Swiss giant shows how not to cement a $35-bn merger

Bloomberg

As cement sets and hardens, it binds materials together, creating a stronger whole. LafargeHolcim’s first yearly results as a combined company gave little indication that their union has done similar.
The Franco-Swiss cement producer, the world’s biggest, booked a 3-billion Swiss franc ($3.1-billion) impairment in the fourth quarter, attributed mostly to Brazil, Russia, Iraq and China. As a consequence, it made a 2.9-billion Swiss franc quarterly net loss.
CEO Eric Olsen appeared relaxed when telling CNBC: “It’s a 3-billion charge out of a 55-billion balance sheet.” But after a more than 40 percent decline in the share price since last July’s $35 billion merger, the impairment is equivalent to 7 percent of the company’s market capitalization. Investors won’t be quite so at ease.
Indeed, Phil Rosenberg at Bernstein Research is concerned the writedown signals “a permanent adjustment to earnings potential.” Emerging markets account for about 60 percent of Ebitda, according to Natixis. The company conceded that headwinds in some of those markets would continue.
In China, for example, the country’s property woes caused cement prices to fall 15.9 percent in 2015. China accounts for 22 percent of the company’ capacity, according to Bernstein.
And it’s not much easier in western countries. While North America remains a source of strength for cement-makers, prices fell 1.5 percent in Europe last year and LafargeHolcim’s European like-for-like earnings by 9 percent. The strong Swiss Franc has knocked construction in the company’s home market.
The pressure on prices also tends to be a function of overcapacity, which spells lower margins for producers.
So there are understandable worries about the ambitious medium-term cash flow and earnings targets laid out by the company in November. Divestments, cost-cutting and restrained capex will help, but the targets rely a lot on the relatively inexperienced Olsen being able to wrestle out the more than 1 billion Swiss francs of synergies promised from the merger. That’s a tall order.
Finding these savings also involves upfront costs — substantial in LafargeHolcim’s case. Restructuring and other one-off costs totaled 407 million Swiss francs in the fourth quarter alone, double the amount anticipated by UBS.
Realizing the full benefit of synergies will be particularly arduous given the lingering fears about combining two very different corporate cultures. Senior management departures, including chairman Wolfgang Reitzle and finance chief Thomas Aebischer, haven’t helped, as Bloomberg News colleague Alice Baghdjian reports.
Cement demand is expected to increase by as much as 4 percent this year, but Olsen didn’t provide earnings guidance, which hardly inspires confidence. Bloomberg consensus estimates see Ebitda rising from 5.8 billion Swiss francs in 2015 to 6.1 billion Swiss francs this year, before climbing to 7.3 billion Swiss in 2018 — well short of Olsen’s goal of 8 billion Swiss francs.
So the shares look fully valued at 18.4 times forward earnings, even after the steep drop since the merger. European rival HeidelbergCement, which hiked its its dividend on Thursday, trades at about 16 times.
To win over doubters, Olsen has to meet those earnings targets while his pricing power is curtailed. And he needs to do this while filling any cultural cracks in the LafargeHolcim foundations. Construction jobs are never as simple as they first appear.