Over 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 possiblerecession in Asia and Latin
America, joining the ranks of major European economies already
mired in a slump.
, the world's third-largest cement maker and producer of
concrete, any fresh slowdown could cause real distress for its
reboundingstock . For investors who have managed toprofit from
this stock's heady two-year rebound, now is the time to book
profits asshares could give up thosegains ifcash flow doesn't
Even before the recent slowdown in China and elsewhere, Cemex
has been through a rough period. Anemic levels of construction
have hurt pricing and demand for cement, leading this company to
bleedcash . Cemex generated -$563 million infree cash flow in
2012 and is on track to post another $400 million in lost free
cash flow thisyear . Negative free cash flow is a real problem
for any company carrying $15 billion inlong-term debt .
So why has this stock been rising higher in recentquarters ?
Because investors are hopeful that the globaleconomy will rebound
in 2014 and 2015, which will help Cemex deliver improved
financial results. Consensus forecasts, for example, anticipate a
19 cents a share profit in 2014. That would be the company's
first profit since 2009.
Thanks to a series of recentdebt moves, Cemex only has roughly
$500 million inbonds to worry about over the next 18 months. Cash
on hand is more than sufficient to meet thosebond redemptions.
Instead, it's the banking restrictions on that debt -- known
asloan covenants -- that should have investors concerned. When
banksissue debt, they anticipate companies will generate strong
enough cash flow to pay down 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 cancall in theirloans , which in the case of Cemex, would
Although Cemex has a high degree of exposure to manyemerging
markets , it's the United States that could actually spell
trouble, as it accounts for more than half of Cemex'sEBITDA . The
company is counting on a much higher pace of U.S. construction in
2014 to meet its cash flow targets and keeplenders 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
Let'sput suchheavy concerns aside for a moment. And let's
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 manyanalysts now expect,
then shares are still quite expensive. For example, they trade at
nine times projected 2014 EBITDA, on anenterprise value basis ,
and 7.7 times projected 2015 EBITDA. Heavily-indebted cyclical
companies rarely trade for more than five or six times forward
In effect, this stock has shifted from being a deep bargain
back in 2011 to being clearlyovervalued these days. And that even
assumes the economy -- and Cemex's numbers -- will vastly
Cemex's $15 billiondebt load may explain why short sellers are
targeting this stock. Close to 98 million shares were held short
at the end of July, making this the ninth most-heavily shorted
stock on the New York Stock Exchange. Short sellers had a chance
to digest Cemex's second-quarter results on July 22, and came
away unimpressed with management's comments about better days
ahead. These short sellers likely doubt the company is going to
be able to deliver the much-improved financial results in 2014
and 2015 thatWall Street analysts are now penciling in.
In sum, this stock is more than fully valued in a best-case
scenario, and it is vastly overvalued if financial results remain
weak. This stock could fall by half in coming quarters if
management is forced to concede that 2014 will be yet another
year of negative free cash flow. The fresh concerns around
Cemex'sbalance sheet would cause many investors to
Action to Take -->
--Short CX at prices down to $8
-- Set stop-loss at $14
-- Set initialprice target at $6 for a potential 50%gain in
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