During the past few months, an economic slowdown in China has led to a series of economic headwinds for many of the country’s key trading partners. Indeed, for the first time in several years, economists have raised the prospect of a possible recession in Asia and Latin America, joining the ranks of major European economies already mired in a slump.
For Mexico’s Cemex SAB de CV (ADR) (NYSE:CX), the world’s third-largest cement maker and producer of concrete, any additional slowdown could cause real distress for its rebounding stock. For investors who have managed to profit from this stock’s heady two-year rally, now is the time to book profits as shares could give back those gains if cash flow doesn’t improve.
Even before the recent slowdown in China and elsewhere, Cemex SAB de CV (ADR) (NYSE:CX) was having a tough time. Anemic levels of construction have hurt pricing and demand for cement, leading this company to bleed cash. Cemex had -$639 million in free cash flow in 2012, and is on track to post another -$410 million loss in free cash flow this year. Negative free cash flow is a real problem for any company carrying more than $15 billion in long-term debt.
So why has CX been rising in recent quarters?
Because investors are hopeful that the global economy will rebound in 2014 and 2015, which will help Cemex SAB de CV (ADR) (NYSE:CX) deliver improved financial results. Consensus forecasts, for example, anticipate earnings of $0.19 per share in 2014, up from an expected loss of $0.32 this year. That would be the company’s first profit since 2009.
Thanks to a series of recent debt moves, Cemex SAB de CV (ADR) (NYSE:CX) only has roughly $500 million in bonds to worry about over the next 18 months. Cash on hand is more than sufficient to meet those bond redemptions. Instead, it’s the banking restrictions on that debt — known as loan covenants — that should have investors concerned.
When banks issue debt, they anticipate companies will generate strong enough cash flow to pay down that debt at a steady pace. So the loan covenants become ever tighter, requiring companies to sport increasingly stronger debt-to-equity ratios as the years pass. And they demand that cash flow levels rise ever higher. If not, banks can call in their loans, which in the case of Cemex SAB de CV (ADR) (NYSE:CX), would be devastating.
Although Cemex has a high degree of exposure to many emerging markets, it’s the United States that could actually spell trouble, as it accounts for more than half of Cemex’s EBITDA. The company is counting on a much higher pace of U.S. construction in 2014 to meet its cash flow targets and keep lenders at bay.
But what happens if this anticipated construction boom fails to materialize? Indeed, the recent rise in U.S. interest rates is expected to act as a brake on housing and commercial construction. Economists suggest rates will keep moving higher once the Federal Reserve winds down its current stimulus programs.
Let’s put such heavy concerns aside for a moment and instead assume that the global economy will be faring quite well in 2014 and 2015. Even if that happens, and Cemex delivers the much-improved financial results that many analysts now expect, the shares are still quite expensive.
For example, CX trades at 9 times projected 2014 EBITDA, on an enterprise value basis, and 7.7 times projected 2015 EBITDA. Heavily indebted cyclical companies rarely trade for more than 5 or 6 times forward EBITDA.