Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
Mexico is in the midst of a presidential election -- and investors are nervous.
Mexico kicked off its 2018 presidential campaign season last week, and is due to pick a new president on July 1. Former Mexico City Mayor Andres Manuel Lopez Obrador is leading the pack of presidential contenders, and investors may be worrying that a victory by the fiery opponent of U.S. President Donald Trump (and avowed critic of NAFTA) will be bad news for Mexican businesses -- cement giant Cemex (CX -0.35%) in particular. Over the past nine months, Cemex stock has shed fully one-third of its value.
That's the bad news. The good news is that, according to banker Merrill Lynch, Cemex's much lower stock price today now incorporates any "election risk." In fact, according to coverage of the analyst's note this morning on TheFly.com, investors may even have overreacted to what risk there is in Cemex stock -- which Merrill believes could rise as high as $8.50 per share a year from now, delivering as much as a 24% profit to new investors.
Here's what you need to know.
Merrill Lynch is building a case for cement maker Cemex. Image source: Getty Images.
Upgrading Cemex
Merrill Lynch sees two primary macro factors benefiting Cemex stock, the first being the steadily weakening U.S. dollar, which makes Cemex's products less expensive in foreign markets. A weak dollar also makes each pound or euro Cemex earns abroad (after the U.S. and Mexico, the United Kingdom and the European Union are two of Cemex's most important markets, according to data from S&P Global Market Intelligence) more valuable to Cemex when translated into dollars.
As explained in a write-up on StreetInsider.com (subscription required) this morning, "most" of Cemex's foreign markets are looking relatively strong in local currency terms when compared to the dollar..
Merrill Lynch predicts that strong sales combined with a weak dollar will "drive strong earnings" for Cemex, and recommends that investors buy the stock.
Sales and volumes
Merrill does see the potential for weak volumes of cement being sold in Mexico next year, possibly related to NAFTA fears. At the same time, however, the analyst is predicting that volumes of cement shipped will "pick up" in the United States, Europe, and the Philippines. Merrill doesn't specifically highlight President Trump's trillion dollar-plus infrastructure plan as key to its buy thesis. However, it's worth noting that despite being technically a Mexican company, nearly half of Cemex's assets are in the U.S. It's logical to assume that, if the infrastructure plan comes to fruition, Cemex would be a major beneficiary.
Valuing Cemex
And yet, as Merrill Lynch points out, investors don't seem to be giving Cemex credit for this potential. Currently, says Merrill Lynch, Cemex is "the least expensive large cap in Mexico."
Valued on its $775 million in trailing GAAP earnings, Cemex stock sells for less than 13.5 times earnings. That's not bad for a stock that, according to analysts surveyed by S&P Global, is set to grow earnings at better than 28% annually over the next five years. In fact, analysts who follow the stock predict that Cemex earnings that stood at $0.48 last year will nearly double to $0.90 per share by 2022 -- and free cash flow (FCF) will more than double to roughly $2.2 billion. Meanwhile, with roughly $1 billion in trailing free cash flow today, Cemex stock trades for barely 10 times trailing FCF -- an even cheaper valuation.
Now, it's worth noting that Cemex's valuation isn't quite as cheap as meets the eye. Factor Cemex's $11.6 billion in net debt into the picture, and the company's enterprise value is more than twice its market capitalization (which doesn't take debt into account) -- roughly $22 billion. Still, that works out to an enterprise value-to-free-cash-flow ratio of only 22, which seems reasonable if analysts are right about the company's 28%-plus projected growth rate.
Granted, Cemex still needs to deliver that super-fast growth to justify Merrill Lynch's buy rating. But if it can execute as promised, then Merrill Lynch is right: Cemex stock is cheap enough to buy.
