|Shares Out. (in M):||650||P/E||0.0x||0.0x|
|Market Cap (in $M):||520||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||0||EBIT||0||0|
I am long the TXI 9.25% senior unsecured notes maturing August 15, 2020. I paid 80.0 this morning for a YTM of 13.1%, or a spread of +1,000 bps over Treasuries. The bonds are down from 109.75 on March 31 and 98.375 on July 29 - about the same % declines as the stock. I think this is an opportunity to earn stock-like returns with bond-like risk. The CUSIP is 882491AQ6 and they are NYSE-listed. Total face value is $650 million so this idea is better suited for personal accounts or small client portfolios. Issue date was January 1, 2011. It has a split rating of B-/Caa2. No CDS are traded on this name.
There are $175 million of existing obligations I am modeling in front of the bonds, so the enterprise needs to have ~$825 million worth of value for the bonds to be made whole. I think there's at least $1,275 million of value even when building in a large margin for error. I've heard estimates the equity is worth $80 based on full replacement cost basis compared with the current quote of $33. My estimates are much more conservative than that (implied residual value of ~$19), but I'm just trying to make sure there's enough value to cover the bonds rather than perform a full and fair valuation of the equity.
Have a look at cnm3d's excellent bullish case on U.S. residential construction equities posted on September 11. I thought it was really nice work and owning these bonds is a good way to get exposure to the thesis. A housing recovery is just a matter of time. If you don't like this idea you should short the stock. It's at 1.2x tangible book.
The company makes essential products for which there are no viable substitutes - cement, aggregates and concrete. They make those products with assets that can't be reconstructed by competitors because of permitting difficulties, nor are they subject to competition from low-cost labor regions like China because of the need to make the products within a short distance of the end users due to the low value-to-weight ratio. 80% of revenues are from Texas, which is an attractive market due to above-average population growth (the other 20% are from California). There are plenty of strategic buyers that would have interest, and I think I can demonstrate that TXI's assets place a floor under the enterprise value with plenty of room for error. These guys have been on the wish list of industry consolidators for years.
Further, Southeastern Management and LaFarge board member Nassef Sawiris have built stakes of 25% and 20%. They are unlikely to stand by and watch their equity investment completely disappear. Board members Thomas Ransdell (ex-Vulcan Materials VP) and John Baker (ex-Florida Rock CEO and Vulcan Materials board member) also know how to get things done in the space. Worse comes to worse, the company could do a secondary to meet interest payments shortfalls (LTM cash flow interest coverage ratio struggles to exceed 1x depending on how you want to calculate it; reported Debt/Capital is 48% FYI) until the construction recovery starts and complete $91.5 million worth of unfinished capital investments that, when completed, will enhance asset values.
The liability structure is well termed out so the company has some time. These are the only bonds and they don't come due for 9 years. The $200 million senior secured credit facility doesn't expire until 2016. It was undrawn as of August 31. Required pension contributions are under $4 million per year for the next few years. In addition to doing a secondary the company could take on a term loan if necessary because the bond indenture allows them to take on $450 million of secured debt ahead of the bonds. Obviously as a creditor I would prefer they go the secondary route.
I have shorted the stock regularly over the last few years. There's a lot to dislike - bad management, a construction depression and regional concentration, a weak Altman Z-score, not to mention a valuation that's gotten extreme at times because of recovery speculation (think 2x book for a company that hasn't generated a positive ROE over any 4 consecutive quarters in more than 2 years). However, that speaks more to limited upside for the stock rather than lack of downside protection for the bonds. Classic case of 'B' management with 'A' assets.
I calculate ~$825 million as the total liabilities the business needs to meet in order for the bonds to be made whole.
Their California subsidiary has a defined benefit and health plan. Fair value of the DB plan assets at May 31 (fiscal year-end) was $39.8 million. The benefit obligation was $57.8 million, leaving an unfunded liability of $18.0 million. The health plan has zero assets. The obligation is $7.9 million. The combined unfunded obligations of the DB and health plans total $25.9 million. On the balance sheet they roll the pension liabilities into an entry called "Other Credits" under "Long-Term Liabilities" which also includes deferred comp and asset retirement obligations. The Other Credits balance stands at $85.2 million at August 31. Since they don't break out the components of Other Credits by value I'll just put the whole $85.2 million ahead of the bonds, not just the $25.9 million unfunded plan liabilities.
Making cement creates lots of pollutants including mercury. It's bad stuff, similar to power plants. The EPA has issued stringent new guidelines that power plants and cement plants will have to meet to stay in service. Only 1 of TXI's 3 existing plants is already compliant with the new rules. The others will require environmental capex of $20-30 million. With this management team you need to go with the high end of their estimates, so I'll go with $30 million as an obligation the company will need to meet.
TXI still has to spend $61.5 million to finish the expansion of a 4th plant. Let's put that ahead of the bonds too. I do that because this 4th plant will be state of the art in terms of energy efficiency and cash production costs, so completing the plant is value enhancing for the enterprise.
The company is in a deferred tax asset position and has positive net working capital of $212.5 million, so that's about it for liabilities that come ahead of the bonds.
$85.2 million Other credits
$30.0 million Environmental capex
$61.5 million Expansion of the 4th plant
$650.0 million Senior unsecured bonds
$826.7 million Total liabilities
There are 3 business segments: 1) Cement 2) Aggregates 3) Ready-mix concrete. Let's run through the assets then I'll take a stab at what they're worth.
1) Cement: they have 3 plants with combined existing capacity of 5.25 million tons. All are coal-fired. There's the Midlothian plant near Dallas with 2.2 million tons of capacity that went into service in 2001. There's the Oro Grande plant near Los Angeles with 2.2 million tons of capacity that went into service in 2008. It is best in class in terms of efficiency - tons of cement produced per man hour, kilowatt-hour of electricity, and tons of coal. There's the Hunter plant halfway between Austin and San Antonio with 850,000 tons of capacity that went into service in 1979.
They are adding 1.4 million tons of additional state-of-the-art capacity at the Hunter plant on top of the existing 850,000 tons. Project cost range is $365 - 375 million excluding capitalized interest so we'll go with $375 million. They've spent $313.5 million as of August 31 leaving $61.5 million to go.
California capacity is running at 50% and existing Texas capacity is running at 65-75%. The plants have enough limestone reserves to go for decades. They should run at full tilt in a recovery because normalized demand in their markets exceeds local production capacity.
2) Aggregates: sand and gravel. This segment has the most attractive economics. They have 783 million tons of proven and probable reserves as of May 31 on 20,400 acres of land. 79% of the tons are owned and 21% are leased (owned reserves are worth more than leased reserves). There's not a lot of mystery about how much rock is in the ground. Most of this is surface mining. The quarries also have machinery with productive capacity of 19.7 million tons.
Lightweight aggregates: shale and clay. They have 146 million tons of proven and probable reserves on 4,062 acres of land. Their machinery has productive capacity of 1.6 million cubic yards.
3) Ready-mix concrete: They have 85 plants and 539 trucks. This segment has the least attractive economics, but the trucks are modular sources of value (you can take them from one plant and move them to another), and in some markets you need to have vertical integration with aggregates and cement in order to play ball. It gives the aggregates a protected sales channel or it gives the concrete a guaranteed source of aggregates supply - kind of like a refinery owned by Exxon that gets its feedstock from Exxon's upstream production.
We can do this a few different ways, but let me first try and discredit a method I think don't makes sense.
S&P figures the recovery for the bonds will be about 35%. They get there by applying a 6x multiple to "distressed" EBITDA of $65 million for an enterprise value of $390 million. (LTM EBITDA is $36 million, but hey). They risk the EV by taking 5% off for administrative bankruptcy costs and another $135 million for priority claims, like amounts they estimate the company will have to draw on the revolver in a last-ditch effort to fund operations and avoid bankruptcy. Net value left over for the bondholders would be $235 million.
The problem with S&P's approach is they're putting a mid-cycle multiple on trough earnings, and they're assuming the company circles the drain without anybody stepping forward. TXI doesn't make solar panels at plants that can be moved to China for 90% labor savings. They make essential products with no substitutes that have to be made near their local markets at plants that can't be reconstructed by competitors. These assets will not go the way of old car-making equipment owned by Motors Liquidation Co. - picture in your mind bored guys with clipboards on an auction tour shuffling past rows of tagged machinery that used to make Pontiac Sunfires - that is not the situation here.
I don't see the company slipping first through the fingers of Sawiris and Southeastern followed by strategic buyers who have had these assets on their radar for years, but if bondholders end up owning the company it could work out well if you can stomach the MTM losses you would experience as the company went through Ch. 11.
The existing assets could maybe do $150 million EBITDA mid-cycle. Mid-cycle multiples are 6.5x, giving you an EV of $975 million. M&A gets done at 7.5-8.5x on average, 10x is not unheard of.
To give you a sense of possible earnings upside, peak 4 quarters EBITDA on existing assets was $242 million in 2007, although back then they had another 600,000 ton plant near Dallas that doesn't run any more. Management estimates EBITDA earnings power will be $375 million after the Hunter expansion is finished. They still have do the environmental and Hunter capex (30.0 + 61.5 = 91.5) to be in a position to generate those earnings, so total EV of the $235 million S&P number plus $91.5 million = $326.5 million.
Even if management has overstated future earnings power by 2x so it's really just $187 million, paying an EV of $326.5 million to get $187 looks really good - probably enough to clear most people's hurdle rates and make an investment in these bonds worth it in the end.
Back in reality, I think there's a better way to value the assets.
1) Cement: Once the Hunter expansion project is finished they'll have 6.65 million tons of first class capacity. The Hunter expansion project costs $268 per ton. The California project completed in 2008 cost $174 per ton. (Remember those are brownfield, not greenfield.) Since cement is more cyclical than aggregates I'm looking for a reference transaction that will give me an excuse to be more conservative with the values than what I do with the aggregates below - without making up numbers whole cloth. I think I've found it. TXI originally bought their California assets back in 1998, paying just $88 per ton of capacity for Riverside Cement. That was 13 years ago (just think about the replacement cost inflation!) and those assets aren't as high quality as what TXI will have after Hunter comes onstream.
6.65 million tons * $88 per ton = $585 million
2) Aggregates: Martin Marietta estimates their entire portfolio of owned reserves throughout multiple states is worth $1 per ton and their leased reserves are worth 40 cents per ton on average. Texas is a better than average market for aggregates so I think it's safe to apply their numbers to TXI's reserves.
783 million tons * 79% owned * $1.00 per ton = $619 million
783 million tons * 21% leased * $0.40 per ton = $71 million
Total value = $690 million
The machinery costs about $12 per ton of capacity. TXI's capacity is 19.7 million tons. At $12 we have $236 million worth of value at replacement cost. Between the reserves and machinery we've got $926 million at replacement cost. Consolidated PP&E is depreciated by almost 50%, and since I want to risk the reserve values anyway let's just haircut the whole segment by 50%, leaving us with $463 million. Valuing the lightweight aggregates is tougher, so between that and the desire to have room for error in the valuation let's just not even put a number on it. Throw it into the buffer.
3) Ready-mix concrete: The trucks are easy to value because there are lots of comps to look at. Let's start there first. New cement trucks can easily run six figures. I've been looking through online ads for used trucks and I think $25,000 per truck is a safe estimate assuming all the trucks weren't bought back in the 1980s. 539 trucks * $25,000 = $14 million.
What about the 85 plants? Throw it into the buffer along with the lightweight aggregates. I want to get this posted and I don't have a comp list of ready-mix project capacity costs at my fingertips.
$585 million Cement
$463 million Aggregates
$14 million Cement trucks
$213 million Net working capital
$1,275 million Total
Notes and Notables
1) These bonds had a YTM of 8% back in June and 10% in August. The yield on TXI's old bonds got up to 17% in March 2009
2) I don't want to waste any time handicapping the odds of new infrastructure investment spending at the federal level. The need for it exists but I am not in a position to get an edge on the politics
3) The bonds have a change in control put at 101. Change in control payouts to executives would be modest unfortunately (how ironic), so we've got a couple obstacles to M&A outside bankruptcy
Company-specific risk indicators I'll be watching are:
A) Operating cash flow adjusted for changes in working capital compared with $60 million of annual cash interest due on the bonds (just under 1x LTM)
B) Liquidity, defined as cash and cash equivalents plus allowed portion of the credit facility's borrowing base (currently $60.6 million + $151.6 million = $165.1 million)
C) How the equity market values the stock with an eye towards the possibility of doing a secondary