Description

BACKGROUND:

Both Snarfy and Broncos727 wrote up Ash Grove Cement in 2012; an idea that appealed to us on the merits of its valuation, humdrum business description, and trading illiquidity that served as a deterrent for many institutional investors. And yet we wanted cheaper, more boring, and more illiquid. So last spring, two intrepid investors flew out to Kansas City, rented a red Dodge Challenger and hauled butt down route 69 to Humboldt, Kansas; the birthplace of Walter Johnson and the home offices of Monarch Cement.

COMPANY DESCRIPTION (FROM LATEST 10Q):

The Monarch Cement Company (Monarch) is principally engaged in the manufacture and sale of portland cement. The marketing area for Monarch's products consists primarily of the State of Kansas, the State of Iowa, southeast Nebraska, western Missouri, northwest Arkansas and northern Oklahoma. Sales are made primarily to contractors, ready-mixed concrete plants, concrete products plants, building materials dealers and governmental agencies. Subsidiaries of Monarch (which together with Monarch are referred to herein as the "Company") sell ready-mixed concrete, concrete products and sundry building materials within Monarch's marketing area.

Thesis:

Monarch Cement is an exceedingly cheap stock—has been for a while, and might always be. However, there seems to be a land grab for cement assets domestically and the stark difference between the private market value for these assets and the public value of the security is glaring. The company is committed to retiring shares at levels up to stated book value, which coupled with a safe 3.5%+ yield, should protect the downside from here. While most investors might not consider events 3-5 yrs in the future to be a catalyst, for patient capital I think there’s a fairly high probability that the company will sell its Des Moines and Earlham, Iowa assets and be left with a nice-sized cash pile on the balance sheet. Management cares deeply about the company and the community and just needs a nudge to realize that those values aren’t incompatible with attempting to maximize value for all shareholders.

Valuation:

Market cap @ $25= 99.5mm (class A and class B super voting stock)

Net debt= 10.9mm

Investment portfolio= 22.5mm

*EV= 87.9

Fully loaded EV with pension and opeb= 137.5mm

Price/tangible book: 1x

EV/TTM ebitda: 8x

EV/peak ebitda: 2.8x

EV/ton: $67.60

*the # I’ve used in the above numerators

Kansas Isn’t Bleeding:

The mounting cost of complying with clean air regulations (http://www.epa.gov/Compliance/monitoring/programs/caa/neshaps.html) has resulted in plant closures throughout the US. Kansas is now down to Monarch and Ash Grove as the only two companies left in the state. While Kansas is hardly Texas or Florida in terms of demographic tailwinds, it also didn’t experience the boom and bust of the latter. In fact, when you take a look at the MSAs that Monarch covers, the building outlook isn’t so bad (source is NAHB website):

 http://www.nahb.org/reference_list.aspx?sectionID=132

THIS THING IS REALLY CHEAP ON AN ASSET BASIS. REALLY CHEAP:

So, taking the balance sheet at face value, the stock is trading right around book value and tangible book which is more or less the same number. There are two adjustments we should make to get a clearer picture of what an economic book value looks like. The first is to add back the value of their terminal and quarry in Des Moines and Earlham, respectively.  The company bought the parcel of 250 acres in Des Moines, situated near the airport, for 10mm in 1978. I have zero idea what it could be worth but it has been written down to zero. It is conceivable to me that it could have doubled over 36 years. Walter indicated that the city of Earlham might be interested in using the depleted quarry as a reservoir that would also be a development opportunity for housing. Who knows but I’m calling it 20mm or roughly $5/share of book value that is unaccounted for. However, clearly the PPE is the store of ‘hidden’ value .

The timing couldn’t have been better for this section as this past week saw two announced deals in the space that give some good data points for what these hard assets are worth.

Vulcan Materials sold their Florida (granted a better location) cement and ready mix assets to Cementos Argos.

• What they sold: a 1.4mm ton capacity plant, 69 ready-mix sites, and 13 concrete blocks and building material sites. The 9 month financials were 153mm in sales and 1mm in EBITDA

 What they got: 720mm

Cleveland Research’s Commentary:

Interestingly, the Florida cement & aggregates asset divestiture announced by Vulcan Materials (VMC) to Cementos Argo is further evidence that underlying sentiment is changing for downstream distribution assets. For review, Argos paid $720 million for the downstream Florida assets, which came in roughly $200 million above our original expectations. The price paid reflects 3.6x price/sales and 10.6x presumed mid-cycle EV/EBITDA. We assume the cement asset represented $500 million of the price and the

terminal created another $50 million of value. This implies the concrete assets were acquired for approximately $170 million or 1.7x price/sales.

Texas Industries sold out to Martin Marietta.

• What they sold: 7.4mm tons of cement capacity, 106 ready-mix plants and 800mm tons of aggregates reserves
• What they got:  roughly 2.7B

Cleveland Research’s Commentary:

Our cement valuation was determined by three separate factors: (1) we applied the previous cement asset transactions to the legacyoperations which have been $275-280 per ton; (2) we gave a slight premium (5%) to the legacy Texas cement assets due to the undersupplied position for th state; and (3) we incorporated the normal replacement value of $300 per ton on the newly constructed assets @ Hunter. Our math shows a value for the 6.8 million tons of cement kiln production capacity @ $2 billion or $72 per share.

Types Of Cement Assets                             Capacity        Est. Valuation       Net Value

California - Oro Grande                                         2,300            $275                    633

Legacy Texas                                                      3,100            $290                    899

Newly Constructed Assets                                  1,400             $300                   420

The numbers get silly when applied to Monarch. Our visit to the plant gave us comfort that there’s nothing about Monarch’s plant or quarry that makes it that much different than its peer group. Snarfy was right that management makes a world of difference in this space-you can argue in any space-but there is little question that an Eagle Materials management team, e.g., would get lots more juice from the Humboldt orange. Here is a sensitivity table for what the stock might be worth under various per tonnage scenarios:

@ $100/ton                        $35.50

@ $125/ton                        $43.70

@$150/ton                         $51.90

@$175/ton                         $60.00

@$200/ton                         $68.20

@$225/ton                         $76.40

@$250/ton                         $84.50

@$275/ton                         $92.70

@$300/ton                         $100.90

You’ll also notice an investment portfolio on the balance sheet at slightly over 22mm. What is this? That’s right, a concentrated portfolio made up of………mostly cement stocks that Walter presides over. The portfolio, as far as I know, consists of Eagle Materials, Texas Industries, Vulcan Materials, CVR Energy, and Pultegroup. I’ve stopped discussing the subject with him since I grew tired of making the case for him buying his own stock at depressed relative multiples.

BUT IS RUN BY A MAN, WHO WHILE PERFECTLY PLEASANT, MAKES YOU WANT TO GAUGE YOUR EYES OUT:

Walter Wulf lives and breathes the business. His house is about 200 yards from the company’s headquarters and he takes very seriously his role as steward of his family’s legacy. On the occasion of Monarch’s 100 yr anniversary in 2008, he commissioned a two volume compendium of every mention of the company in the local papers going back to 1908 which he generously gave us when we left (it’s actually pretty cool to see old box scores with Walter Johnson’s game stats).  He’s a lovely guy but doesn’t care a whit about the stock price, has never heard of the phrase shareholder value, and quite frankly, gives primacy to the dividend above most else. To him, his stock has hovered near book value for most of its trading history, and that’s all the evidence he needs to guide his thinking about intrinsic value.

SO YOU’RE SAYING THERE’S A CHANCE?:

Walter is a loyal guy so his decision to shut down their Tulsa ready-mix operations was slightly surprising; pleasantly so. Tulsa lost them 8mm+ in 2012 as they underbid on fixed price contracts and got nailed in the process. The ready-mix business line mostly exists to soak up cement capacity and is inherently a low margin business that traditionally has lost a little bit of money. They’ve recently installed a different management team at the unit and believe that the unit can be marginally profitable going forward. Also, the board of directors has contemplated selling their Des Moines terminal and land and is thinking about commissioning an appraisal of the Earlham quarry. Des Moines represents about 15% of their capacity and Walter is waiting until the rest of the markets closer to home tighten up a bit before going down this path.

The above might not hint that a change is a comin’ but does suggest that the board has a pulse.

TO SUM UP:

Monarch is a name that is awfully cheap on the numbers and relatively well positioned in a part of the country where the local economies aren’t large enough to attract new supply (at least without dramatically higher cement prices). Management’s indifference to maximizing value seems to be the reason for the value dislocation but there are reasons to believe that they are taking small steps in a positive direction.

Catalyst