Company

Buzzi is a cement and ready mix manufacturer with presence in US (2/3 of EBITDA), Italy, Eastern Europe (Russia, Poland, and Czech Republic), and Central Europe (Germany, Norway). While the Company is Italian by origin, it derives a majority of its earnings from the U.S., where it has 10% market share of cement capacity. Buzzi also owns 33% of Mexican cement manufacturer Moctezuma.

Thesis

There is general enthusiasm behind US-based aggregates and cement manufacturers as evidenced by the multiples ascribed to Vulcan and Martin Marietta in the 14-15x EBITDA range. The overarching thesis is that capacity utilization of cement plants in the U.S. today is above 90%, existing infrastructure plans will continue to increase demand, and a Trump infrastructure plan that boosts annual spending by $30 to $60 billion could lead to cement demand exceeding 110% of capacity. This is already beginning to materialize by stated price increases, as 1) LafargeHolcim has announced a $US 20/tonne price increase – a 17% increase, 2) Heidelberg announced $8-$12/ton beginning January 17, and 3) Cemex announced intentions to raise prices $18/ton .

Our thesis is not overly complex, we believe Buzzi is 1) well positioned to participate in the rising demand for cement in the U.S., 2) is likely to see some improvement in Italy which makes up 14% of its revenues but -6% of its EBITDA, 3) is positioned in a consolidating industry that has decent barriers to entry, and 4) is trading attractively at ~7.5-8x EBITDA once we back out the Company’s publicly traded Mexican equity ownership. The valuation is particularly attractive in context of U.S. growth likely to pick up strongly.

Why the Opportunity Exists

We think the Company’s smaller market cap at EUR 4bn (listed in Italy, family owned) precludes it from heavy ownership versus peers like CRH, Heidelberg, and US peers. Management is also very conservative in guidance and we think that pressures sell-side estimates downwards, which sets up a potentially nice earnings-derived catalyst going into 2017. Q3 was also relatively weak in the US as precipitation was 36% higher in Texas and 77% higher in Missouri, which account for ~60% of Buzzi’s production capacities.

Furthermore, Buzzi beat Q1 and Q2 EBITDA estimates by 38% and 12% but missed slightly in Q3 (.86%) due to a weak/very rainy Texas and 3 fewer trading days. Management is incredibly conservative on all its conference calls and has guided to 520 million EBITDA for the full year, implying a 14% drop YoY after being up 18% YTD. While the street is higher at 542 million for the full year, this still only implies 4% YoY growth. We believe this has created a very easy hurdle to beat, and our conversations with the company suggests the weakness in Q3 is unlikely to be replicated going into the end of the year (energy is hedged for 6 months in advance, should begin to impact in 1Q’17 coincident with price increases).

Valuation

Buzzi is extremely attractive on a valuation front. We believe the reasons cited above has created a disconnect between Buzzi’s valuation and peer multiples in the U.S. (Vulcan, Summit, Martin). Furthermore, Buzzi has 2 shares: ordinary shares and savings shares, which complicate the capital structure a tiny bit. The savings shares act like quasi-equity, with the higher of a 5% dividend, or 4%+the dividend on the common. For valuation purposes, I treat it as preferred stock

At the current price of €21.80, Buzzi has an enterprise value of €4.9 billion (market cap of €3.6 billion, ex savings shares). Subtracting the Company’s 33% equity stake – worth roughly €765 million – the EV ex Mexico is €4.2 billion. I think 2016E EBITDA is likely to be around €550 million, giving the company a 7.6x EBITDA multiple and a 12x EBIT multiple. If you think the US is worth at least 10x EBITDA, which is probably more akin to peers (US Concrete, a lower quality ready mix manufacturer, trades at 9x), the remaining European business is worth 3x EBITDA. If you think the Company is worth 12x EBITDA (in between aggregate and ready mix multiples), then Europe is worth nothing despite generating €191 million in 2016E EBITDA (€225m without Italy).

I think the Company is worth €30-31 by 2018 at an 8x EBITDA multiple (~18% IRR), and could be worth significantly more as detailed below if infrastructure spending accelerates under president Trump.

Thesis Point 1: Rising Demand in the US

In the U.S., demand for cement peaked in 2006 at over 130 million tons, while today it is at roughly 93 million tons. US capacity has been roughly flat at ~100 million tons throughout this entire period. In 2006, the US imported significant amounts of cement to meet high demand (25+%). As that demand waned, imports cushioned the blow, as demand halved while utilization only dropped from 90% to 60% (in contrast to European capacity). Today, utilization is estimated to be in the 80% range.

• US cement consumption comes predominantly from public construction and utility (~50%), residential buildings (28%), and nonresidential buildings (17%). ~70% of US infrastructure cement consumption goes into highways, which the PCA estimates will grow between 4-6% through 2021 based on FAST Act’s 5 year funding program.

• Aside: Budget for highway spending is just over $100billion currently, National Surface Transportation believes we need $185 billion p.a. for 50 years

• In residential, ~63% of cement is used for single family housing. Single family housing starts are roughly 700k right now, and we believe it is not unreasonable to assume that housing starts will creep back up to the long term historical average of 1-1.1 million over the next 5 years.

• In non-residential construction, spending is creeping up to within ~10% of peak (~$400bn vs trough of $270bn), and it seems that this number could be flat or declining

• Hence, assuming US highway grows at 5%, single family cement grows at 7%, and the remainder grows at 1%, we get to 3.5% consumption demand growth. I think this is a decent base assumption for the next 3-5 years, though conservatively you can haircut that down given Buzzi has a slightly worse mix of regional market exposure (largely to Gulf and Central)

• I think this is reasonable, as it just more or less tracks FAST’s funding as well as single family starts

• Summit: “cement demand will exceed US capacity by 2019”

• Deutsche Ba7nk forecasts 4.2% volume CAGR from 2017-2019, in line with PCA

• CRH: “US. Management highlighted that it expected a 21% increase in infrastructure spending over the next five years in its markets, following recent voter approval for a number of bond issues. This does not include any contribution from a new Presidential infrastructure programme.”

• CRH: “So, my overall comment to you is that the infrastructure spend is solid. I think probably the most significant fact I can give you is that despite a very strong performance by our businesses in the first nine months of this year, where you would expect possibly to strip out some of the backlogs, the backlogs are flat with last year – in line with last year, which is a very good position to be in because we're already finishing out work. This is a lower level of backlogs for us at this time of the year with the indication they are well spread… U.S. residential. We're very much plugged into developers and contractors. And of course, they're working 6, 12, 18 months ahead. So, looking at what they're talking to us about and their demand levels going forward seems to be fairly solid for 2017 as well”

Pricing in the US

Buzzi operates 8 cement plants with 10% of US capacity (10.4 million tons/yr). Capacity is heavily focused in the South and Midwest– with 2.2mt in Texas, 1mt in Oklahoma, 3.7mt in Missouri, and the remaining in Tennessee, Indiana and Pennsylvania. EBITDA margins are likely to hit ~32% this year and slowly move up to ~35% as 1) utilization climbs higher and as 2) pricing power exceeds the cost of rising energy and materials. All the big important players have already signaled their intent to price cooperatively.

Buzzi does not believe that it will experience high single digit/double digit price increases its peers have publicly announced. The reason is predominantly because of exposure – Buzzi’s footprint is focused more on Texas and the Midwest, which has been experiencing sluggish trends from a combination of weather as well as energy exposure. The Company believes it will raise prices mid-single digits (like this year), which will more than offset increase in energy prices. From an aggregates perspective, Buzzi states that the supply chain is generally systematic – it is unlikely for aggregate prices to increase substantially without similar price moves in cement and ready-mix. The combination of increased demand in volume as well as higher profitability should allow EBITDA margins to continue expanding (primarily from operating leverage). In fact, competitors are all increasing prices well above cost inflation – DB estimates ~4% cost inflation vs. mid teen’s price increases announced (even if half stick, that is still 5% price above costs).

Going forward into 2018 and onwards, while we do not have a very strong opinion on Trump’s potential infrastructure bill, we think that the likelihood of something passing that increases demand for cement (whether marginal or impactful) in 2018-2020 is more likely than not. Our model predicts 5% pricing and 3-4% volume growth in 2017 and 2018, with margins expanding roughly 1% point a year to ~34% in 2018 (using historical incremental margins). Below is a chart on mid-cycle volume/price combination for cement:

We have attached some analysis from UBS that tries to quantify the potential impact of Trump’s promises. Needless to say, if any of these scenarios play out, the upside on price/volume could be more significant:

• PCA assumes if infrastructure plan goes through, cement consumption growth will increase from 3.1% to 8.3% from 2017 to 2019

• HSBC put out a good scenario analysis that looked at Trump’s boost to infrastructure, assuming a $30 billion or $60 billion a year annual increased spend (a 40 or 70% discount to the trillion dollar spend). Deficit aside, this would increase US civil engineering anywhere from 13% to 25% (base of $260 billion)

• Here’s is the upside optionality in a nutshell: “In our base case forecasts, we estimate US cement capacity utilisation at 93% in 2018e, which mean that our proposed increase in infrastructure spending and the resultant growth in cement consumption would just exceed capacity by 2019. In the scenario of a USD30bn increase in spending in 2019, we forecast US cement capacity utilisation to be 102%, while in our USD60bn scenario we forecast utilisation at 108%. Given that the construction of new cement plants would be unlikely by the beginning of 2019, imports would be the logical source of satisfying the additional demand. These imports would generate lower profit margins, which are reflected in our company scenario estimates.”

• If this were to occur, I believe the market would value Buzzi at higher than 7.5x EBITDA given the growth component likely to happen between 2019 onwards (and for a period of potentially 5+ years)

Thesis Point 2: Italy – A Free Turnaround?

“No one in Italy is making money” – Buzzi IR

Buzzi is the #2 player in Italy with 18% market share after Heidelberg (25%). Colacem (16%), Cementir (15%), and Lafarge (8%) round out the top 5.

Even though ~14% of Buzzi’s 2016E revenues comes from Italy, the Company earned -10% margins in 2015 and is likely to earn -9% margins in 2016 (this accounts for -6% of Company’s EBITDA). Italy has been a problem market ever since 2006, when cement consumption peaked at 46 million tons (over 90% capacity of Italy’s 50mt). In 2015, cement consumption was 19 million tons, versus capacity of 55 million tons. The Company has been cutting costs, but it is understandably difficult to battle 40% utilization levels. Last year, Buzzi made a binding bid for Sacci with the plan to close down Sacci’s capacity and move the 3 million tons of production over to Buzzi’s plants (the plan was approved by Italy’s Antitrust Authority). This would have increased utilization level at Buzzi’s existing plants to 80+% (Buzzi has 9 million tons of capacity).

However, Cementir Italia came out and outbid Buzzi. Cementir did not close down Sacci’s capacity because there wasn’t significant overlap in geographic coverage…hence everyone continues to run at very low utilization levels …and everyone continues to lose money.

With Heidelberg’s complete acquisition of Italicementi in July 2016, there is increased optimism that Heidelberg’s focus on costs and returns on capital will lead to consolidation in the country. Our talk with the company revealed optimism around Heidelberg’s acquisition, and Buzzi believes that they may do an asset swap with Heidelberg in the not-so-distant future to optimize some capacity footprint. They do not believe there will be regulatory hurdles, given the previous approval for the acquisition of Sacci. Our impression from talking to the Company is that the likelihood of an asset swap is much more concrete than what is casually written in analyst reports (“there is potential for an asset swap…”). This creates a potential springing catalyst, as DB puts it: “With consensus continuing to forecast a loss at EBITDA in the country (DB ests moving to marginal profits) any significant market consolidation or capacity closures were they to be able to improve pricing power could drive upside to consensus estimates.”

While we do not have a view on Italy’s future demand for cement, we think we are nearer to a trough, with demand having dropped ~60% and with all players mired in losses. Italy used to do ~250 million in EBITDA – if it gets to breakeven over the next 4 years, that will be ~2% organic growth on EBITDA for the Company. Perhaps it even returns to profitability at some point?

Thesis Point 3: It’s a Decent Business!

Generally, aggregates and cement are decent businesses, while ready mix is not. Aggregates lends itself to local monopolies, given

• Hard to find good quarries where rock is close enough to the surface, meets local department of transportation criteria, and is also well situated to end customer demand. Aggregates can be trucked only 30-50 miles before the cost of trucking exceeds the rock being sold at $12-13/ton.

• Requires ~1000 acres for mine and land and to prevent emissions from dust/property

• Takes on average 12 years and $160 million to open a quarry

As such, once a large quarry exists to service an area, it is very unlikely for competition to enter (Martin Marietta is #1/2 in 85% of its markets). Aggregates also have the highest gross margins at ~60+% vs. cement in the mid 40% range (ready mix and asphalt is in ~20-30% range).

Cement is also a decent business because of logistic constraints as well as complex and expensive capacity. While you can ship cement further than aggregates, it is still very expensive to do so by truck (100-150 miles, 300 miles on train, 700+ miles on barges). This is the reason why generally big plants are near the river where cement can be loaded on barges easily. It costs $300-$400 million for a cement plant, so the decision to add capacity is very important upfront. As such, you also want to locate your facility next to 40-60 years of raw materials access (Buzzi’s aggregates are basically integrated with its cement plants). It is simply not possible to buy all the raw aggregates you need for a large cement plant off the spot market. Permitting and construction will generally take at least 4-5 years (Buzzi’s own brownfield expansion at Maryneal required 1.5-2 years of permitting). In summary, cement isn’t as local as aggregates, but it still travels poorly and faces the same (and more expensive) barriers to entry. Also note that the peer average EBITDA margin is 37%, vs. 28% for aggregates.

Ready mix is not as defensive a business because it only costs $500,000 to $1 million to put up a ready-mix plant, so capacity additions are easy to come buy if an incumbent decided to vertically integrate to consume its own aggregate and cement (this is what Buzzi does. In Italy for example, 100% of its ready mix uses internally sourced cement). This is the reason why U.S. Concrete operates at a much lower EBITDA margin (ready mix gross margin is in the 20’s) and is valued at ~8.8x EBITDA vs. peers like Summit/Vulcan/MM at low to mid teens.

Buzzi is predominantly a cement business that also offers ready mix as a way to distribute its own cement products, hence the business quality lies somewhere between pure ready-mix and pure-aggregates.

Per Davy: “Our analysis failed to identify any capacity plan of note in Western Europe. The reasons are again obvious, with large overcapacity in a consolidated market ensuring no new supply. With many of these markets at demand cycle lows, the lack of supply suggests significant gearing potential. There are several upgrade projects underway in the US, but ultimately the market is moving close to sold out and imports will soon be required to meet demand.” Davy identifies a total of just 2mt of capacity currently going out through 2020. A couple projects were pulled earlier this year – one due to environmental concerns in Massachusetts, and the other due to rising costs. Interestingly, the increase in the power of the dollar makes importing more attractive, which (while putting some pressure on incumbent pricing) makes the risk profile of building a $300+ million-dollar plant harder to swallow. Buzzi itself has no plans to expand or renovate capacity for the next 3 years.

• Why Imports Find it hard to compete: “Based on a $78/t landed cost of cement (costs being relatively similar level across all Coastal US deep-sea imports terminals) our analysis suggests that the margins for an importer on the Coast varies between $5-10/t in California, $15-20/t in Florida and up to $30-35/t in Houston, New York or Seattle. The higher end of these margins (Seattle, New York, Southern Texas) we believe are comparable to those achieved by incumbent producers in all-but the most efficient plants. However as soon as the product has to be moved any sizable distance over land, the economics of those imports deteriorates quickly. With logistic costs of $10-15/t for 100 miles in the US, we estimate that beyond a radius of 100 miles from the port, the margins fall below $20/t and imported cement would be much less competitive compared to domestic production,” Players are also hesitant to spend capex to build more import terminals after many were shuttered in the recession, as the capex costs do not necessarily justify the volatility of the import margin.

• Specific Mention of Texas: Buzzi is 13% of the Texas market, after Martin at 21%, Cemex at 16%, and Lafarge at 13% (this will increase as Buzzi doubled capacity of its Maryneal plant to 1.2mt in July). While Texas is currently undergoing challenges, in 2015, it consumed 14 mt of cement vs. 10 mt of capacity, and so continued slowdown should first detract from imports. Buzzi’s capacity expansion also lowers costs to allow it to capture more market share. However, there are some import competitors that have sprung up over last couple years (Cementos Argos). We also don’t have a particular view on oil and the state of Texas, but proffer up some encouraging remarks:

Other Countries:

Buzzi generates significant sales from Germany as well (more than Italy at 21%), and then has low to mid single digit sales in Benelux, Russia, Czech Republic, Poland, and Ukraine. I don’t have opinions on these countries. I expect Germany/Benelux to grow 2-3%, and Eastern Europe to grow 5-7%. The regions are important but not core to the thesis (largely undifferentiated). Incremental margins in Europe generally are pretty high given that utilization ranges in the 70%-80% range across Buzzi’s footprint (with exception of Italy and Ukraine, 40-60%). Incremental margins can therefore be quite high given the operational leverage:

Some quotes:

• CRH: “And I give you one example there, the Polish markets, which, given as where we are now in 2016, the price of cement in Poland is 25% below the price it was in 2007. And that's not sustainable given the level of investment that it takes to build and run and continue to invest in cement plants and modern facilities. So, we have to get properly paid where our product's at…  as I said, it will take us some short-term pain in volume hits to maintain the pricing. But broadly speaking, I think that the pricing environment is slowly improving across Europe, and I think that the second half of the year has shown some signs of improvement, and I expect that to continue in the first half of 2017…. Germany as a whole remains broadly stable.” – 11/17 sales call

• Heidelberg: “Germany, overall okay. We are on volume-wise about – first nine months up by about 4%. And as I said, the result is up…. The same is true for Bulgaria, volumes up. Russia, volumes up, price up. Ukraine, pricing up 30%” – 11/09

• Lafarge: “That being said, the environment remains challenging in Spain, Italy and Poland…We are seeing signs of stabilization in Russia where pricing has improved” – 11/04

Mexico:

I haven’t spent a significant amount of time on Mexico: Moctezuma has ~10% Mexican capacity (6.3mt), and is running at full capacity, with EBITDA margins hitting ~47% in 2016. Cemex is the huge player with 48% market share, followed by LafargeHolcim (20%), and the Cruz Azul at 15%. Margins will come down over time, but might persist longer given concentration of the top 4 players. The valuation currently sits at ~9x EBITDA.

Risks:

• Texas South Exposure: oil is not a high consumer of cement but its indirect influences are very high – if oil weakens, then Texas will likely drag Buzzi’s performance, particularly as over a quarter of its capacity is Texas oriented (some Missouri capacity flows down to Texas). There is an increasing bifurcation of performance in North Texas vs South Texas, and this is one of the bigger risks for Buzzi (that the Houston area continues to split in terms of performance:

• CRH (about competitors): “Most of their business were down in the Gulf Coast, where there's some very, very wet weather. And also, a lot of their businesses are focusing on the Houston area, which has suffered as a result of the slowdown in oil and investment in non-residential and industrial construction there”

• Martin Marietta: “I think if you get a little bit farther south in Texas, clearly Houston is feeling the effect of an energy downturn. And we have seen some of that in our business. I think it's important to remember, as you think about Houston and Texas overall, 45% of our aggregates volume are in Dallas, 30% are in Central Texas and San Antonio and Austin, about 15%are in Houston. So do we feel some headwinds in Houston? We do… As we look at that Texas market, you still have a market that's broadly sold out. So I mean, let's start with the notion that you still don't have enough domestic production to meet domestic needs.”

• Energy Prices: Buzzi holds 6 months of energy reserves, which means as pet coke and coal prices begin to increase into H2’16 and 1H’17, it will be a drag on gross margins. We believe pricing should be more than able to offset energy price increases, but if prices rise high enough there may be demand curtailment (roughly 2/3 of Buzzi’s fuel comes from coke and coal). Energy was ~6-7% of net sales over last 18 months. If prices go up 25% vs. 2016 average, this would be a 1.5-2% margin drag, which should be more than offset by mid-single digit price increases.

• CRH: “So, as I said, we expect about $50 oil, so we're just, broadly speaking, slightly up on this year and coal and pet coke to be slightly up this year. But, again, we feel we'll be able to cope with that and maintain our margins and hope it gets an improvement as we go through 2017 doing that”

• Europe Collapses: While it is hard to imagine Italy doing much worse, if Eastern and Central European demand fall due to global macroeconomic reasons, they are still a substantial portion of EBITDA in aggregate and can drag the performance of the business down. Biggest risks would likely come from Russia – this risk is highly correlated with Texas not recovery as well, so the risk here may be amplified

Quick Summary of Investment Highlights:

• Demand Imbalance: Per Davy: “Europe and US devoid of material new supply Our efforts to identify capacity additions in Western Europe failed to highlight any new project of note. The current oversupply situation makes adding capacity irrational. In the US, we identified ten upgrade projects at different stages of construction. The combined additions will result in c.5.5mt of new supply versus demand growth of c.16mt over a four-year period. With supply tight and consumption expected to grow steadily (as per recent PCA revisions), we expect material cement imports to step-up. This will support domestic prices and margins for the US producers.”

• Long Term Pricing Power: While it is not surprising that aggregate pricing improved double digits leading up to 2006, pricing was still high single digits in 2007-2008 and was subsequently stable from 2009-2012 – this is a business that has strong pricing power despite the volatility of demand in end markets. “Geological Survey has reported for the industry as a whole a 25% increase in crushed stone prices between 2006 and 2013 despite a 33% reduction in volumes”

• Scarce Resource: Aggregates and cement do not travel well – in fact, beyond 30 miles, the cost of trucking equates to the price of the crushed stone itself. Trucking generally costs 15-35 cents a ton mile, train 4-9 cents, barges 1-4 cents, and shipping .5-1.5 cents. Hence, given that aggregates typically sell for $10-$12 a ton, a 10-20% price increase only accommodates 3-10 more miles of travel distance. Not a significant amount

• This hasn’t changed over the last 15 years. This is from a 1999 report from Deutsche bank: "Perhaps the most important of these factors is transportation. Since aggregates are extremely heavy, they are very expensive to transport, and with selling prices only about $5 per ton, transportation costs can double the cost of the product just 25-30 miles away from the plant… not even railroad or barge is economical for transporting product over long distances. Once the rail or barge reaches its destination, additional trucking costs must be added to carry the aggregates to the job site.”

• Furthermore, quarries require 5-8 years at a minimum to license and open

• Oligopolistic: In the US, aggregates has consolidated significantly, with top 6 players (Vulcan, CRH, Martin, Heidelberg, Cemex and Lafarge) controlling ~30%, versus 20% in 1980. As these large players continue to consolidate, they are executing “asset swaps” in order to exchange and create synergies by locality where they operate

• Appendix:

• Long Term Pricing in Buzzi Territories:

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• Long Term EBITDA Margins:

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• US Market Share:

• 

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Global Forecast for Consumption and Capacity:

• North American consumption expected to increase around 4-6% each year through 2020

• Western Europe recovering – 3% growth a year

• Eastern Europe 3-4%

• While India and other Asia Pacific growing very quickly, capacity is a big issue (Heidelberg)

• Indonesia, a big market, has 100 mt capacity and has ~70mt in the pipeline through 2020. Heidelberg’s Indocement (#2 player) has seem EBITDA margins compressing form 38.5% to ~34% 2012-2015, which will likely continue. Estimated ~40-50% excess capacity by 2020

• India, similar story, with estimated ~30% excess capacity by 2020

• See below – almost no growth in capacity expected in Europe and US

• Almost no growth in capacity expected in Europe and US

• Massive growth in India and Africa (the new frontier)

• Indonesia very fast growth (US sized population)

• 3 players control 80%, but many new entrants coming in

• India

• Fragmented market – top 3 only 1/3. Currently 33% excess capacity