Description

FLSmidth & Company is a leading plant & equipment supplier to the cement and minerals industry.  It is a short because customer consolidation, large capacity overhang, and capex cuts put the company in a structurally weakening environ with sales and margins under pressure, and debt looming as negative operating leverage emerges.

The current consolidation in the cement industry is similar to the consolidation the steel industry went through during approximately 2004-2008 creating ArcelorMittal, Tenaris, Nucor and others, which led to plant closures to rationalize formerly competing capacity.   This is now happening in cement with Lafarge/Holcim, Heidelberg/Italcement, and other mergers creating a tighter oligopoly.   This is particularly bad news for their equipment suppliers, but FLSmidth has hung in thus far at 10X EV/EBITDA while industrial corollaries / comps are much lower (Technip for example at 6X). 

Sharp cuts in capital expenditures at the major cement companies of down 25-50% or more in certain categories falls heavily on FLSmidth.  LafargeHolcim reports “Expansion capex” down 49.9% YoY in Q1, and Heidelberg’s  “Growth Capex” was down 27% to €350m in Q1, but they guide to €600m total for the year so there is only €250m left for the remaining 3 quarters.  As projects in process are completed, they are cutting to the bone.

Back in 2013, which were the “good old days”, FLSmidth did DKK 26.9B in Revenue.  This year it will be sub 18B, and the analyst community is using a 1% plug thereafter offering the benefit of doubt while the view ahead is murky:   

According to a June 23 NY Times Op-Ed by Vince Beiser, “From 2011 to 2013, China used more cement than the United States used in the entire 20th century.”   It’s an incredible statistic, but having seen extraordinary construction activity that has led to scores of ghost towns in China, I think this might be true.  The implications it raises for a capacity overhang in the cement industry is scary.

The revolver & term loans are all due by 2019.  Currently at ~2.7x Debt/Ebitda, sweating hasn’t begun but there is some vulnerability on refi if trends continue to the point that operating leverage starts sharply working against them.

Management, to their credit, is facing the tough challenges head on… They talk about right-sizing the business, investing in people, and efficiencies.  The major contracts they used to tout are simply no longer, but they make the best of what is available.  Announced contracts are mostly from sovereigns such as Algeria and an extension in Egypt.  They are reducing trade receivables and squeezing out working capital for FCF where they can, but the backlog is negatively impacted (severely).  The smaller mining end of the business was already caught in the commodity tailspin, and they’ve become more dependent on the fewer large European cement players.  They are emphasizing the parts replacement business, which is higher gross margin, but also higher cost to service.

After missing on every line item in Q1, the rather muted share price reaction implies a wait-and-see approach for how Q2 is going to look with guidance still unchanged.  Heidelberg reports on July 29 and LafargeHolcim on August 5. These should be quite telling about what’s happening down their supply chain, and FLSmidth reports on August 11.

Catalyst

Catalysts:

• Q2 looking like Q1

• Guidance update

Risks:

• Stronger parts biz at better margins

• Economic rebound and or more sovereign contracts