Value Investors Club / Buzzi Unicem saving shares (BZUR IM)

Description

Thesis Summary

Buzzi Unicem is a building materials company emerging from a deep cyclical trough. Buzzi has two

classes of shares, voting and non-voting. I believe Buzzi Unicem “saving shares” (Bloomberg ticker: BZUR

IM), which at the current price of EUR 9.14/per share trade at a 45% discount to the voting shares,

represent a very attractive long term investment opportunity. The shares trade at 9x 2016 earnings and

8x 2016 free cash flow (operating cash flow minus total capex). I believe there is significant runway for

earnings to grow in the next few years. As earnings recover from a cyclical trough and dividends

recover, I expect the shares to double over the next three years driven primarily by earnings growth and

modest multiple expansion. The risk reward is particularly attractive because I see very little downside.

The company owns several very desirable assets and trades at a deep discount to the replacement value

of its assets. Leverage is low at 1.1 times net debt to EBITDA.The management is capable and well

respected in the industry and has a good long term track record of value creation in a cyclical industry.

History and Company Description

Buzzi Unicem is an Italian based, internationally diversified manufacturer and distributor of building

materials. It was founded in 1907 and listed on the Italian stock exchange in the 1980’s. The Buzzi family

controls the company through its ownership of 56% of the voting shares. The company in 2015

generated revenues of EUR 2.7 billion, 62% from cement and the balance from ready mix concrete and

aggregates. In 2015 the company sold 25 million metric tons of cement, 12 million cubic meters of ready

mix concrete, and 8 million metric tons of aggregates. Although the company is domiciled and listed in

Italy, it only derives 14% of revenues from Italy. Revenues are derived from the US (42%), Germany

(21%), Russia (6%), Czech Republic (5%), Poland (4%), Luxembourg (4%), Ukraine (3%), and the

Netherlands (2%). Additionally, Buzzi has a 33.3% economic interest and shares voting control of

Cementos Moctezuma (Bloomberg ticker: CMOCTEZ* MM), the third largest cement producer in

Mexico. Cementos Moctezuma is accounted for under the equity method, but is the second most

valuable asset for Buzzi after its US operations. Cementos Moctezuma is listed on the Mexican Bolsa and

has a EUR 2.5 billion market capitalization and no debt.

Market Capitalization

Buzzi Unicem has two classes of shares, voting shares and “savings shares.” The voting shares (BZU IM)

trade at EUR 16.68 per share, and the “savings shares” (BZUR IM) trade at EUR 9.15 per share, a 45%

discount. Although the savings shares have no voting rights, they are almost identical in terms of

economic value. The savings shares are senior in a liquidation, and they pay a slightly higher dividend

(common share dividend + 5% of the nominal value of the saving shares). In the table below, I have

calculated the price that one is paying for the company by buying either of the shares. At the voting

share price, one is acquiring the company at a EUR 3.4 billion market capitalization and a EUR 4.5 billion

enterprise value. At the savings share price, one is creating an ownership in the company at a EUR 1.9

billion market capitalization and EUR 2.9 billion enterprise value.

Below is a history of the discount of the voting and the saving shares going back to 1997.

The “savings shares” have historically traded at a steep discount to the voting shares and currently trade

at a 45% discount. This discount is primarily due to their relative illiquidity. The voting shares have an

average daily trading volume of roughly 1 million shares versus 100,000 shares for the savings shares. It

is common for Italian companies to have voting and non-voting shares. In 2002 Buzzi retired some of the

savings shares at par as part of a merger with a previously listed German subsidiary. However, it is highly

unlikely that we will see a similar transaction in the near future because it is unlikely that the family will

cede its voting control. Given their illiquidity, I believe the savings shares are only attractive to an

investor who is willing and able take a longer term view.

Cyclical Peak and Trough

Buzzi’s consolidated EBITDA peaked in 2007 at EUR 1 billion. At that time the company had a return on

equity of 21%, a return on capital of 13%, a return on assets of 8.8%, and an EBITDA margin of 28%. The

Global Financial Crisis had a devastating impact on volume and pricing in every single one of Buzzi’s

markets with the exception of Mexico (which is not consolidated). EBITDA declined to a trough of EUR

387 million in 2009. Operating cash flow declined from EUR 590 million in 2007 to EUR 247 million in

2009. Since then, EBITDA has recovered to roughly EUR 500 million and operating cash flow has

recovered to roughly EUR 300 million. However, most of Buzzi’s markets, especially those in Western

Europe, Ukraine, and Russia, remain deeply depressed. ROE remains depressed at 7% and ROIC remains

depressed at 4%. EBITDA margins, although up from a trough of 14%, remains depressed at 18%. GAAP

eps peaked at EUR 2.23 per share and troughed at a loss of EUR 0.38 per share. The company earned

EUR 0.61 cents in 2015 and consensus expects the company to earn EUR 0.99 in 2016. I believe there is

15-20% upside to consensus numbers in 2016.

The table below shows total market consumption relative to peak demand.

US cement volumes are still 30% below peak, but they are on their way back to recovery. Germany

never declined much and is currently stable. The Italian market collapsed by 57% and remains at the

trough since 2009. Buzzi’s Italian operations swung from a EUR 186 million operating profit at the peak

to a loss of EUR 81 million in 2015!

A Brief Discussion of Cement Market Profitability

Buzzi derives 58% of consolidated revenues from Western and Eastern Europe. I am not positive on a

recovery in Western European economies. However, I am optimistic about the outlook for the cement

markets in most of these countries for the following reasons. Most of the markets are deeply depressed.

Even if the economies do not grow or contract, the current level of cement consumption represents

“replacement” demand. Shifts in market structure and competitive actions will be a much bigger driver

of profitability than volumes, and I am optimistic about the trends in most of Buzzi’s markets.

Furthermore, I believe we are on the verge of a meaningful consolidation in Italy which has been the

biggest drag on earnings. Such a consolidation could take the Italian market from deeply unprofitable for

all players on a cash basis to marginally profitable.

Cement markets are regional and market structure determines price. Price is the biggest driver of

profitability by a wide margin, more so than capacity utilization. For example, Mexico, despite a

relatively low 60% capacity utilization, is one of the most profitable cement markets in the world. Cemex

and Apasco, the two largest players represent 70% of production and they exert price discipline.

Geographic characteristics matter too. Geographic barriers create a very high price ceiling for seaborne

imports due to the high cost of transporting cement on land.

The most attractive markets in the world in terms of realized cement price per ton are: Nigeria, Kenya,

Colombia, Argentina, Ghana, Peru, South Africa, France, Tanzania, Canada, Australia, and Mexico, in that

order. The least profitable markets in the world in terms of realized price per ton are: China, UAE,

Vietnam, Turkey, South Korea, and India. As one can see, some of the the fastest growing economies in

the world have some of the least attractive cement markets because of industry fragmentation while

some of the most stagnant economies in the world, such as France and Argentina, have some of the

most profitable cement markets because of industry concentration.

The Outlook for Buzzi’s Markets

Although industry structure is the most important driver of prices and therefore profitability, all things

being equal, given the fixed cost nature of the industry economic tailwinds and growing volumes are

better than economic headwinds and declining volumes. In terms of industry structure, all of Buzzi’s

markets are either stable or getting better. The exception, Italy, is terrible, but has the potential for the

most improvement. In terms of volumes, with the exception of Russia, Buzzi’s markets are currently all

stable or improving. This should lead to stable or gradually improving capacity utilization and margins.

Currently the US and Mexico (if we do a proportional consolidation of Cementos Moctezuma’s EBITDA),

account for 70% of Buzzi’s EBITDA versus 38% in 2007. The US and Mexico are both benefiting from

strong pricing and volume growth. Germany, the third biggest market, is a very mature market with a

very depressed level of construction activity, but trends are positive and the competitive situation is

stable. Luxembourg, Czech Republic, and Poland, are doing well and getting better. Ukraine is recovering

after a major collapse. Russian volumes are still declining but the company is benefitting from a recovery

in the Ruble. Italy is going to be the big swing factor.

As I mentioned, Italy generated EUR 186 million of operating income for Buzzi at the peak and generated

EUR 81 million of losses in 2015. Italian volumes are down 57% from the peak and have stabilized at

very depressed levels. I do not expect Italian volumes to recover. Current levels represent basic

replacement activity in the construction sector. However, I believe that it is very likely that the loss in

Italy will swing to a modest profit in the next couple of years primarily driven by an improvement in

market structure which will lead to better pricing. Italy remains a very fragmented market, and

everybody is losing money including the two largest players, Italcementi and Buzzi which collectively

account for 40% of a capacity followed by the next two players which collectively account for 22% of

capacity. Heidelberg Cement, a German listed cement company, just acquired the number one player,

Italcementi. Heidelberg is a rational competitor and competes across many markets with Buzzi. I believe

that there is a high probability that we will see a rationalization of this market in the next few years

driven by a series of asset swaps between the two companies as well as the acquisition of smaller

players which are not viable. This in turn, should lead to better pricing and better profitability in Italy.

Cash Flow Outlook

Buzzi generated GAAP operating cash flow of EUR301 million in 2016 (excluding Mexico) despite the

losses in Italy. If we include Moctezuma’s results on a proportional basis (i.e. 33% of Moctezuma’s

operating cash flow), Buzzi generated operating cash flow of EUR 367 million in 2015. 2016 should see

an improvement of $50 to 70 million in Buzzi’s GAAP operating cash flow driven by robust volume and

pricing recovery in the US and Mexico and by modest volume and pricing recovery in Europe. These are

my assumptions based on recent market checks and the latest quarterly results. There are two specific

drivers which should improve cash flow in 2016 beyond price and volume. These factors are not being

properly captured in the lowest consensus estimates. The operation of the new line at Maryneal Texas

plus the expiration of a contract with Lafarge which required Buzzi to deliver 400,000 tons at variable

cost should provide an uplift of $25 to $30 million to cash flow. I would expect 2016 Buzzi’s GAAP

operating cash flow to be around EUR 340 for Buzzi (excluding Mexico) and EUR 430 million including

Mexico on a proportional basis.

Capital expenditures which peaked at EUR 300 million in 2015 because of the Maryneal expansion

should revert to EUR 150-160 million a year for the foreseeable future as per management guidance.

This is in line with historical capex: EUR 174 million in 2014, EUR 150 million in 2013, EUR 144 million in

2012, and EUR 148 million in 2011.

As a result, free cash flow for Buzzi, excluding Mexico, should be roughly EUR190 to 200 million (EUR

350 million of GAAP operating cash flow minus EUR 150-160 million of total capex). These numbers do

not assume any meaningful reduction in Italian losses in 2016.

Free Cash Flow Valuation

Through the savings shares, one is buying into Buzzi at a EUR 1.9 billion market capitalization. This

compares to an estimated free cash flow of EUR 190 to EUR 200 million. This does not include Mexico.

Buzzi’s stake in Moctezuma is currently worth EUR 832 million (Moctezuma market cap of EUR 2,482 x

.333). Given that Buzzi is likely a buyer rather than a seller of Moctezuma, it’s probably better to do

proportional consolidation of Moctezuma rather than a sum of the parts which would make the non-

Mexican assets look incredibly cheap.

Moctezuma has no debt and generated EUR 203 million of operating cash flow in 2015 and spent EUR 43

million in capex. Therefore, Moctezuma generated EUR 160 million of free cash flow in 2015. If I add

33.3% of Moctezuma’s free cash flow to my consolidated free cash flow estimates for 2016, I arrive at a

free cash flow estimate of EUR 243 to 252 million for Buzzi for 2016 including Mexico. This is

conservative because I’m using historical numbers for Moctezuma while pricing is improving in Mexico.

Based on my assumptions, Buzzi savings shares are trading a little under 8 times 2016 free cash flow.

Earnings Based Valuation

Consensus earnings per share are for EUR .99 for 2016 and EUR 1.23 for 2017. Having reviewed many of

the sell side models, I believe that most sell side analysts are underestimating the cyclical recovery in

Buzzi’s end markets and the impact of the Maryneal line coming on stream. On earnings Buzzi saving

shares are trading at 9x 2016 earnings estimates, but I think there is 10-20% upside to 2016 numbers.

The Outlook for Earnings in Two to Three Years

I have modelled the company based on my assumptions for price, volume, margin, and FX for each

individual country. Barring a deep recession in the construction sector in Western Europe or the US, I

believe that the company can reach and possibly exceed EUR 2 of eps in 2018 or 2019. The driver will be

a reduction of losses in Italy combined with steady improvement across all the other markets.

Asset Based Valuation

Buzzi is very inexpensive based on asset valuations as one would expect for a cyclical business coming

out of a trough. Buzzi owns 32 cement plants plus a 33.3% stake in Moctezuma which owns 3 cement

plants. Additionally, Buzzi owns 22 quarries, 458 ready mix batch plants, and 45 terminals and deposits.

In 2015 Buzzi sold 25 million tons of cement. In some markets, such as Italy, it is operating at 50%

capacity. In others, such as Mexico, it is operating at 100% capacity. If we just value Buzzi based on tons

of cement sold, Buzzi (based on the saving shares) is trading at EUR 117 per ton of cement sold. The

Maryneal line in Texas, a brownfield expansion, cost EUR 230 per ton to build. The Azapazan line in

Mexico, which is in the final stages of construction and is almost identical to the new Maryneal line, will

have a cost of EUR 140 per ton. Building capacity in developed markets is a lot more expensive due to

the cost of labor and zoning/environmental regulations. Clearly asset values are not useful if the assets

are not profitable. Look at the history of refiners. But historically cement companies trade at or below

replacement value when profitability is depressed and above replacement value when profitability is

high.

Risks

• A depression in European construction. Volumes are incredibly depressed and are unlikely to

decline in a recession.

• A major recession in the US.

• A value destroying acquisition. Management has a good track record with acquisitions, and will

likely deploy excess cash for tuck in acquisitions. Divestments from the Lafarge Holcim merger

and consolidation in Italy will be the source of opportunities. We have to monitor the rationale

and price paid for acquisitions.

Catalysts

• Upward earnings revisions.

• Consolidation in Italy which leads to higher cement prices.

• Accretive tuck in acquisitions in other markets.

• Dividends. The company has a policy of paying 30% of earnings. If earnings recover, as much as I

expect they will, the savings shares will have a very high dividend yield. The differential in

dividend yields between the voting and non-voting shares may drive a narrowing of the savings

shares’ discount.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts:

Earnings recovery from cyclical trough.
Upward earnings revisions.
Consolidation in Italy which leads to higher cement prices.
Accretive tuck in acquisition in otehr markets.
Dividends. The company has a policy of paying 30% of earnings in dividends. If earnings recover as much as I expect they will, the savings share will have a very high dividend yield. The differential in yields between the two share classes may drive a narrowing of the saving shares' discount.

show sort by

			2016	2017
Price:	9.14	EPS	1.00	1.60
Shares Out. (in M):	206	P/E	9	6
Market Cap (in $M):	1,878	P/FCF	8	6
Net Debt (in $M):	1,060	EBIT	350	440
TEV (in $M):	2,938	TEV/EBIT	8	7