The Files: Holcim (SMCB.JK) Feb 2019

This is a company that is in dire state. It has been that way since the measurement period that I have chosen in 2015. Its return on capital (ROIC) is going from terribly low in 2015 to non-existent in 2017, from 1,7% to 0,2%. In effect, EVA keeps tumbling from minus IDR 1,4 T in 2016 to minus IDR 1,9 T in 2017. That is unquestioningly a really bad situation. What makes it even more alarming lies in the source of this dire performance. That would tell us how plausible it is to make a turnaround from this situation.

It has fatally low invested capital turnover which went from 0,63 to 0,13 mainly because it could not generate sales from its fixed assets. Typically, a problem in ROIC could not be remedied by higher sales growth. In fact, value is destroyed more rapidly if a company grows its revenue while it could not cover its cost of capital. But this special situation is typical for highly intensive capital business such as in cement and plantation industries. It is therefore imperative for these companies to achieve high capacity utilization in order to generate acceptable returns for investors. It has to be able to have enough sales for its plants. In this circumstance, a strategy to increase ROIC is tied to sales growth.

From this analysis, we could see that although cement margin is decreasing, it is not as substantial as its fixed asset utilization is. That is to say, the key of turning around SMCB situation lies in finding substantial demand for its cement...or, aggressively reducing its plants. This is beyond control of its management. The prospect of getting positive EVA, I’d argue, is not there in the foreseeable future. Cement consumption heyday was propelled by China huge real estate developments. It already stopped and there is little reason to believe that it would go back to the way it was. Not with current credit situation. Let’s not forget that China also could really use help in getting demand for its massive cement production. Who is going to take China’s place? Developing emerging market? I think they are not enough. Things won’t go back to the way it was.

Here comes the juicy part. What is currently expected by investors of SMCB? Are they being optimistic? Let’s get the fact first. EVA in 2017 was minus IDR 1,9 T. No wonder SMCB share price tanked. If we assume there is no change in SMCB business, that is to say EVA is constant, its market value would be less than its capital. With invested capital at the beginning of 2017 of IDR 17 T, its market value would be IDR 233 Billion. That is significantly less than the book claim of its debtholders of IDR 8,5 T and is only 1% of what the market values now. How is this even possible?

With share price of IDR 2000/share, investors are effectively valuing SMCB total value at IDR 24 T. In business performance term, it means investors are expecting that SMCB could grow its EVA, scaled by sales, for a ridiculous 18%, for 10 years. That is unrealistic expectation, and since SMCB stock price is depressed for a good reason, it is something else than unrealistic optimism. For a reference, a business that could grow EVA scaled by sales for even just 4% is a really good business.

I think the answer lies in the fact that Semen Indonesia Tbk (SMGR) would acquire SMCB. I suspect that since SMGR is an SOE, this acquisition is a mandate by the government. Hence, greedy investors see this as a big opportunity to drive up prices because SMGR would eventually have to take up that price plus premium. Good for SMCB investors, not good for SMGR investors. Irrational pricing adds up to acquisition premium, and one who pays too much loses.