Analysis

CRH has made good on its intentions. This week it stumped up Euro6.5bn to buy assets from Lafarge and Holcim in four continents. The move follows preparation since at least May 2014 when the Irish building materials group announced a divestment programme. In October 2014 it announced that it would sell its brickwork division.

CRH is finding the cash through a mix of existing cash, debt and equity placing. Interestingly, back in 2012 an Irish stockbroking analyst who was interviewed reckoned that the company could spend up to Euro3.5bn on acquisitions whilst remaining within its banking agreements. Throw in the recent sales and planned divestments and the planned acquisition from LafargeHolcim doesn't seem like too much of a stretch for CRH.

If completed, the purchase will see CRH take on 24 cement plants with a production capacity of 36Mt/yr. As a back of the envelope calculation suggests the sale price of Euro6.5bn isn't far off the occasionally used price of US$200/t for western cement production. The deal also includes aggregates, ready mixed concrete and asphalt assets.

The purchase marks a change in CRH's buying strategy both in terms of scale and distribution. Much of CRH's previous acquisitions have been minority shareholdings that make it difficult to accurately report the company's position in the cement industry. For example, in our Top 100 Report CRH was reported to have a production capacity of 6.49Mt/yr for majority shareholdings with another 19.9Mt/yr for minority shareholdings. The new cement capacity being purchased blows this away because it more than doubles CRH's total capacity and it appears to be all majority owned. CRH thinks that this will propel it to become the world's third biggest building materials manufacturer after LafargeHolcim and Saint-Gobain, leapfrogging Cemex and HeidelbergCement in the process. Strangely there is no mention of the huge Chinese players in the top five manufacturers in CRH's acquisition presentation.

CRH has avoided buying plants in southern Europe but it is relying on the slowly improving growing UK market, where CRH will pick up four plants, to balance the risk. Elsewhere in Europe, the three Holcim plants in France have been suffering from continued low construction rates in that country and the two Lafarge cement plants in Romania are unlikely to have recovered from a production fall in 2013. Outside of Europe growth has been poor in Quebec in 2013 and 2014, where CRH is buying two plants from Holcim. Both Lafarge and Holcim have also seen a slowdown in Brazil. However, the Philippines does seem like a better bet for CRH, with solid cement volumes growth seen by Lafarge in 2013 and the first three quarters of 2014.

With CRH now looking like a company that wants to produce cement rather than one that owns parts of companies that produce cement, all eyes are on the construction markets. 14 of the 24 cement plants CRH are buying are in Europe. Buying at the bottom of a sustained production slump makes sense because the asking price will be low. However, has the bottom been reached yet?

The Portland Cement Association (PCA) put out a positive forecast for residential housing in the US last week. PCA Chief Economist and Group Vice-President Edward J Sullivan announced that housing starts will increase by 20% to 1.2 million units in 2015 from around 950,000 units in 2014. Strong gains are also expected for 2016.

This is relevant because in previous forecasts growth has been pinned on residential construction demand where there was a lag in demand following the recession in 2008. The PCA has not said whether this improves on its last forecast from late 2014. At that time the US cement market in 2014 was expected to grow by 8% despite a late start to the building season and weaker than expected housing start figures. The latest release suggests that the PCA has become more optimistic about the number of houses being built.

Interestingly, Sullivan pointed out that the focus is on family homes, with high student debt levels excluding the millennial generation born in 1980 - 2000 and with the baby boomers now leaving the market. As an aside, it is worth mentioning that specifying millennials in relation to housing starts is pertinent outside the US also. In the UK, for example, age of first time house buyers has been steadily rising in recent years. This has implications for the construction market and the cement industry alike.

Back in the US, demographic trends are on the side of the cement producers, led by a rising population. Cement demand growth of around 8% is expected in 2015 and 2016. Forbes placed Houston, the location of last week's 2nd Global Well Cem Conference, as America's fastest-growing city. Census data show that it saw a population growth of 392,742 inhabitants in the metropolitan Houston area between 1 July 2010 and 1 July 2013. Put another way this amounted to an extra 10,909 people moving into town each month (!) during this period. That calls for a lot of cement as these people demand houses and infrastructure.

Unfortunately the fly in the ointment here is that the global price of oil has been falling since mid-2014 and Houston's growth is dependent on the oil industry and its associated industries. By extension the cement industry in Texas, the US's biggest producing state, is also vulnerable. Houston may be an extreme example but the PCA is already wondering what the implications of low oil prices will have on the US construction industry as a whole. To this end, Sullivan is set to forecast that short-term gains could be made in the housing market if the oil price stays low but it could have a negative effect if the low prices continue.

One question is whether the US housing market is already experiencing this boost yet. If it is, housing starts and cement production in 2014 may have been artificially stimulated by cheap oil. In this case cement production growth in the US over the next few years may be slower than expected. We'll have to wait and see what Sullivan predicts but in the meantime it might be worth delaying buying that nice new house in Houston.

On 15 January 2015, the Swiss National Bank (SNB) abandoned the Euro1.20 cap on the Swiss Franc. The effects of the decision were immediate, with the value of a Franc dropping from Euro1.20 to just Euro0.99. The decision caused turmoil for currency brokers and big business in Switzerland's normally bullet-proof finance sector, with some brokers out of business by the end of the same day.

It is not hard to see why these brokers were caught out by the sudden change in the SNB's position. On 18 December 2014 Thomas Jordan, Chairman of the SNB's Governing Board, stated in no uncertain terms that, "The SNB remains committed to purchasing unlimited quantities of foreign currency to enforce the minimum exchange rate with the utmost determination." In research conducted by Bloomberg News on 9 - 14 January 2015, not one of 22 economists questioned expected the SNB to abandon the cap in 2015. That's quite an about-turn by the SNB in less than a month.

The decision to 'scrap-the-cap' shows the potential of outside influences to suddenly unseat even the most secure of businesses. Such companies include Holcim, the share-price of which went on a rollercoaster on the SIX Swiss Exchange in the immediate aftermath of the announcement. At one point on 15 January 2015 Holcim had lost 20% of its value before closing 11% down on the day. It has since recovered somewhat, although a whopping Euro3bn of its capital has been swallowed up due to the plummeting Franc.

Following the sudden changes to its circumstances, Holcim immediately reinforced its commitment to its merger with Lafarge. "Regarding a possible impact on the combination with Lafarge, what we can say is that we remain committed to the merger," said spokesman Eike-Christian Meuter. There was an almost simultaneous reciprocal statement from the French producer, also stating its commitment. No change there then.

The calmness of Holcim's statements was broadly in line with commentary from bankers, which stated that large deals were unlikely to be affected by the change. This is because Swiss firms can insure themselves against the effects of such moves. Another 'get-out of jail free card' could have been a material adverse change (MAC) clause. If in place a MAC would allow the merging parties to terminate a transaction if an external event significantly changes the outlines of the deal. It is not possible to know whether Lafarge and Holcim have such a clause due to confidentiality issues.

Despite the fundamentals of the LafargeHolcim merger appearing to be unaffected, the scrapping of the Franc cap is an excellent example of how external policy makers can have a direct and unexpected impact on the underlying conditions of the global cement industry. Another major external influence at present is the low oil price, mainly affected by the oil producing cartel OPEC. HeidelbergCement said this week that it expects the oil price fall to have a positive impact on its profit in 2015. It makes 80% of its revenue in oil-importing countries, which should see reduced transport and production costs. This will result in improved economic conditions, higher levels of construction and hence cement production. For HeidelbergCement 2015 could be a case of costs down, sales up.

That surely sounds like good news, for some stagnant 'old' developed economies at least. However, in the world of 'new normals' it is the IMF that has sounded the biggest warning this week. It dropped its 2015 global economic growth forecast from 3.8% to 3.5%. As fuel prices slump, so too has inflation. In the EU this has resulted in deflationary pressures that could yet stump the recovery. Consumers (and construction firms alike) may go from a position of not being able to afford things, to not wanting to buy them. In the longer term, this may be yet more bad news for the cement sector in established markets.

If you ever visit Lima be sure to try the wonton soup! One of the surprises of the Peruvian capital is the large number of Chinese restaurants. Peru has one of the largest proportions of inhabitants of Chinese-descent in Latin America. This adds a spoonful of historical context to this week's news of China's Jidong Development Group's intentions to buy Cementos Interoceanicos. It is one of a few stories affirming Peru's growth in recent years, although this trend may be changing.

The major Chinese producer is acquiring a cement plant with mineral rights that was first proposed in 2008. Originally the 1.6Mt/yr plant was budgeted at US$250m with construction set to start in 2009 and production intended to start in early 2011. At the time company executive director Armando Belfiore told local press that reserves of 700Mt of limestone and 390Mt of pozzolan exist in the Macusani, Ajoyani and Potoni districts in the Carabaya province of Puno. Subsequent plans were to develop lime and calcium carbide also. However, at present the project still appears to be in the development phase. No doubt Chinese money will be very welcome.

Meanwhile Peru's local producers have steadily been making their own progress towards becoming regional players in their own right. In December 2014 Union Andina de Cementos (Unacem) completed its purchase of Lafarge's cement assets in Ecuador. The US$517m deal included a 1.4Mt/yr cement plant in Otavalo. This followed Holding Cementero del Peru, a subsidiary of Gloria which operates Cementos Yura, paying US$300m to buy up to 98.4% in Sociedad Boliviana de Cemento (Soboce), Bolivia's largest cement producer. Media analysts have predicted that Cementos Pacasmayo is also likely to expand internationally once it has finished its local projects.

Internally, each of the major Peruvian cement producers has its own projects. Unacem is investing US$374m on its Atocongo and Condorcocha plants between 2014 and 2018, with a focus on the cement mill, the development of the Carpapata III hydroelectricity project and the construction of bagging facilities in Condorcocha. Cementos Yura targeted US$50m towards machinery and equipment at its Yura plant near Arequipa. Cementos Pacasmayo's new US$385m cement plant at Piura is due to start operation in the second half of 2015. The new plant in northwest Peru will have a production capacity of 1.6Mt/yr of cement and 1Mt/yr of clinker.

Cement production in Peru has slowed since 2012 when the country saw production rise by 16% year-on-year to 9.85Mt. 2013 saw production rise by 6% to 10.5Mt. Currently released figures from the association of cement manufacturers in Peru (Asocem) to November 2014 suggest that this growth has continued to fall to 1.5% year-on-year.

Cementos Pacasmayo reported in its third quarter report for 2014 that the Peruvian economy had experienced a slowdown during the first nine months of the year although it was expected to recover in the final quarter and beyond due to impending infrastructure projects and spending. Given Peru's continued growth in gross domestic product (GDP), Jidong, Pacasmayo and Peru's other cement producers could do worse than order a nice bowl of wonton soup while they wait and see what happens.

The end of 2014 proved a good time to tidy up outstanding business for various organisations with links to the cement industry. Lafarge and Holcim received clearance from the European Commission for their proposed merger and they announced their executive committee, Holcim and Cemex concluded their transactions in Europe, the US Environmental Protection Agency (EPA) announced regulations for coal ash, HeidelbergCement found a buyer for its Hanson Building Products business and even PPC managed to appoint a new CEO.

The HeidelbergCement sale is of interest because the company has said it is using the proceeds to pay off debt rather than to make purchases. CEO Bernd Scheifele said in the press release that the intention was to improve the company's 'credit-worthiness.' This isn't directly related to the cement industry because Hanson Building Products produces concrete gravity pipe, concrete and steel pressure pipe and clay bricks in the US, UK and eastern Canada. Yet the potential cash bonanza is relevant. Remember, this is happening at the same time that Lafarge and Holcim have been offloading lots of their own assets to meet competition regulations in various territories.

When the initial public offering was made for Hanson Building Products in September 2014, analysts assumed that HeidelbergCement was positioning itself for a spending spree. The purchase price for Hanson Building Products agreed with a private equity firm was US$1.4bn. This could be used to buy five 1 Mt/yr cement plants at an average price of US$250/t for cement production capacity!

Unfortunately for HeidelbergCement its net debt rose from Euro7bn in 2012 to Euro7.5bn in 2013. This was the first time it had risen since 2007 when it hit a peak of Euro14.6bn. That year was when it agreed to purchase Hanson. It also marked the start of the 2007 – 2008 financial crisis. Similarly, ratios such as net debt to operating income before depreciation (OIBD) also rose in 2013. Although it looks from interim financial reports that HeidelbergCement's debt may have decreased again in 2014, it is probably not doing so at any great speed. Hence the Hanson Building Products sale.

For comparison with debt held by the other European-based cement producers, Lafarge's net debt stood at Euro10.3bn at the end of 2013, Holcim's net debt was Euro7.9bn, Italcementi's net debt was Euro1.9bn and Mexico-based Cemex's net debt was Euro14.8bn. Compared to most of these their operating incomes these company's have net debt to earnings before interest, taxes, depreciation, and amortisation (EBITDA) ratios (net debt/EBITDA) of between two and three-and-a half suggesting that they can pay back their debts within a few years if absolutely necessary. The outlier here is Cemex with a ratio of over six following previous acquisition bursts.

The implication here is that Lafarge and Holcim have chosen to sell their wares at a time when their European competitors are weakened. Meanwhile their Chinese competitors have only just started to directly expand outside of mainland China. Smart move.