Description

Loma Negra (LOMA) is a great business in a bad geography trading at 3.5x EV/EBITDA and half of its private market value of $12 per share based on the valuation of its own buyout in 2005. LOMA is Argentina’s largest cement producer with 46% market share. Cement is a commodity but it does not trade at one global price like copper and gold. It is priced in USD but its pricing is local. Argentina has one of the worst governments, but one of best cement markets on the planet.

The negatives of Argentina are well known: it is the embarrassment of the Americas as it was one of the 5 wealthiest countries in the 1950s and it devolved into a nation of perpetual crises, hyperinflations and IMF bailouts. Argentina is unlikely to recapture even a portion of its prior status as there are structural reasons for why it won’t escape its cycles or recurring crises. But one doesn’t need escape velocity for LOMA to work out well because of the starting point: Argentina just went through another crisis and is emerging once again.

Cement demand was near peak levels in 2017 and 2018, and quickly rebounded back to peak levels after a Covid-fueled 50% drop in April 2020. There remains meaningful growth ahead to address the country’s large underinvestment in housing and infrastructure. Renegotiating its IMF debt will likely be the macro catalyst for the large “country risk” attached to Argentine equities to be reduced, and for Argentina to put this crisis behind it. After selling an asset in Paraguay at a very good price, LOMA has a modest net cash position of $3 million, and is repurchasing its undervalued shares.

Cement plants are valued on a capacity basis, specifically EV/ton of cement produced annually. There is rich M&A data globally so one can usually easily estimate what a cement business is worth in a certain country or region of a country. For LOMA, we have its own buyout as a data point. Here are some relevant valuation data points:

·      100% of LOMA was acquired in 2005 for $135/ton shortly after Argentina’s 2000-2002 crisis. This represents the lowest M&A valuation in JP Morgan’s Latam list (median = $195, average = $232, 15 transactions). Given Argentina’s history of recurring crises, an easy argument can be made for an Argentina discount. LOMA was acquired by Brazilian cement producer InterCement which then IPO’d a 49% stake in LOMA in 2017 at $19, or $220/ton. InterCement still owns 51% of LOMA. You should give zero weighting to LOMA’s $220/ton IPO valuation as the deal was very promotional given InterCement’s overleveraged status and need to find sucker buyers to overpay. It found them in the form of US growth funds who bought into the Argentina dream. LOMA was the first Argentine investment for many of these funds and LOMA being Argentina’s largest IPO in 25 years seemed to mean something special at the time.

·      In 2013, a 10.6% stake in Cementos Avellaneda (#3 in Argentina) was sold for $195/ton, 7.1x EBITDA, 12.7x net profit and 1.7x revenues.

·      LOMA’s recent brownfield expansion cost $130/ton. Recent capacity expansions by LOMA’s two competitors cost $164/ton and $286/ton, respectively.

After stripping out $50mn (10x EBIT) for the value of its concrete and aggregates businesses, and railroad concession, LOMA shares are currently valued at just $54/ton on a straight EV/ton basis.

LOMA recently expanded its capacity by 2.7 million tons to 12.2 million tons. Since the new capacity is more efficient and will result in higher margins, it mothballed 2.7 million tons of old capacity until demand grows into that capacity. Those mothballed 2.7 mn tons should be valued at a discount since they won’t be productive for a while, and cement M&A is measured on productive capacity. I’ve valued the mothballed capacity at a depressed $50/ton, which assumes it won’t be utilized for some time. This means that LOMA’s productive 9.5 million tons of capacity are being valued at $55/ton.    

Keeping everything else constant and valuing LOMA’s productive capacity at the $135/ton of its 2005 buyout suggests LOMA’s fair value is $12 (100% upside). This valuation reflects 7x EV/EBITDA, in line with the Cementos Avellaneda transaction. Cement transactions in developed markets take place at high teens multiples, so 7x reflects a punitive but warranted Argentina discount. The discount reflects the Argentine government, not the cement industry.

Bernstein Research placed Argentina among the world’s most attractive cement markets. Just 4 companies supply the country, there are no undisciplined players and imported cement is not a factor. Note in Bernstein’s chart below that Argentina sits in the sweetspot phase of development with more growth ahead. In addition, Argentine cement players earn above average margins within the sweetspot category. Only a handful of countries are as or more attractive than Argentina.  

There are 3 reasons for Argentina’s above average margins. (1) The business is very consolidated between 3 large publicly traded players and a 4^th regional player. Only 2 players compete in each province, so Argentina has regional duopolies. Market shares have been stable over time

(2) Argentina does not have the port infrastructure to unload cement which removes imported cement from the equation. Because of cement’s weight, it is expensive to transport over land, but it is cheap to transport by sea. Oversupplied markets like Turkey export cement which dampens pricing near the coast of importing nations. The following chart shows cement pricing in Africa and how it is lowest along the coastline where it competes with imports, and rises the more inland you go as the transportation costs added to imported cement allow for higher pricing for the inland producers. In Argentina, coastal pricing is not depressed due to import competition. Prices vary in each region due to transportation costs.

The presence or lack thereof of imported cement is the single biggest contributor to local cement pricing and the margins cement producers generate. France has some of the highest pricing because the large cement players bought up most of the ports and don’t allow imports to come in. There are a small number of independent ports in France through which cheap Italian cement (Italy is oversupplied) can, theoretically, come in. But if the Italians try to bring in their own cement, the French will flood Italy with their cement, so everyone behaves.

There is the theoretical risk that Argentina could follow in Israel’s footsteps. In the past, Israel also did not have the port infrastructure to import cement and prices were high. In order to boost construction activity, the government built the port infrastructure to allow imports and bring down cement prices at the expense of the domestic cement industry. But Argentina is not Israel. It does not have the money nor the political will to hurt its domestic industry.

The Argentine industry has shown discipline. Total capacity, which was up 15% from 2006 to 2016, increased at a slightly lower rate than demand - up 22% from 2006 to 2016. Capacity utilization has averaged 73% from 2006 to 2016.  

The Big 3 all increased capacity in recent years which was necessary because if Argentina would not have had a crisis, demand would have kept growing and the market would have become undersupplied in a few years. The next table illustrates that Argentina has the lowest per capita cement consumption in Latam. Almost all Latam countries saw significant increases in per capita cement consumption in the past two decades. Argentina is the laggard. The Argentina dream that IPO investors bought into is that Argentina will follow its neighbors and has 2 decades ahead of it of strong cement demand growth. That could still happen.    

2016 Per Capita Cement Consumption: Argentina vs. Other Latam

Due to a history of recurring inflation and hyperinflation, Argentines save in real estate. They do small construction projects to convert their pesos into real assets. As a result, bag cement which represents household demand accounts for the majority of demand (currently 60%) and is relatively stable. Bulk cement demand is cyclical and is currently depressed as the country had to implement austerity after its IMF loan and cease public works projects. Some projects by local government have restarted in recent months, but federal projects have not and that remains a source of demand that will restart if/when Argentina renegotiates its IMF debt.

IMF debt renegotiation is the big catalyst for LOMA and all Argentine equities. The stock will probably be up +50% pretty quickly, but there’s no visibility on this catalyst. Argentina is undergoing hyperinflation but it isn’t as bad as it sounds. Salaries are increased in line with inflation on a regular basis. People are not losing purchasing power, there are only temporary issues. For example, your employer increases your salary at the beginning of every month to keep up with inflation. Taxis and restaurants raise their prices in the middle of each month. During the first half of each month, taxis and restaurants are cheap, in the second half they are expensive. Other than that and your savings losing value quickly and there being capital controls (so you can’t take your money out of the country and are forced into investments that mostly drive up cement demand), life is kind of normal there.

LOMA raises prices every month and tries to maintain a fixed EBITDA/ton of cement in USD terms. One last detail on FX is that the official exchange rate, which LOMA and everyone in corporate Argentina  prices off of, grossly understates that “blue chip” exchange rate which is about double. The blue chip rate is the implied rate in Argentine ADSs. Once capital controls are lifted the blue chip rate is a better indicator of where the official FX rate will go. The last time capital controls were lifted, LOMA closed its pricing gap with the blue chip rate within a year.

There’s one final potential catalyst and I don’t want to make too much of it because I think the odds are low. InterCement could put all of LOMA up for sale. InterCement is still overleveraged and has continued looking at selling more assets. It consists of its Brazilian cement plants, some African cement plants and its 51% stake in LOMA.

LOMA’s CEO told me that selling LOMA is a last resort for InterCement, and is not hard to see why. InterCement consolidates 100% of LOMA, so they show all of LOMA’s EBITDA and LOMA has no net debt, which reduces InterCement’s leverage ratio. LOMA’s EBITDA is around 40% of the Group’s EBITDA. Earlier this year InterCement looked at a partial IPO of its Brazilian business but pulled the deal due to a weak market. There was also a Reuters story that they considered a partial IPO of their African assets.

InterCement’s was implicated in Brazil’s Car Wash corruption investigation. If they’re found guilty, which I think is likely, they face large fines which they can’t afford. A recent article stated that they may have to give up 2 cement plants in Brazil in lieu of paying a fine – and they’ll lose the EBITDA of those assets.

Africa is a mixed bag because Dangote Cement is a disruptor there. It is using its dominant FCF-machine in Nigeria to build modern cement plants in other African countries and disrupt the incumbents by selling higher quality cement at lower prices. It’s unclear what InterCement could get for its African assets given that long-term threat. 

While selling LOMA is a last resort, InterCement may be forced into it. If LOMA is put up for sale today, it won’t get a great price because of the hyperinflation and capital controls in Argentina. A buyer would be earnings pesos which can’t be exported out of the country and are being devalued. A buyer can only start a DCF once there’s a stable currency and capital controls are lifted, and since these are unknowns a haircut to a valuation that already reflects an Argentina discount will be the case.             

Lots of uncertainty, but LOMA is repurchasing its shares with its FCF, which is a great use of fiat currency that will be devalued away. Its shares are not liquid enough to soak up all of its FCF so it is looking at potentially acquiring more concrete operations.

I’d like to close with the best case which is what IPO investors bought into. The Argentina dream is still possible and I’m comfortable being long it through a 50 cent dollar that has exposure to the blue sky scenario. The following is from LOMA’s F-1. It describes the path of other Latam countries and points to Argentina’s potential if it ever gets its act together.        

The Long-Term Upside for Cement Demand in Argentina if it Follows Other Latam Countries as Described in LOMA’s F-1

Chile

After having seen its economy expand during the 1990s, Chile experienced a moderate economic downturn in 1999, due to its high degree of integration into the global economy, following the Asian financial crisis in 1997. The economy remained sluggish until 2003, when it began a long recovery cycle. Cement consumption per capita peaked at 386 tons/inhabitant in 2013. 

Note: Real GDP multiplier stands for the ratio between cement consumption growth year-on-year and GDP growth year-on-year.       

Ecuador

Following a period of relative political stability and increased public investments, Ecuador has seen its cement consumption structurally increase to above 400 kg per capita in the last decade.

Peru

Following the election of President Alejandro Toledo in 2001, and the subsequent political and market reforms, Peru entered a period of economic expansion that lasts until today. Cement consumption followed GDP growth, leaving its historical level of below 150 kg/capita, peaking at 418 kg/capita in 2013.

Colombia

Colombia continued its course of market friendly reforms upon the election of president Santos in 2011, which has led to economic growth and a structural increase of cement consumption to 300kg/capita in the last five years.

Brazil

Following a period of relative political stability and increased public and foreign investments, resulting in housing, real estate and infrastructure developments, Brazilian cement consumption has structurally increased to above 300 kg per capita.

Argentina

Following a sharp devaluation of the currency at the end of 2001, real GDP contracted by 10.9% in Argentina in 2002. As economic growth recovered over the next five years, cement consumption increased much faster than the rest of the economy with a real GDP multiplier of 3.6x in 2003 and an average of 2.1x between 2003 and 2007. However, economic growth and growth in cement consumption came to a halt in the last years of the prior administration due to the lack of investor-friendly policies, scarcity of capital, tightening of FX rate regulations, and monetary and fiscal imbalances resulting in lower investments.

Catalyst

Argentina's renegotiation of its IMF debt.

InterCement puts LOMA up for sale.

Strong GPD growth. Cement demand is typically a multiple of GDP growth. In Argentina, it has averaged 2.1x.