilization rate could be larger in the future, which would increase the company's FCF/Sales even more.
Presentation To Investors
With regard to the company's target markets, management noted that the company is the only manufacturer in the northern region of Peru. Besides, the company cited double-digit cement sales volume thanks to public investment in that particular area. In my view, if the government has to make new investments, CPAC will likely benefit.
We are currently the only cement manufacturer in the northern region of Peru and we produce and sell substantially all of our cement in the region. In 2020, the northern region accounted for approximately 32.5% of the country's population and 16.0% of its GDP. From 2017 to 2021, GDP in the northern region increased at a CAGR of 4.5%. During the same period, our cement sales volume grew at a CAGR of 12.4%, above northern region GDP mainly due to increased public spending resulting from the government's reconstruction plan after El Niño in 2017, and the resilience of the auto-construcción segment, mainly driven by high employment levels in agriculture which is prominent in the North. Source: 20-F
Assuming net sales growth of 4% and an EBITDA margin of 23%, 2032 EBITDA would be PEN714 million. With an effective tax of 29%, 2032 EBIAT would be close to PEN409 million.
My DCF Model
If we subtract capex close to PEN131-PEN186 million and conservative changes in working capital, DCF would be close to PEN441-PEN636 million. I used a discount of 15% because the company operates outside the United States. I also believe that an exit multiple of 6x EBITDA is conservative. Summing future FCF and the terminal value, I obtained a valuation of $615 million. The fair price would be close to $6.7 per share.
My DCF Model
My Bearish Case Scenario Would Lead To A Valuation Of $3-$3.5 Per Share
There are a number of risks, which could push the company's stock price down. First, let's note that the company operates in Peru. Economic indicators that may not be linked to the economy in the United States may affect Cementos Pacasmayo. Inflation, public expenditure, currency depreciation, and changes in the interest rate in Peru may destroy the company's FCF/Sales ratio.
Therefore, variations in economic indicators such as inflation, gross domestic product, the balance of payments, the appreciation and depreciation of the currency, access to credit, interest rates, investment and savings, consumption, spending and fiscal income, employment, among other variables, over which we have no control, could affect the development of the Peruvian economy and, therefore, could generate adverse consequences for our business, financial condition and results of operation. Source: 20-F
In line with the previous rationale, the government in Peru may implement restrictive exchange rate policies, which would affect the company's ability to pay in United States dollars. As a result, I believe that the price of the stock could decline.
In addition, if the Peruvian government were to institute restrictive exchange rate policies in the future, we might be obligated to seek an authorization from the Peruvian government to make payments on the notes and the guarantees. We cannot assure you that such an authorization would be obtained. Any such exchange rate restrictions or the failure to obtain such an authorization could materially and adversely affect our ability to make payments under our U.S. dollar-denominated debt and to pay dividends on our ADRs. Source: 20-F
The company could also suffer as a result of several corruption investigations related to the infrastructure industry. If the company or its directors find themselves involved in any case, we could see a deterioration of the company's reputation. Shareholders may sell their shares, which could result in an increase in the cost of capital and decline in the stock price:
Peruvian authorities are currently conducting several high-profile corruption investigations relating to the activities of certain companies in the construction and infrastructure sectors, which have resulted in suspension or delay of important infrastructure projects that were otherwise operational and permitted. The overall delay relating to such projects has resulted in a drop in GDP growth and overall infrastructure investment. Source: 20-F
Besides, changes in the tax regime would most likely diminish the company's free cash flow, which would lead to a decrease in the fair valuation. Under the worst-case scenario, I believe that the stock price would decline as soon as a sufficient number of journalists note the change.
The effects of any tax reforms that could be proposed in the future and any other changes that result from the enactment of additional reforms have not been, and cannot be, quantified. However, any changes to our tax regime or interpretations thereof may result in increases in our overall costs and/or our overall compliance costs, which could negatively affect our results of operation. Source: 20-F
Finally, supply chain issues, increase in salaries, or increase in transportation costs could lead to less free cash flow margin. Investors may reduce their expectations, which may lead to a deterioration of the company's financing conditions. The stock price could ultimately fall.
Under detrimental conditions, I envision -25% sales growth in 2023 and sales growth between 5% and 0.5% from 2025 to 2032. I also included a decline in profitability in 2023 followed by an EBITDA margin of around 23% from 2026 to 2032. With an effective tax of 29%, 2032 EBIAT would stand between PEN275 million and PEN285 million.
My DCF Model
Under these circumstances, I obtained a free cash flow that is significantly smaller than that in my previous case. Free cash flow would range between around PEN45 million and PEN445 million. Using a discount of 15.5% and an exit multiple of 5.5x EBITDA, the implied fair price would stand at close to $3.
My DCF Model
The Company's Financial Situation Appears Stable
As of June 30, 2022, cash stands at PEN277 million, inventories are worth PEN720 million, and properties are worth PEN1.947 billion. With an asset/liability ratio of 1x-2x, I believe that the company's financial situation appears quite stable.
10-Q
Total financial obligations are worth PEN1519 million, close to 3x forward EBITDA. Considering the total amount of inventory and property and equipment, I don't think that the total amount of debt is that large.
10-Q
Takeaway
Cementos Pacasmayo is expecting to profit from the increase in infrastructure spending in Peru. I believe that the business model will likely benefit from the existing facilities all over the country and its know-how in the cement industry. Even considering risks from inflation in Peru, supply chain risks, or corruption cases, the current stock price is too low. In my view, it is much more likely to see the price going up than falling down.
For further details see:
Cementos Pacasmayo: Massive Upside Potential, But Outside The United States