Description

Summary

I am recommending a long position in Loma Negra Compania Industrial Argentina ADR´s (LOMA) currently trading at $7.18/ADR.  LOMA is Argentina's leading cement and ready mix producer with roughly 45% market share. The company is attractively valued as a stand alone entity. It trades at a substantial discount to replacement cost. It offers a 11% equity free cash flow equity yield. It is unlevered ( <1x net debt/ebitda). And, it has the potential to grow its cash generation potential if and when the Argentine economy recovers from its current crisis. I believe there is a greater than 70% chance that the company changes control in 2024. In that event, it is likely that the minorities will be able to exit at $11-$16/ADR providing 50-120% upside from current levels. 

VIC History

LOMA was written up by beethoven on 12-20-21 when it was trading at $5.92/ADR. In two years, the shares have appreciated 20% but have generated a total return of 71% including dividends. I highly recommend reading beethoven´s excellent write up and ensuing Q&A because it provides a thorough and accurate overview of the company´s history and its economic and accounting characteristics. Here I provide a summary and focus on the current set up. 

Business description 

LOMA is the largest cement producer in Argentina with 45% market share. It produces 6.8 million tonnes of cement a year and has 9.5 million tonnes/year of installed capacity. It operates a highly efficient logistics and distribution network which includes the concession of  3,100km of railroad. It supplies its own limestone and aggregates to feed its clinker and concrete operations and has over 100 years of reserves of both. 

Economics of cement largely depend on industry structure. Argentina has an excellent industry structure with LOMA controlling almost half the market and the number two and three players, who are rational, controlling the rest. Logistics and taxes make it nearly impossible for a new entrant to disrupt the market by importing clinker from a low cost location such as North Africa and setting up a grinding operation. A testament to the quality of the business is the fact that, despite latest currency crisis in Argentina which began in 2018 and triggered a sovereign debt default, 150% inflation, and a contraction in cement demand, LOMA  has been able to fund the $350 million expansion and modernization of the L`Amali Plant (2.7Mt/yr expansion) and pay $159 million in dividends while maintaining it´s net debt/EBITDA ratio below 1. LOMA, is currently valued at $883 million market cap and $1.1 billion enterprise value

History, Ownership and Current Set Up

LOMA was founded in 1926, and it operated as a family controlled business until it was acquired by  Intercement, a Brazilian holding company controlled by the Camargo Correa family of Brazil. In  2005 Intercement paid a price equivalent to $12/ADR.  At the time, it was considered a distressed sale because the country was still in a depression following the 2001 balance of payments crisis/debt default. Intercement paid  $135 per tonne of installed capacity. 

In October 2017, when there was still hope that Mauricio Macri´s center right government could stabilize the country and usher in an era of prosperity for Argentina, Intercement IPO´d the company at $19/ADR, (equivalent to $220/tonne of installed capacity), retaining a 52% controlling stake and using  the proceeds to reduce Intercement debt. 

Argentina cement consumption peaked in 2017 at 13 million tonnes a year. Industry sources at the time projected that it would reach a level of 18 million tonnes a year by 2023. Instead consumption declined and did not recover 2017 levels until 2023. The market remains very depressed. 

LOMA is attractive as a standalone company. It is well capitalized with net debt/ebitda under 1x. It currently generates roughly $100 million of free cash flow, or an 11% free cash flow yield. And, it has sufficient capacity to meet growing demand with minor capex requirements over the next decades. If Argentine cement volumes were to recover, there is tremendous upside. Keep in mind that Argentina has been in a crisis for decades and in an acute crisis for the past four years. It does not have a mortgage market. Bank assets/GDP are roughly 8%, below most sub Saharan African countries. There is no leverage in the system. I believe that the new president has the potential to stabilize the economy, but one does not have to bet on it for this stock to be a good investment. If Argentina renegotiates its debt and regains access to capital markets, there could be a decade-long boom ahead in Argentine cement consumption. 

The situation of Intercement makes LOMA a particularly attractive risk reward situation in 2024. Parent company Intercement became over extended with acquisitions. It sold its assets in Africa in order to reduce debt, but competitive dynamics (the aggressive entry of CSN) in its home market, Brazil, have not enabled it to stabilize its debt situation. In April 2023 Intercement was able to negotiate the extension of its debt with its major Brazilian creditors, Banco Bradesco, Banco Itau, and Banco do Brasil. However, Intercement has been unable to refinance its $750 million  senior unsecured bond due in July of 2024. The bonds currently trade at 73 cents. Intercement has hired BTG Pactual to explore strategic alternatives. It seems, based on conversations with industry players and various leaks to the press, that the third generation Camargo Correa family is interested in maximizing whatever equity value there might remain for them via a sale of the assets in Brazil and Argentina. 

Who will be the buyer? Cemex and Holcim are out of the running. Cemex does not have the appetite or the balance sheet. Holcim is  the number 2 player in Argentina, and would face regulatory hurdles. Chinese cement companies, despite a troubled cement market at home, remain active buyers of emerging market cement assets. I believe that a Chinese cement company is the most likely buyer. CSN, the Brazilian iron ore, steel, and cement, conglomerate controlled by Benjamin Steinbruch is also a potential acquirer. He has expressed interest in the Brazilian assets, but most likely will face antitrust issues and will need to divest some assets in Brazil. I would not be surprised if CSN  buys LOMA in addition to some of the Brazilian assets. Pampa Holdings (PAM), which I wrote about on January 13, 2020 (up 234%), has a $963 million cash position and has amassed a 5% stake in LOMA via the local shares. Pampa`s  Chariman and largest shareholder, Marcelo Mindlin, has openly expressed interest in the asset. I would consider them as a buyer of last resort given their history of only buying deeply undervalued assets.  

Based on my own, unscientific analysis of the situation, I assign a 70% or greater chance that LOMA will be sold to a third party in 2024. If there is a change of control, based on the local exchange laws and company bylaws, the buyer will have to offer the same price to minority shareholders. 

Valuation 

I think in a sale, LOMA will fetch $11 to $16 dollars a share. The average price for Latin American cement companies in private transactions in the past decade has been $200/tonne of capacity. LOMA has 12.2 million tonnes of installed capacity, but I reduce that number by 2.7 million tonnes that have been mothballed following the L´Amali expansion.  If one values the company based on 9.5 million tonnes of capacity and a value of $200/tonne, the equity is worth $1.9 billion or $16/ADR. The company has $220 million of net debt, but I assume, in my valuation,  that the  logistics, railroad, aggregates, offset the $220 million net debt. Using a conservative valuation of  $150/tonne and following the same methodology yields $11/share.  This range implies a  50% to 120% premium to  the current price. 

Risks 

The biggest risk is that LOMA is  not sold and the near term volumes disappoint. I believe that in the near term, cement volumes are going to be weak because of the economic adjustment that Argetina is undergoing under new president Milei. I expect weak 1Q volumes and very messy results because of FX control adjustments. 

If the Brazilian  and Argetinean assets  are sold together, it is possible that the buyer will assign a low purchase price to Argentina in order to avoid having to take out the minorities. This would result in a take under offer. Thiis a possibility. Fortunately, they cannot force minorities to tender the shares. In this case, the status quo would remain. The company would likely continue to be anchored by a very high dividend yield because the buyer will need to fund the interest expense from the acquisition.

Catalyst

A change of control triggered by the parent company´s leverage problems