This Stock Is Up 60% -- Time To Sell?


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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.

For Mexico's Cemex ( CX ) , 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 improve.

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 be devastating.

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 programs.

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 EBITDA.

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 improve.

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 flee. 

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 six months.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing

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