Author’s Note: This is a shorter version of the iREIT on Alpha article posted on the 12th of May 2022. The version on the private marketplace was posted 1 day before the company’s ex-div date in 2022. The company is now past its ex-div date.
In this article, we’re going to visit HeidelbergCement (OTCPK:HDELY) as an investment.
In this article, I’m going to clearly reiterate and update my bullish thesis for HeidelbergCement, and show you what I expect out of the company in the long term.
There is a lot to like about HeidelbergCement, and I’m going to show you all of it.
Revisiting the HeidelbergCement thesis
So, HeidelbergCement has underperformed since my last article on the company. In this piece, I’m going to show you why I think now Is a good time to buy the company.
If you recall my base article on the company, the results for 2021 were good. HeidelbergCement saw a near-double digit sales revenue increase, a 6% EBITDA increase, and above all, a successful across-the-board price hike increase and fixed cost management that preserved the company’s operating margins and profit.
The company also maintained a huge focus on shareholder returns, spending billions on dividends and share buybacks, with more buybacks coming. Prior to the war, the outlook for 2022 was positive. This has obviously changed now – even though many of the fundamentals have not.
Revisiting 2021, let’s remind ourselves that HeidelbergCement is well on track of meeting every single one of its 2025E targets.
These price increases successfully managed the margin pressures that the company saw, and expected for 2022. HDELY managed solid EBITDA growth both compared to 2020 as well as to pre-pandemic 2019.
Like most of HDELY’s peers, the company is internationally diversified. Because of this, regional trends are important. NA is seeing solid trends, with Revenue and EBITDA improvements. These are similar trends to regional/national peers such as Martin Marietta (MLM). Pressures in NA derive primarily from high freight rates, but for now, the demand continues to be positive and causes the company to expect good trends for 2022.
In Europe, things are more unclear. High energy prices are no longer able to be offset by price increases, leading to profitability pressures in the company’s home markets. However, this is very similar to European peers. Furthermore, HeidelbergCement was able to record some significant revenue and EBITDA increases in parts of Europe where pressures aren’t as pronounced, such as Southern/Western Europe.
Strong trends were seen in the Middle East and Africa, which remain relatively unimpacted by COVID-19 trends, and saw significant volume demand and price increases. Egypt is still a turnaround market, but positive results are improving on a QoQ-basis.
On a very broad basis, only Asia is really negative for the time being.
HeidelbergCement is also fully engaged in an ongoing portfolio optimization – selling unprofitable assets and purchasing more appealing assets. This is something that the company has always been a little up/down in, but overall the last 10 years have seen HeidelbergCement turn into a more appealing business.
Without the Russia/Ukraine situation, I have no doubt that we would be in a very positive situation for the company. However, with energy prices skyrocketing and macro now in chaos, things have taken a turn to the negative. The commercial excellence/optimization program effects will likely be lower than expected or delayed – the pressure for the company to increase its sales prices is higher than before.
Many of the company’s upsides remain.
Indonesia is going to be a significant growth factor, and the company’s portfolio optimization makes a lot of sense. Unlike with its M&A in the USA of Hanson, HDELY managed to get a very appealing price for ItaliCementi. These aren’t the most attractive assets in terms of profitability, but demand is high.
Furthermore, perhaps the most important upside, the current company valuation does not represent the inherent value of its assets. To replace the European and international production capacity for its product, the investments that would need to be made are significantly above the current NAV/share for HeidelbergCement.
This makes it only a question of time until we see an upward trajectory for the company – though the timing of it might have grown more uncertain given these recent macro developments.
However, I really want to take a moment to emphasize just how the company has improved actual ROIC, one of the more crucial metrics for a concrete/cement company.
The company’s leverage is now at 1.3X. Net debt is below 5 billion euros, which considering that the company can generate well over €3.5B EBIDTA in a single year, is impressive. EPS was significantly up for 2021, was expected to grow for 2022, but can now be expected to be somewhat moderated. The strong pricing across all markets reported on a pre-war basis have now been impacted, and the cost and energy inflation will now be even worse than expected.
However, let’s make one thing clear.
The company is reporting solid revenue increases during the first quarter, with expectations around €4.2B (reported at €4.4B), increasing sales across the board. However, company EBITDA was expected to be down, and EBITDA margins were expected to suffer and see levels below 10%, of a range between 8.4%-9.3%, compared to a 13.6% for 1Q21.
For the full year of 2022 at current forecasts, the impacts are somewhat more moderated. The pattern is similar – we’re seeing increased sales revenues, up to over €20B on an annualized 2022E, due to strong demand, but with a lower full-year EBITDA for the full year, coming to between €3.680 to €3.780 compared to €3.875B for 2021FY, with margins declining to 18.3-18.5% on an EBITDA level.
Operating income is expected to decline to between €2.4-€2.48B, compared to €2.6B in 2021.
None of these impacts will significantly make HeidelbergCement an unappealing investment. None of these headwinds will make the company a business I won’t be investing in. What’s changed in the 1Q22 is essentially confirming that things are taking a turn towards the somewhat complicated, but that overall, it’s under control.
What’s changed is that the continued long-term trajectory for the 2025E targets has been broken – and it seems doubtful that all of the company’s targets will be realized, if things continue along this line. We can see this by taking into account what we’ve seen in 1Q22 – that HeidelbergCement posted results in-line with consensus, but with somewhat weaker inflation protection than peers. This is due to its energy hedging policies, which HEI is now trying to change.
As a small note, a sale of business activities in US west will color EPS with non-recurring sales gains of close to €500M.
We will know more once the actual quarterly figures are released – but I don’t expect any significant surprise from them.
Energy is crucial to HDELY. The pricing for Energy is skyrocketing. The company will have to raise prices and push efficiency to compensate. But this does not change a very positive demand situation – not just in Europe but across the globe.
As such, I consider HeidelbergCement only marginally impacted in terms of valuation.
HeidelbergCement – Updated Valuation
Like with other companies I’m updating my valuation on, it does not matter through what lens you choose to view HeidelbergCement. Every single one shows you an undervaluation here, ranging between 15% to 80%.
The only impact I’m calculating and adjusting for my forward modeling is a margin impact due to lower margins from energy pricing and inflation. I’ve also added an adjustment for carbon prices, allowing for another 50-100% increase after the 200% Co2-price increase in 2021. I’m now working from the following assumptions for Co2-pricing.
- Carbon Emission Allowance: Based on current trends, I expect 2022E prices to increase, but not cross above €100. I don’t expect a Co2-price of above €100 for the entire first half-decade of 202X, based on the calculations that would have companies paying the penalty as opposed to adjusting operations or buying Co2-rights on the market.
- Allowance forecast: I have forecast carbon rights allocation by estimating the company’s market share in various countries, forecasted to be flat until 2025, and a linear decrease of 5% from 2026 onwards, based on company plans.
S&P Global has significantly changed its own PTs, now coming to around €70/share, which is far less than both my target and the targets by analysts such as AlphaValue. This reflects a lack of conviction that the company will be able to manage the inflation and the energy costs this year. less than 6 months ago, the target was almost €90/share.
My view of this target change is that the company’s 20 following analysts are overreacting, and failing to recognize the potential in this investment. On a 10-year basis, the company’s trough has been around €30-€40, and highs of €92. I successfully invested in HeidelbergCement between 2014 and sold in late 2017, making a return in the triple digits.
My intention is to repeat this once more, should the company go above that level again, and the upside fails to change.
I view the company as a solid “BUY” to my price target here. Yes, it’s possible that HeidelbergCement will see further lows once 1Q22 comes out, or once the next couple of quarters shows the overall impacts on the company’s operations, but the long-term company trends show things going in one direction, and one direction clearly – up.
Based on this, I set my price target to €82/share for HeidelbergCement.
I view the overall thesis for HeidelbergCement as positive. Despite cost inflation and macro risks, the upside for the company is solid, and a full upside seeing a 90€+ valuation calls for a 100% RoR inclusive of dividends. That’s what I’m looking for, in a 3-5 year period.
If you’re unwilling to hold this for a longer-term, you shouldn’t be investing in this company. If you’re willing to wait a few years, while knowing that the company you invest in will be delivering a solid yield and you’re exposed to a superb, fundamental business…then you’re in good company with HeidelbergCement.
My portfolio is currently ~2% exposed to HeidelbergCement, and I’m looking to increase that substantially.