Pouring the foundation
It's been a wild and wooly ride for emerging markets over the past few months, and Mexico is no exception. Since reaching a 52-week high on May 10, the AMEX Mexico Index has fallen some 20%, hit by the same factors affecting markets worldwide: concerns over higher inflation and rising interest rates, fears about the growing violence and political instability in the Middle East, tensions with North Korea, and spiking oil prices.
As if these issues weren't enough, investors in Mexico have also had to contend with a disputed presidential election in which the pro-business candidate, Felipe Calderon, won by a mere 244,000 votes. Not surprisingly, the leftist candidate, former Mexico City Mayor Andres Manuel Lopez Obrador, has called the results invalid and is demanding a total manual recount. Since the election court has until Sept. 6 to issue a final verdict, it could be a long summer of protest marches by Obrador's supporters and jitters among nervous investors.
Not a pretty picture. But beauty is in the eye of the beholder, and I view this chaotic time in the Mexican market as a beautiful opportunity for long-term investors to scoop up shares of some unfairly beaten-down stocks -- one of which is Cemex
Simply put, I believe that investors have thrown the baby out with the bathwater in the case of Cemex. This company, like two of my other favorite Mexican plays -- cellular behemoth America Movil
Now, maybe I'm crazy, but I don't think investors are giving LaFarge a French premium as much as they're dinging Cemex with a Mexican discount -- a discount that has the company's shares trading at around 7.5 times fiscal 2006 earnings, a 41% discount to its larger rival and a 32% markdown to Cemex's own growth rate.
Don't get me wrong, I'm not arguing that Cemex needs to trade at a multiple in line with LaFarge -- or even the global industry average of 12 times earnings -- but simply that the valuation gap is too wide and will inevitably narrow as investors realize that many of their fears are overblown.
Let's take a quick look at the company and help lay some of these misplaced concerns to rest.
Cementing the case
Cemex is the third-largest cement company in the world, with operations in more than 50 countries and an installed capacity to produce more than 98 million tons of cement per year. In fiscal 2005, the company generated more than $15 billion in sales and in excess of $2.1 billion in net profits -- not a small chunk of change in anyone's book and well ahead of the $8.1 billion in revenue and $1.6 billion in profit booked in 2004.
Of course, most of that increase was due to Cemex's accretive acquisition of U.K.-based RMC Group in March of last year for some $4.1 billion in cash and the assumption of $5.8 billion in debt. While not inexpensive, the transaction did give Cemex exposure to higher-growth Eastern European markets, bolstered its position and cash flow in Western Europe, and also made the company the world's largest provider of ready-mix cement.
Yes, I know: One of the major concerns investors have with regard to emerging-market stocks is company debt -- and the impact of higher interest rates on that debt. But investors in Cemex need not worry. At the end of the first quarter 2006, Cemex had around $8.5 billion in debt, down $202 million during the quarter, and $2 billion less than in the prior year's quarter, while interest coverage stood at a comfortable ratio of 6.9.
Not satisfied? How about the fact that the company's debt is 49% fixed-rate, or that Cemex has investment-grade ratings from Moody's (Baa3), Standard and Poor's (BBB), and Fitch (BBB)? Did I happen to mention that Cemex expects to generate free cash flow in excess of $2.5 billion this year, money that it can use to pay back debt?
Building on shaky ground?
Everybody knows that the once red-hot housing market in the U.S. is cooling. Sales of new homes in May fell 5.9% from the prior year, and Freddie Mac
No, I'm not joking. For example, the SAFETEA-21 bill that President Bush signed into law in August 2005 authorizes $286.4 billion to be spent over six years to improve the nation's highways. And the federal government spends $10 billion to $15 billion annually just to build and upgrade airport infrastructure.
Those things alone will take a lot of cement.
Furthermore, according to a recent study by the Portland Cement Association (PCA), all is not doom and gloom for the long-term U.S. housing market. The PCA expects that housing development will grow 23% between 2005 and 2030, with much of that growth coming in Cemex's strong regional markets -- Florida, Arizona, and Texas. I should also note that fewer than a million tons of additional cement production capacity will come on line in the United States over the next two years, thereby creating a tight supply-and-demand environment until 2008.
Oh, and I didn't mention that the recent agreement to gradually phase out anti-dumping tariffs for Mexican exports to the U.S. should prove beneficial to Cemex. The company is expected to double its exports in 2006, and with cement consumption per capita expected to grow by 25% by 2030, it's well positioned to capitalize on solid long-term growth in demand.
The finishing touch
Patient, long-term investors have the opportunity to pick up shares of a blue-chip company at a rock-bottom valuation because of misplaced fears in the marketplace. Why not build a position?
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Fool contributor Will Frankenhoff is enjoying his time writing for the Fool more than he enjoys reading The Financial Times, rooting for the New York Giants, or pondering the vagaries of life. (He's been pretty unsuccessful on that one.) He welcomes your feedback and does not own shares in any of the companies mentioned above. The Motley Fool has a disclosure policy.
