Cemex Latam Holdings ANALYSIS BANCOLOMBIA: EQUITY RESEARCH – Update Cement I January 10, 2017 Reassessing the Start of the Maceo Plant SPECULATIVE BUY Following the events related to the plant in Maceo, Antioquia, we decided to exclude CLH from our Top Picks for 2H16 on September 26th. Subsequently, on October 12th, we put our coverage Return and Trading Data under review, with the purpose of making an in-depth analysis of the situation the Maceo plant, Target Price (COP) 14,300 the company’s main source of organic growth, is currently undergoing. This, seeking to protect Previous (Sep/26/2016) 16,600 the portfolio of investors with a low or moderate risk profile against the high expected volatility in Closing Price (Ene 06, 2017) (COP) 11,600 Upside +23.3% the asset. 52 Week Range (COP) 9,020 – 14,300 This decision was effective since volatility in CLH’s shares has been greater than the market’s, Market Cap (COPmn) 6,453,972 nd Outstanding Shares (mn) 556 with a standard deviation of returns equal to 2.23% since September 22 , 2016, while the Floating (Excluding AFPs)(mn) 142 volatility of the COLCAP has been 0.71%. Also, since September 16 the company has corrected ADV 12 months (COPmn) 4,223 15.6%. Dividend Yield 0.0% Total Return 23.3% However, despite the final impact regarding the Maceo plant is not clear, we wanted to run an Bloomberg: CLH CB exercise excluding the entry into operation of the plant in order to offer a target price of CLH ex- Maceo, and identify whether the stock is under or over rated. The result leads us to a recommendation of SPECULATIVE BUY, despite the cut of the TP from COP16,600/share (with Maceo) on September 26 to COP14,300/share (-14%, ex Maceo). The decision to place it under SPECULATIVE BUY is due to the increase in the volatility mentioned above and possible future movements tied to the pending permits, reasons that make it an asset CLH vs. COLCAP 12 months (base 100) for professional investors and with high risk tolerance. 140 The main changes were: i) exclusion of the Maceo plant from entering into operation; ii) new macroeconomic forecasts for the coming years; iii) increase in the risk-free rate, from 2.6% to 130 3.2% in US treasuries; iv) inclusion of financial results as of 3Q16 and the company’s 120 expectations for year-end; v) new tax rates according to changes in the tax reform, and vi) deduction of USD20mn on irregular payments and USD74mn for a possible fine by the DIAN – 110 tax agency. 100 Why not to Include Maceo in our Valuation? 90 The decision responds to our interest to provide investors with a vision of CLH without the 80 ene-16 abr-16 jul-16 oct-16 ene-17 inherent risk of obtaining the pending permits for the entry into operation of the Maceo plant, and CLH CB Equity COLCAP Index without the implicit uncertainty about the final decisions made by the General Prosecutor’s Office for violations of the code of ethics made by several former employees, which at the moment is Source: Bloomberg, Bancolombia difficult to estimate, both in amount and in time. Despite of the above, it’s clear that from a fundamental point of view, CLH’s stock is undervalued, and we could say that the entry into operation of the Maceo plant would perform as a free option, that if incorporated would generate greater fundamental value for the asset, as we will show later. Analysts Name: German Zuñiga Saavedra Multiples (USD000) 2014 2015 2016E 2017E 2018E Phone: (574) 6047045 Net Sales 1.724.710 1.427.058 1.326.295 1.419.991 1.522.663 E-mail: [email protected] Operating Income 481.131 364.818 346.138 363.506 395.402 EBITDA 576.942 449.772 441.515 461.391 495.978 Name: Jairo Julian Agudelo Restrepo Phone: (574) 6047048 Net Income 273.398 95.491 109.419 129.543 139.728 E-mail: [email protected] P / E 16,1 21,7 19,1 16,9 15,4 EV/EBITDA 9,7 7,0 7,3 6,9 6,2 P / BV 3,2 1,6 1,5 1,4 1,3 Dividend Yield 0.0 0.0 0.0 0.0 0.0 Source: Grupo Bancolombia 1 Cemex Latam Holdings| Cement January 10, 2017 Maceo Plant will Enter our Model once its Economic Impact is Certain Recently, Corantioquia, agency in charge of regional environmental licensing, informed CLH of the refusal to modify the environmental license in Maceo, with which the company sought to increase the quarry’s operating capacity to 950,000 tons/year. The main reason for this decision is the partial overlap with a renewable natural resources management district. However, CLH will appeal the decision before a higher court. It’s important to keep in mind that the current exploitation capacity of the quarry has not been disclosed by the company, so it’s difficult to estimate the potential impact of this decision, which, if confirmed, would oblige CLH to replace the remaining with another quarry, which in our opinion could make the clinker operation not feasible, taking into account the high transport costs. In addition, the environmental license to operate said mining title will return to C.I. Calizas y Minerales, which means neither CLH nor its subsidiary Central de Mezclas S.A. shall be the owners of said license. In spite of this, it’s important to keep in mind that CLH has a lease through which it can operate, exploit and manage the complete operation of the plant, from the quarry to the production of cement. Two additional issues are pending permits and procedures for the proper operation of the plant. The first is the expansion of the free tax zone, since the clinker line does not have this tax benefit and, second, the pending permits to finish the access route to the production plant. Such procedures may take time or may eventually receive an adverse response. Based on the above, we consider it appropriate not to include Maceo’s production until it is effective, since delays, legal impacts, fines, penalties, the partial or complete operation of the plant are uncertain and difficult to measure. Valuation - Discounted Cash Flow Our model was developed using the discounted cash flow methodology. With the aforementioned considerations, we reached a TP of COP14,300/share (+23.3% vs. market price) that leads to a SPECULATIVE BUY rating. The perpetuity growth rate used was 3.17% and the discount rate 10.6%, both in nominal terms. The weighted average cost of capital (WACC) was calculated with a risk free rate of 3.2% in USD (+600bps vs. previous report), a country risk for Colombia, Panamá, Costa Rica, Nicaragua and Guatemala of 3.2%, 2.03%, 4.8%, 4.8% and 2.6%, respectively, and a leveraged beta of 1.12x. On the other hand, the perpetuity growth rate was calculated as a weighted average between the long-term inflation of markets where CLH operates and its share in the generation of EBITDA expected by us. We incorporated into our model the new tax rates according to changes in the tax reform by the government, these corporate taxes will changes as follows: 40% for 2017, 37% for 2018 and 33% for 2019 and henceforth, direct changes are reflected in the WACC and cash flows. The main adjustment made in the discount rate comes from: i) higher risk-free rate that goes from 2.6% to 3.2%, ii) higher beta as a result of the increase in the volatility of the asset and the asset’s risk perception, and iii) new country risk metrics measured by the EMBI+ in the last 12 months. 2 Cemex Latam Holdings| Cement January 10, 2017 Table 1. Summary DCF valuation model Table 2. WACC Calculation USD 000 2017E 2017E PV of cash flows 2.127.708 Liabilities 1.147 PV of perpetuity 2.322.213 Kd 9,0% Enterprise value 4.449.921 Net debt 997.550 E/E+D 70,1% DIAN legal demand 74.000 D/E+D 29,9% Irregular Payments Maceo Plant 20.000 Tax rate 30,2% Other non current liabilities 664.936 Equity value 2.693.434 Shares outstanding 556.054 Leverage Beta 1,12 FX 2.950 Risk Premium 5,5% Target price 14.300 Risk Free Rate 3,2% market value 11.600 Country risk (Colombia) 2,9% Upside (downside) potential 23,3% Country risk (Panama) 2,0% Source: Bancolombia Country risk (Costa Rica) 4,8% Country risk (Nicaragua) 4,8% Table 3. Sensitivity analysis - WACC vs. g nominal Country risk (Guatemala) 2,6% Ke (USD) 12,5% Perpetuity growth rate (g nominal) 14.300 2,2% 2,7% 3,2% 3,7% 4,2% WACC 10,6% 9,6% 14.709 15.663 16.766 18.054 19.578 Source: Bancolombia 10,1% 13.679 14.502 15.444 16.532 17.802 WACC 10,6% 12.772 13.488 14.300 15.229 16.302 11,1% 11.966 12.594 13.300 14.101 15.017 11,6% 11.246 11.799 12.418 13.115 13.906 Source: Bancolombia Table 4. Sensitivity analysis – WACC vs. COP COP Currency 14.300 2.450 2.700 2.950 3.200 3.450 9,6% 13.926 15.346 16.766 18.186 19.606 10,1% 12.828 14.136 15.444 16.752 18.060 WACC 10,6% 11.878 13.089 14.300 15.511 16.722 11,1% 11.048 12.174 13.300 14.426 15.552 11,6% 10.315 11.367 12.418 13.470 14.521 Source: Bancolombia Reactivation of Construction Sector in Bogotá and Participation in 4G Projects: Catalysts 2017 will be a year in which the Colombian economy will be driven by the construction sector, mainly during the second half.