LafargeHolcim (LHN:VTX/PAR) share : Analysis

LafargeHolcim shares are listed under the "LHN" ticker on the Paris and Zurich stock exchanges. LafargeHolcim Ltd is the world leader in building materials and solutions. The Group was formed from the merger of Lafarge (FR) and Holcim (CH) in 2015. They didn't bother too much with the name. At the same time, if company directors were really original, we would know about it. It is also not certain that shareholders would appreciate companies being run by clowns. From a certain point of view, the former directors of the French group Lafarge behaved like such in the recent past. We will go into more detail on this later.

The headquarters of the Franco-Swiss trust are located in the canton of St. Gallen in Switzerland. The history of the two companies goes back a long way, since Lafarge was founded in 1822 and Holcim in 1912. The company produces cement, concrete and aggregates. It prides itself on being at the forefront of innovation in construction materials. It is present in 80 countries and has a whopping 72,000 employees. The world's population is growing rapidly, especially in cities. The need for infrastructure is particularly great. LHN can therefore rely on the dynamics of a particularly promising sector of activity.

The scandal

The newspaper "Le Monde" reveals the June 21, 2016 that Lafarge (before its merger with Holcim), is suspected of having financed the Islamic State for more than a year. The new group admits it nine months later. Eric Olsen, CEO of LafargeHolcim (former deputy CEO of Lafarge), then presents his resignation. In December 2017, he is indicted on charges of financing a terrorist enterprise and endangering the lives of others and placed under judicial supervision (with bail). The former CEO of Lafarge Bruno Lafont and his former deputy CEO of operations Christian Herrault accompany him in this disastrous adventure.

In 2018, the company set aside 35 million Swiss francs. It stated that "there is no indication that the judicial investigation is likely to have other negative financial impacts". This provision should be put into perspective by specifying that it only represents 2.3% of the net profit for that year. In November 2019, the Paris Court of Appeal confirmed the preliminary criminal charges. It declared that Lafarge had violated international embargoes by seeking to maintain its activities in Syria despite the civil war. However, the court rejected the more serious charge of crimes against humanity. Today, the legal case is still ongoing and the case could take several more months or years before it can be judged.

LafargeHolcim stock valuation

At first glance, the valuation of LafargeHolcim shares on financial sites seems attractive. The price is barely more than 12 times earnings per share and the dividend yield is a whopping 4.4%. With the speculative madness currently on the market, for a company of this caliber, it gives the impression that the stock is frankly being sold off. Even if the company had to line up a few tens of millions in the future to pay for its mistakes in Syria, it wouldn't change much.

The devil is in the details and LHN is no exception. Profits are inherently fickle. This is particularly marked at LafargeHolcim, which happily alternates between good results and losses. It is therefore difficult to value it by taking into account only the profits (and therefore the dividend) of the last financial year. If we push the analysis a little further, we notice that the LHN share price amounts to:

• 12.25 times current recurring earnings, but 60.18 times average recurring earnings (over the last five years)!
• 8.36 times current free cash flow and 16.36 times average free cash flow
• 0.96 times book value and 1.85 times tangible assets
• 1.03 times sales

Overall, it's not bad, even interesting if we look at it in relation to sales, book value and of course current results (last fiscal year). The free cash flow can also disturb us. It seems to indicate that the stock is very cheap based on the latest results. Even if we take into account the figures of the last five years, its valuation remains correct. But if we look a little more closely, we realize that these attractive figures are misleading.

The traps

Compared to the book value, the price is attractive, but almost half of this value comes from intangible assets, which are difficult to estimate by nature. Furthermore, if the ratio to sales is so low, it is because LafargeHolcim has a monstrous difficulty in transforming its turnover into net profit. Over the last five years, the average net margin is only 1.7%! As for free cash flow, if we compare it to the enterprise value rather than its capitalization, the valuation becomes much less attractive:

• Current EV/FCF: 13.37
• Average EV/FCF: 26.61!

Enterprise value takes into account debt and cash reserves. It tells us how its capital is structured. We can already guess here that net debt is quite high. This obviously does not help LHN's profitability problems, even if the influence of debt on net margin remains low given current interest rate levels.

LafargeHolcim share dividend

There remains the attractive dividend of 4.4%. It has not changed since 2016 and for a good reason, which you have probably already guessed. The distribution ratio is low if we compare it to the profit and the current free cash flow (54.67%, respectively 36.69%). On the other hand, it is catastrophic if we look at the figures for the last five (273%, respectively 73%). The significant variations in results are obviously not unrelated to this phenomenon. The future prospects for the dividend are therefore not very encouraging. We are rather moving towards a maintenance, or even a reduction, but certainly not sustained growth.

Balance sheet & result

It is difficult to detect a trend in LHN's results over the last five years. Profit and cash flow are yo-yoing. Cash reserves therefore tend to stagnate, while asset values have been slowly but surely melting for the last five years. LafargeHolcim is clearly struggling to create value for its shareholders and this is reflected in the share price, which has failed to take off since its creation.

Liquidity is correct, with a current ratio of 1.34 (up) and a quick ratio of 1.06. No problem paying bills, that's already something. The gross margin is appreciable, with 42.2% (down very slightly). Even looking at the average figures for the last five years, we are still at 37.4%, which is good. The free cash margin is also interesting, with 12.3%, as is the net margin, with 8.4%. Let us recall, however, that for the latter, if we take into account past data, the situation is much less encouraging, with only 1.7%. In terms of profitability, it is not great either, with an ROA of 3.85% (up), a CFROA of 8.27% and an ROE of 7.86%. It's not catastrophic, but one might have expected more from a world leader.

Debt

The enterprise value already suggested a fairly high debt level. This is confirmed since the long-term debt amounts to nearly 21% of the value of the assets. Even if the total debt represents only 0.6 times the equity, it would take LafargeHolcim more than ten years to amortize it using its free cash flow. However, it should be noted that the company seems to have understood that its debt could be a problem. It has been falling steadily since 2015. The average annual return for the shareholder for the amortization of the net debt thus represents more than 8%, which is particularly significant.

2020 Outlook and the Chinese Virus

In their interim report for the first quarter of this year, LHN claims that the result is resilient despite the impact of COVID. The company announces "revenue of -3.31TP3Q and recurring EBIT of -2.61TP3Q compared to the prior-year period, both on a like-for-like basis". However, they were much more discreet about the fact that in reality sales and EBIT fell by 11.21TP3Q and 14.11TP3Q respectively (not using the accounting trick of like-for-like). They expect an even greater impact for the 2nd quarter. We look forward to reading all this soon.

Return for the shareholder of LafargeHolcim stock

LHN's shareholder return is certainly very attractive, with a dividend yield of 4.4% and a net debt amortization yield of over 8%. However, the company will not be able to maintain this generosity in the future unless these results increase significantly. Indeed, the total shareholder return currently uses over 200% of the resources from the average free cash flow generated. It will therefore be necessary to choose either to maintain the dividend or to continue to reduce the debt. Unless they decide to issue shares to finance it all. This would obviously make no sense for shareholders.

Risks

Despite its status as a leader, self-proclaimed at the forefront of innovation, LafargeHolcim is not a franchise at the moment. The gross margin is certainly good, but it is not reflected in the net margin, which is pitiful. Overheads are very high, at 83%. Goodwill is declining. Finally, capital expenditure is monstrous, since it represents 371.3% of profits over the last five years. This explains many of the difficulties encountered by the company.

We are not going to talk about the risk of bankruptcy, even if the Z-Score (Altman) is in the red, with 1.72. Banks are indeed still and always fond of lending to big shots. They are currently doing it well for hairdressers. It makes you wonder if the term bankruptcy should not be banned from the dictionary, the central banks having decided that we live in the world of Care Bears. Let us note however that with an F-Score (Piotroski) of 6, LHN can be considered quite solid, without however being able to offer good prospects in terms of stock market capitalization.

Even though its sector of activity is buoyant, it is particularly exposed to economic upheavals. With LHN's debt and its profitability problems, it is not surprising that LafargeHolcim shares are volatile (39%) and sensitive to the market (beta of 1.6). As a large company, institutional investors are jostling for position. We will note the presence of Vanguard, UBS, Credit Suisse, BlackRock, Invesco and Vontobel, among many others! Who wants to measure themselves against this great team? Not me in any case... The day they decide to leave the ship, it could shake up the slightest thing.

Conclusion

Despite an apparently attractive valuation on the usual financial sites, LafargeHolcim shares are too expensive for what they are really worth. Like many other stocks at the moment, its price could easily be halved. We would then return to historically more appropriate standards.