Description

Monarch Cement Co. (MCEM) supplies cement and ready-mix concrete to regional markets in Kansas, Missouri, and Des Moines, Iowa. It’s been written up here before (admittedly when the stock was a lot cheaper), but it's a quality, underappreciated company in a supply constrained industry with structural tailwinds. Full year 2023 operating income grew by 40% over 2022, and Q1 2024 Operating income was up another 40% over Q1 2023, and while the stock has begun to rerate, it’s still just over 7x ttm EBTIDA. 

The company has been around since the early 1900s, and terminated its registration with the SEC in 2014, and it breaks down some operating performance statistics by product but does not disclose full operating segment details. Revenues are split 60/40 between cement and ready-mix concrete, but cement accounts for nearly all operating profit. Concrete operations are considered “downstream” and are used to drive upstream volumes in the industry. It’s a standard, but low margin practice.

Industry

In 2010, the EPA introduced emissions restrictions on portland cement manufacturing through NESHAP. These specifically limited SOx and NOx emissions on a per plant basis – meaning that cement capacity cannot be expanded without building additional plants. These new plants are very difficult to build, and most incumbents turn to acquisition rather than greenfield development which can take 7-8 years and has severe permitting/approval risk. Here’s a chart from EXP’s investor materials that shows total US Clinker (the intermediate product before cement is made). 

Going forward, cement and aggregates should be able to push pricing in excess of the 4-5% that they’ve been able to historically. Pricing theoretically carries with it 100% incremental margin at no incremental fixed investment, so this will be very beneficial to shareholder returns should it pan out. I do not foresee a great amount of risk in relation to NESHAP standards being relaxed; many final rules have been put in place to amend the initial standards, mainly to give plants more time to regain compliance, but none have changed the allowable emission limits. Coastal cities have begun importing cement, but because of the low value-to-weight ratio of the product, there really isn’t a stopgap to fill in excess demand growth in the future. Additions to existing plants do get approved (EXP recently announced a 400k ton addition), but the incremental capacity is pretty marginal from these over time. 

Cyclicality

Cyclicality is certainly a consideration when evaluating Monarch’s business. Volumes fell by over 20% in the housing downturn of 2007-2009, and while still profitable, the company had a significant decline in earnings. On the other hand, I don’t think a deterioration in the macro environment would look as bad for Monarch if it happened today. Housing was particularly bad in the last cycle. There’s also a massive push from the government for infrastructure spending from both sides of the aisle, which obviously bolsters cement volumes with the construction of roads and bridges. Above all else, Monarch has a strong balance sheet, and as a result, weathered the previous cycle much better than competitors. In fact, MCEM’s share price had a ~30% drawdown in the GFC, with full TSR recovery by 2009, while its peer group saw declines of 60%+. I think there’s actually still considerable upside in pricing, especially if demand picks up materially, but there’s always a risk that we are late cycle and volumes have already peaked. 

Most peers carry at least some debt (typically between 1.5-3x EBITDA), but Monarch doesn’t have any, which mitigates the cyclicality risk to some extent. Overall 2023 cement production declined slightly, but MCEM increased both volume (+3% in both concrete and cement) and price (~+5% in concrete and ~+9% in cement). 

Valuation

EBITDA for ttm is about $88m, MCEM trades at 7.3x TTM EV/EBITDA, while peers have consistently been in the 10-15x range. Normalized free cash flow for 2023 was about $40 million or 6.2% to EV.

The company consistently shows strong returns on capital and distributes its income via share buybacks and dividends, so you don’t necessarily have to wait for the market to rerate the stock to earn a decent return.  The last writeup on MCEM in 2021 mentioned the CEO finally relenting to shareholder pressure and buying back stock– they tendered for 1.6% of the outstanding in late 2020, and have continued to reduce share count by about 3% since then. They pay a regular dividend and in recent years have paid a special dividend in August–$6.30 per share in dividends in the last twelve months.

While I don’t necessarily expect the CEO to want to cash out anytime soon, there have been some recent consolidating transactions from large cement and aggregates players. In 2021, Vulcan Materials acquired U.S. Concrete for an equity value of $1.3 billion–approximately a 10x EV/EBITDA. And in 2023, Summit Materials announced a merger with Argos USA, the U.S. subsidiary of Cementos Argos S.A. The deal valued Argos at approximately 10x EBITDA. I think Monarch could still easily fetch 10-12x EBITDA in the event of a sale.

Catalyst

infrastructure demand pickup

price increases

potential acquisition target