Description

Holcim hasn’t been discussed on VIC since its predecessor entity Lafarge in 2010. The entire heavyside construction materials sector looks cheap, particularly European firms. CRH’s pending US relisting was written up in June, but Holcim seems especially attractive given its evolving product mix, clean b/s and high cash generation.

Summary

Holcim was until recently the world’s largest cement manufacturer (ex-China). Under CEO Jan Jenisch it is midway through a multi-year asset recycling program, selling emerging market cement assets and buying developed market building products businesses. Improved cash conversion has supported de-levering, M&A and most recently elevated shareholder returns. Debt had fallen from nearly 3x when Jan arrived in 2017 to 1x this year as absolute net debt went from CHF 15bn to 6bn. The business trades on double digit levered free cash flow yields and <6x forward EBITDA, historically cheap multiples despite its improved balance sheet, product mix and earnings stability. The market is valuing Holcim as if it were a levered EM cement asset at the top of the cycle. It’s not.

Overview/History

In 2015 French Lafarge and Swiss Holcim merged to create LafargeHolcim, the world’s largest cement manufacturer. The merger came together with the support of GBL (21% Lafarge shareholder) and Swiss billionaire Thomas Schmidheiny (20% Holcim shareholder and longtime chairman). There were culture issues from the start and the Lafarge-appointed CEO Eric Olsen was gone within two years, replaced by Jan Jenisch in 2017.

Jan came from Sika, an extremely impressive Swiss construction chemicals firm. He recruited Geraldine Picault as CFO in early 2018. They were a highly effective team. Over 5 years they generated CHF 9bn divesting EM cement assets for 10x-12x EBITDA multiples, including large disposals in Indonesia, Brazil, Africa and most notably India in 2022. They de-levered the balance sheet, bought-in minorities, changed the plant-level incentive structure and cut an entire tier of management. Cash conversion improved from 20% to >45%. In 2020 they launched a “Strategy 2025” to achieve 30% of group revenue from a newly formed “Building Solutions” division focused on lightside building products, most notably roofing and cladding.

Since 2021 Holcim has spent CHF 7bn on 18+ acquisitions to form its new Solutions & Products division. The foundational acquisition was $3.4bn in April 2021 for Firestone Building Products. Firestone was acquired for 1.9x sales and 12x pre-synergy EBITDA, with management claiming a successful 8x post-synergy acquisition multiple now that the integration is complete. Firestone makes Holcim one of the largest manufacturers of commercial flat roofing products in North America, alongside Standard Industries and Carlisle.

Implications of Mix Shift

2023 revenue will be the same as 2018 at circa CHF 27.4bn, masking the underlying mix shift. In 2018 Holcim’s sales were 60% cement, 20% ready-mix, 10% aggregates and 10% “Other” which reflected a catch-all including some building products like precast concrete. This year sales will be 43% cement, 22% ready-mix, 11% aggregates, and 24% Solutions & Products.

The Solutions & Products assets are less capital intensive (~2% maintenance capex vs. ~6% for cement) and less cyclical. Approximately 80% of the S&P revenue relates to roofing, which as a market is 80% repair and 20% newbuild.

Holcim has also become a more US-centric business. In 2018 21% of sales were from North America. This year it’s 40%, with mgmt saying >50% is within sight. Europe has remained stable at ~33% of sales while emerging markets (APAC, Latam, MEA) have declined from 49% to 25%.

Leadership changes

There are notable c-suite changes taking place. After 5 years together Jan (CEO) and Geraldine (CFO) have broken up. Geraldine left in a well choreographed transition earlier this year. She is the incoming CFO of SGS and has been replaced by Steffen Kindler, a Nestle veteran. Meanwhile Jan received shareholder approval at this year’s AGM to become executive chairman. He will hold a dual CEO-Chair role until a successor CEO is named, likely later this year and likely an internal candidate (possibly an American). Jan has publicly said that Holcim will be his last big role and that he’ll stay on as Executive Chairman as long as the board lets him. This is likely a good thing but does raise some questions around the independence of what will likely be his hand-picked CEO successor.

Balance Sheet & capital allocation

Unlike past cycles, all global cement companies have impressively clean balance sheets. None are >3x levered and most are <1.5x. Holcim will end this year <1x, giving it CHF 20bn of dry powder for acquisitions and shareholder returns.

Last November the company announced its first material buyback program. In 6 months through April of this year Holcim repurchased 6% of shares outstanding for CHF 2bn, paying an average CHF 54.30/share. The program is complete but the potential for a reload is high. A 10% buyback over 12 months is possible, on top of the 4.3% dividend yield and clean balance sheet.

Continued acquisitions of Solutions & Products businesses is almost certain. The 2025 goal is 30% of group revenue from S&P. At ~25% this year they will clearly blow through the target but are unlikely to stop there. Mgmt talk aspirationally about 50% of sales from lightside products. So far they’ve shown reasonable restraint, passing on BASF’s specialty chemicals business in 2020 and a rumored interest in Owens Corning last year. Overpaying remains a risk, especially as they near the end of their divestment program and no longer benefit from swapping high multiple EM cement disposals into similarly valued DM building products assets. With the group trading at 6x EBITDA it will become difficult to justify buying assets at 12x.

Macro Comment

Cement and building products are cyclical industries. Cement demand is roughly ⅓ each residential, commercial and infrastructure. Of these three, infra is the only one with highly probable strong demand for the next 5+ years thanks to the Inflation Reduction Act in the US and similar spending programs in Europe. Housing and commercial demand have held up in the US while Europe has seen single digit volume declines (but double digit price hikes, explained below). It is entirely possible that a synchronized global recession would lead to >10% revenue and earnings reductions for Holcim. Long-term cement industry revenues have been GDP+.

Cement utilization rates in the US are right around their operational max at ~85%. This is a consolidated market and the largest players import clinker to meet demand. European utilization is lower at 65% but is benefiting from Phase 4 of the EU’s ETS (Emissions Trading Scheme), which has seen annual allowances of free carbon credits drop below production levels for the first time, forcing carbon emitters to buy credits on the open market, currently at a cost of €85/ton. Compare this to cement prices of €120/ton and you can see that high-polluting plants are uneconomic. In Europe’s more fragmented markets many small players are shutting down rather than investing in expensive retrofits. This trend will accelerate. Holcim, Heidelberg and other major cement producers have talked about the benefit this is having on cement prices in Europe, with the largest and most efficient producers able to capture margin as the industry forces prices higher to pass on some of the carbon credit costs. Cement is 2%-5% of a building project’s total costs.

The per ton price appreciation in US/EU markets over the last two years has been incredible, averaging >20% on stagnant or even declining volumes. This is an obvious risk, although again in Europe the structural inflation of the ETS scheme puts a theoretical basement to pricing. I can discuss this ETS dynamic more in the comments if people are interested. The US is unlikely to ever see a new cement plant permitted, creating monopoly-like dynamics for the regional incumbents.

Finally on commercial roofing (~20% of sales) there has been a well documented destocking trend since 3Q22. 1H23 divisional sales were -14%. Holcim and peers have called the bottom here, with 2Q23 showing a restocking trend and commentary of strong order books.

If global demand fell 20% (px and volume) Holcim would still generate CHF 4bn of EBITDA, keeping it <1.5x levered and putting the valuation at 10x depressed EBITDA, a historically normal figure at cyclical troughs. With clean balance sheets and oligopolistic market dynamics across a globally diversified product mix, it seems reasonable for a long-term investor to value Holcim through-the-cycle. I’m not calling quarters here.

Valuation

Holcim is guiding for FY23 organic sales growth of +6% and EBIT growth of +10%, as well as CHF 3bn free cash generation. On these figures the company will do 27.4bn sales, 6bn EBITDA and 3bn net income, which will convert at 100% to cash.

What’s this worth? Looking out a couple of years and on a 7.5% FCF yield the stock is worth CHF 85/share. This equates to 6.5x EBITDA and 11.5x NOPAT. These multiples are below Holcim’s own history and well below US peers (EXP and SUM at 9x EBITDA, MLM at 15x, Carlisle at 12x) . If you assume 40% of earnings come from lightside products and apply peer multiples (>10x) the stock is worth > CHF 100/share. We’re a long way from this sort of re-rating, but it’s a theoretical possibility.

Meanwhile at CHF 58/share today you’re buying a well run, clean b/s global leader with an increasingly diversified revenue stream trading at 6x EBITDA with a 9% FCF yield, 4.5% dividend yield and the prospects of >10% annual shareholder returns funded by sustainably high cash generation. Holcim will gain share as the European cement market continues to consolidate and as it cross-sells its growing Solutions & Products through its large distribution network.

Risks

• A sustained demand decline that leads to cement price reductions.
• Volatility in energy input costs (electricity, coal, natural gas) as seen last year in Europe, although the industry was able to pass on >100% of this.
• Punitive carbon reduction regulation and/or alternative product innovation to replace clinker
• Value-destroying M&A that re-levers the b/s

Catalyst

• Sustained >10% cash generation leading to >10% annual shareholder returns
• Potential transformational acquisition within the Solutions & Products division
• Eventual re-rating as >50% of business becomes US lightside vs. legacy EM heavyside