The past two years have been a busy time for global cement mergers and acquisitions (M&A), especially in developed markets, with merger activity at levels not seen since before the global financial crisis, as evident from Figure 1. Here RBS' Rupert Taylor looks at the current state of play in the sector and what we might expect in 2016...
After a wave of consolidation before 2008, driven by large, often debt-funded deals, the global financial crisis saw a number of major cement players faced with declining financial performance and increasingly stretched balance sheets. Earnings before interest, tax, depreciation and amortisation (EBITDA), a measure of earnings, fell by over 20% between 2008 and 2009 for five of the largest global players on an aggregated basis.1 Financial leverage (as measured by net debt to EBITDA) increased materially at a number of players, with major players including Cemex, HeidelbergCement, Italcementi and Lafarge all having their external credit ratings downgraded by one or more of the three major credit ratings agencies.2 In response, the major companies looked to lower costs, preserve capital and reduce leverage, with capital expenditure cut from an average of >10% of sales in 2007/08 to closer to 6% of sales in 2011.3 In 2009, four of the largest global cement producers alone announced ~Euro2bn of planned cost saving initiatives.4
Whilst the period between 2008 and 2014 was not without material acquisitions, the focus on deleveraging and operational efficiency combined with a difficult operating environment meant deal activity was relatively muted until 2014. This changed in April 2014 with the announcement of the planned merger between Lafarge and Holcim, an event that, at least in part, helps to explain some of the surge in M&A activity that has since followed.
Indeed, there have been a number of drivers of the recent wave of sector consolidation in the global cement sector. Firstly, the outlook for the sector has improved in developed markets, led by the US but with the outlook for demand growth also stabilising in Western Europe, offering potential acquirers the chance to buy assets at an attractive time in the cycle at valuations that did and do not look overly stretched, against an improving outlook. This can be seen in Figure 2, which shows Enterprise Value (EV) as a multiple of the next full year's EBITDA over the last 10 years.
Whilst the outlook for certain key emerging markets has deteriorated more recently, the long-term trend in volume growth remains positive and M&A has allowed groups to put together businesses with strong geographical fits, offering exposure to fast-growing emerging markets and the ability to balance regional cycles across a portfolio of geographic exposure. Secondly, whilst cost-cutting and other self-help measures are ongoing, the sector has already delivered a material quantum of savings, with each incremental Euro saved harder to achieve. Indeed, those groups who have had the strongest recent track record of delivering efficiency programmes are well placed to use their know-how to deliver savings in target companies. Indeed, consolidation offers cement companies the ability to generate material synergies and, ultimately, rationalise capacity in oversupplied markets.
Third, a number of the largest players in the global cement industry have managed to reduce leverage since the bottom of the financial crisis, giving them increased balance sheet flexibility to take on debt to finance acquisitions. Indeed, both banks and the debt capital markets have been supportive of increased borrowing by major players to fund or part fund acquisitive growth, with the low interest rate environment allowing groups to fund at historically low costs, as can be seen in Figure 3.
Finally, as noted above, M&A in the sector itself has led to further deal activity, both as consolidation and increasingly large and assertive emerging markets players puts pressure on competitors to respond, and, as recent combinations, lead to anti-trust driven disposals. This was the case with CRH's acquisition of a portfolio of assets sold by LafargeHolcim.
Prospects for 2016
Whether for dynamic portfolio management or anti-trust reasons, 2016 should see a number of follow-on opportunities from recent combinations. For instance, LafargeHolcim has recently announced it will target ~Euro3.2bn of disposals in 2016 and HeidelbergCement has stated its confidence in achieving ~Euro1bn from disposals as a result of the proposed acquisition of Italcementi.
There are a number of reasons to believe that we will continue to see M&A activity and consolidation in the global cement sector over the course of 2016, if not perhaps on the scale of the likes of Holcim's merger with Lafarge. The sector is still fragmented: Outside China, the top four players account for ~32% of market capacity with only one (LafargeHolcim) accounting for over 10% today. This is unusual for a mature industry and, while the sector is to a large extent local, it does offer economies of scale.
M&A continues to offer players the ability to enter new markets and to gain share in existing ones where raw materials are scarce, without risking additional supply and without the cost and permitting and environmental challenges associated with new cement plants. In developed markets, the outlook remains supportive, albeit with some variance in different geographies. The US is expected to continue to grow at a high single digit CAGR over the next two years. Western Europe is returning to growth, albeit at a much slower pace and with stronger markets such as the UK and Germany offset by weaker markets such as France. Good growth in Iberia is still not expected to solve very low capacity utilisation rates in the near to medium term. While company valuations have improved, they are arguably still at historically reasonable through-the-cycle levels and, where required, the debt financing markets continue to be supportive with the interest rate outlook relatively benign, especially in Europe.
Potential dampeners to M&A
However, further material M&A is not without its challenges. Having promised significant synergies on announcing major recent deals, the likes of LafargeHolcim, CRH and HeidelbergCement/Italcementi (once closed) will need to deliver on their plans, while ensuring a smooth business and cultural integration. They will have to do this against a backdrop of increasingly difficult key emerging markets, which have been a major driver of recent operating performance for some of the global players.
Emerging markets now account for around ~90% of global cement demand, with China alone accounting for around ~60% of global demand. A hard landing in the construction sector would have a meaningful impact on the global outlook. Ongoing geopolitical risk may add to uncertainty in key growth markets and regulators and competition authorities will continue to pay close scrutiny to a sector that has had a mixed track record.
Nevertheless, it seems we are still in a consolidating phase for the cement sector. Successful emerging markets' businesses are consolidating and outgrowing their domestic markets and are likely to continue to look for expansion overseas. Meanwhile, developed market players that haven't yet participated in the M&A wave may view themselves as sub-scale in the new landscape and look to combine. With material anticipated disposal plans from a number of majors, they will have plenty of opportunity to do so.
Lessons from the global financial crisis (which is still being felt) have been heeded with recent deals either being structured as share transactions, asset swaps or, if debt financed, on a comparatively conservative basis. After a busy two years in global cement M&A, it would seem activity is unlikely to slow down any time soon.
Sources and notes
1. Cemex, Italcementi, HeidelbergCement, Holcim, Lafarge. Source: Factset
2. Standard & Poor's, Moody's and Fitch
3. Unweighted average across Lafarge, Holcim, HeidelbergCement and Cemex
4. The same producers as listed under note 3.