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Buzzi Unicem is an Italian cement company. The Italian cement market is so bad that Buzzi, the number two player, is operating at roughly breakeven EBITDA. No reason it gets better soon. If that statement reflected the economics of the company we would have no interest, but it does not. Management has done the right things, taking down capital expenditures and preserving liquidity through the downturn in two of their biggest markets, and now we have a recovery well underway in the biggest, the U.S. Management provides excellent English language financial disclosure.
If Buzzi were headquartered in the U.S. instead of Italy, maybe Italy would not be the first place investors look, as it is only about 20% of revenues and currently none of their EBITDA. Perhaps they might look at the U.S., which makes up more of their business than Italy, and think of it as a “U.S. housing recovery play.” (We think the intrinsic value of their U.S. assets is more than three times the intrinsic value of their Italian assets even assuming an Italian recovery.) Germany is also bigger than Italy, and is a much more solid market. Or they might look another 29% of Buzzi and call it an emerging markets company (Poland, Mexico, Russia, Ukraine). 32% of year to date revenues and 58% of EBITDA are coming from emerging markets.
“An Italian cement company” is why it is trading at the price it is. One would expect a big discount for that and we are getting one. This is a very global company (the number six cement company in the world) which we will argue could command double the current stock price at a more favorable point in the cycle in a couple years.
There are several ways of valuing this. We are not at all interested in forecasting earnings next quarter. Our analysis has been to think about asset value and longer term earnings power.
The accounting is quite complicated and will require some discussion at different points in this document.
The company is controlled by the Buzzi family, and we have no special insights there, so let’s just assume that a takeover is a longshot but we don’t have any problem with how it is managed.
Earnings power is currently very well disguised as several of their largest markets are at deep troughs. One might think of Italy’s deep trough differently than the U.S.’s as a housing recovery is well underway in the U.S. – EBITDA doubled year over year the first nine months of 2012 but is still WAY below normal earnings power.
Buzzi has a complex ownership structure. Their 93% ownership of Dykerhoff creates a 7% minority interest on their European and Eastern European assets except for Italy, which unfortunately they own 100% of. The U.S. they own 96.5%. Mexico is especially confusing, and big enough to matter. They own 34%, they consolidate 50% and 100% appears in a lot of their disclosure. Got it? Be very careful about how you account for Mexico.
They own 100% of the asset that is losing money (Italy), but they have to book a minority interest on all the rest, so that wreaks havoc on bottom line net income today. Thus you see something like half of net income in 2011 going to minority interest. That does not at all reflect the economics of the business in a recovery.
So let’s start with their markets, the cement tonnage in those markets, and what percentage of it they own. That will lead to an asset valuation.
MM Tons % owned Tons owned
Italy 10.8 100 10.8
US 9.5 97 9.2
Germany 7.2 93 6.7
Russia 3.6 93 3.3
Ukraine 3.0 93 2.8
Mexico 6.3 34 2.1
Poland 1.6 93 1.5
Luxembourg 1.4 93 1.3
Czech Republic 1.1 93 1.0
Let us make a couple points from the above table. Italy is a big part of their assets, but so is the U.S. where there is a sharp recovery underway. Buzzi is the #5 player in the US with 9% market share. Emerging markets are a big part of the business, places without fiscal cliffs or austerity. It should be obvious from the above table that this is not an “Italian cement company”.
Now let’s take that 39.4 million tons of capacity. The enterprise value of the company is 3.3 billion euro, or $4.4 billion U.S. dollars. So it is trading enterprise value/ton of capacity $112.
We have been looking for data points on replacement cost of cement assets, and a lot of them cluster around $250/ton. Lafarge, the industry leader, you kind of get to that from what they disclose, a South African cement company we were working on recently is building at about that cost, as is Texas Industries in the U.S. A recent Barrons article suggested more than $250. Buzzi’s own historic cost is roughly the same number. $250/ton has some credibility after circling around it for a while.
$250 a ton equals 190 euro times 39.4 economically owned capacity equals a replacement cost of the assets of 7.5 billion euro. Net debt is $1.4 billion euro. Share count is 165 million. That gets to an asset valuation of 37 euro per share. That sounds nuts, right? It is high, some of their assets are older (though some are brand new) and 25% of the assets are in Italy which should get a big discount. We don’t completely believe that number either, but is it hard to believe that replacement cost is 25 euro? That would be $187 a ton and still more than twice the stock price. We do not know what the exact number is, but it looks like a big margin of safety with the stock trading in the 11s.
Now we will take a look at earnings power and see if it confirms the asset value. They are clearly not earning it now. Their two biggest markets, the U.S. and Italy are at trough levels, for different reasons. If you go to the company’s November presentation
the last few pages are quite interesting in terms of understanding where their markets are versus where they have been.
We are not terribly interested in forecasting by the quarter or even by the year. We are primarily interested in what earnings power could look like in a recovery where Europe participates somewhat. Our outlook broadly (yours may differ) is a) the US is in a housing recovery which will not go back to past peak, but will go significantly higher than it is today, b) Europe will get better at some point, and c) emerging markets will continue to grow [notably, you don’t have to believe in China to believe in Buzzi’s emerging markets – they are in Mexico, Poland, Ukraine and Russia, not China and places that export iron ore.]
Three things to orient the compass before going into the numbers:
1) We are basing it on the company’s country by country EBITDA disclosure. We checked that this adds up to corporate EBITDA to make sure there is no overhead number that is not included. All overhead is allocated in these numbers.
2) The following will not be using the accounting numbers as presented. We are going to adjust them for the various minority interests as we did for the capacity figures above. So all minority interest is already subtracted in these numbers. To quantify this in aggregate, EBITDA as reported for 2011 was 427, but EBITDA Buzzi actually owns was 370.
3) To make this easier, we are going to anchor to the last annual numbers, 2011. Of course those numbers are old, but it wouldn’t change the analysis if we used last twelve months trailing as what we are really doing is looking back to what some of these markets earned in the past.
First cut, if we look at peak earnings for each of these markets since 2006 and simply add that up (and adjusting down a crazy high 2008 number in Russia), the total is 1,056 of EBITDA, once again already adjusted for minority interest. Enterprise value is 3,700. That is kind of interesting, but of course is a very aggressive way of analyzing the numbers as that would be assuming that Italy goes back to peak and the U.S. goes back to a housing bubble. We get that.
Rather, one can look at each of these markets separately and make assumptions based on history and current cycle.
First let’s look at the United States closely. EBITDA in the near term has doubled off 2011 troughs as housing has begun to rebound, but is still well below normal. In 2006, Buzzi earned 323 MM euro of EBITDA on 926 MM euro of revenue (35% margins). To estimate earnings power in a few years, we will assume normal unit demand today is 80% of that peak. Further, recognize that unit pricing is actually up 20% since 2006, and should rise further as a recovery takes hold. So even at that lower unit demand, revenues could wind up being similar to peak levels all else being equal. But all else is not equal. Buzzi built a new plant in Selma, Missouri which is far more efficient than what they shut down. We would also point out that natural gas prices are down a lot. Peak margins were 35% - if we assume they can do 30% in this cycle, that would be 270 of EBITDA in the U.S., up from 67 in 2011. There is huge operating leverage in the U.S. business. Texas Industries’ conference call a week ago was quite illustrative of the operating leverage of a U.S. cement plant operating at 60% of capacity.
In Italy they did north of 200 MM euro of EBITDA in 2006 and 2007 – that number is now zero. We are going to assume a recovery to 110MM. No sign of that now – Italy is just horrible – but for purposes of estimating earnings power we are going to look to half of historic levels. They earned 100 million in 2009, so 110 does not seem unrealistic if Italy gets a little better.
We are not going to go through the rest of the markets, but if you go to page 19 of the November document we cited above you can make your own assumptions. Generally we took depressed markets halfway back, and were a little more optimistic with stable or growing markets based on our understanding of the strength of the economies. You can use your own assumptions.
We get to about 710 of EBITDA, adjusted for the minority interests. Keep that number in mind as we get to the last part of the analysis, capital structure, which is not obvious either. We will put the valuation together at the end.
There is 1.1 BB euro of net debt. 3x trailing EBITDA (some of this debt would be adjusted down a bit if one applied the same conservatism for minority interest to that as to the EBITDA calculation, but we are simply using the consolidated debt for this calculation.)
Where the capital structure gets interesting is the share count. There are 165 million Ordinary Shares and 40 million of something called Savings Shares. Maybe somebody more experienced with European accounting can make this easy, but we have been thinking about this for a while. The saving shares trade, and their price is about half of the ordinaries. If one believed these were common equivalents they are extraordinarily cheap – buy them. We do not believe that.
Buzzi’s disclosure in English is very good except for this – it is difficult to figure out what these Savings Shares are. They are not convertible, and they are entitled to a preferred dividend by a complex formula based on the common dividend. There is a par value, but we had a lot of trouble footing the dividends paid historically to that par value by the formula they disclosed. So we really don’t have a good answer – we are not using the par value which seems way too low given where they trade and the dividends they have received. But they are also clearly not common stock. You will see on Factset they give the market cap based on the combined trading value of the two classes of shares which is also the wrong way to look at it as the vast majority of the leverage to the upside is in the Ordinary Shares.
Bottom line, the margin of safety is big enough here to be a little wrong on this, but we are going to assign $300 million euro of value to the Savings Shares loosely based on past dividends, probably a touch on the high side. We are going to call that preferred stock, i.e. a liability senior to common equity. So that takes financial liabilities up to $1.4 billion euros. 165 million then is the common share count.
We went through an asset valuation above which got to 25-35 euro per share range, and we were more comfortable toward the lower end of that.
On earnings power, go back to our 710 recovery EBITDA, which does not look either too aggressive or too conservative to us. We didn’t incorporate any emerging market growth and we could certainly imagine the U.S. earning more than the number we used. A 6-7x EBITDA multiple for a cement company well into a recovery seems about right, if not low. That would be a range of 4.3-5.0 BB of enterprise value, or 2.9-3.6 BB to equity, or 18-22 euro per share.
Nothing we have done in this valuation exercise has been terribly precise, but several ways of looking at Buzzi have indicated a large margin of safety with the shares trading at 11. It may take a couple years, but we can be wrong on a few things here and still be looking at a very satisfactory return if the U.S. recovery continues, the European periphery gets a little better, and emerging markets are solid.
The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing. The author will not undertake to supplement, update or revise such information at a later date. The author may hold a position in the securities discussed.
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