Today’s company is bait for a certain type of value investor. By that I mean the investor who loves boring, low-profile companies in stodgy but essential industries. Bonus points if the company is located somewhere deeply unfashionable and has a fantastic logo that was clearly designed in the early or middle 20th century.
OK….this is me. The investor I am talking about is me. The company I am talking about is Monarch Cement.
Value investors have long touted the virtues of cement producers. They exhibit a number of characteristics that may enable them to earn out-sized returns. Cement itself is low-value, but heavy and bulky, making shipping it beyond a certain distance from the plant uneconomical. This limits competition and ensures a captive market for the local producer(s). Cement producers also make bad neighbors. There is dust, noise, and frequent heavy truck traffic, so securing approval to build a new facility can be a difficult proposition. The cement industry is certainly not “low-tech” but advancements do tend to happen slowly, limiting the need for expensive R&D to maintain competitiveness. While there have been innovations, the cement being mixed to form the floor of a modern warehouse is fundamentally the same as that used to build the roof of the Roman Pantheon.
On the other hand, cement producers are capital intensive and experience deep cyclicality. Producers must invest in expensive and specialized equipment. Unable to ship their product over great distances, producers are exposed to the strength of the local economy surrounding their plants. It is not as if cement can be shipped from Kansas to Florida or Maine if the Kansas economy is in the doldrums.
Monarch Cement is a Kansas-based producer of Portland and masonry cements. The company has operated for 110 years and has facilities in Kansas, Iowa, Missouri, and Arkansas. The Wulf family has lead the company nearly since its founding. Walter H. Wulf passed in 2001 at the age of 101, having worked at Monarch for over 80 years. Today, Walter H. Wulf, Jr. serves as CEO and chairman of the board. Monarch Cement deregistered its stock in 2014, but continues to provide quarterly and annual statements. The Wulf family controls the company via super-voting Class B shares, but ordinary capital stock trades over-the-counter in small volumes.
Times have been good for Monarch. A look at the company’s results shows consistent profitability and healthy free cash flow generation. Monarch maintains a large investment portfolio which causes reported net income to fluctuate dramatically, but the underlying operations have been profitable each of the last several years. Monarch has built a substantial net cash and securities position, paying off nearly all debt and paring its pension and retirement obligation to a very, very manageable figure.
Monarch is behaving exactly as a cyclical business should, building its cash position and paying down debt when times are flush, all the while maintaining its capital assets and making strategic investments. Monarch is extremely well-situated for the downturn in the cement industry, whenever that may arrive. And when those bad times arrive, just how bad are they? As it turns out, not terrible! Monarch maintained profitability throughout the financial crisis. It helps that Monarch’s geography never really felt the effects of the housing bubble. If Monarch’s plants were located in Florida and Arizona, the company would likely have had a much more difficult time.
Monarch Cement trades at a fraction of the valuation its larger peers receive. Some discount is warranted. After all, a small, regional producer faces risks and inefficiencies that cement giants with global footprints can avoid. But while behemoths CRH Plc and LafargeHolcim trade at >10x EBITDA, Monarch Cement trades right around 4.4x. I doubt the valuation gap will narrow organically. Monarch Cement is simply too small and its shares too illiquid to attract much attention. A much more likely outcome is an eventual buyout. I am always skeptical of a thesis that depends on a family-controlled company deciding to turn over the keys, but it does happen. Just last year another family-controlled cement producer, Ash Grove, sold out to CRH at a low teens multiple of trailing EBITDA. Ash Grove was substantially larger than Monarch, but valuing Monarch at even 9x trailing EBITDA would value shares at north of $105.
As with any company like Monarch, shareholders must be prepared to wait a long, long time for an eventual catalyst. That necessitates trustworthy, capable management that will cause the company’s value to increase at a reasonable rate until that liquidity event. I think Monarch fits the bill. Management is reasonably compensated and highly motivated to steward the company well. Balance sheet strength is a priority, but the company is not afraid to make small acquisitions to round out its product offerings or access new territory. A bigger question mark is how the company will handle its large securities portfolio, which is invested primarily in shares of other cement and building products companies. This portfolio has performed exceptionally well this year, leading me to wonder if the company will choose to realize some gains as it did in 2018. The value of the securities portfolio has risen to $12 per share before tax, or 20% of market capitalization. Despite the uncertainty, I don’t view the outlook for the securities portfolio as a major concern when the company’s operations are being valued at a 60% discount to competitors and are extremely cheap on an absolute basis.
Alluvial Capital Management, LLC holds shares of Monarch Cement for clients. Alluvial Capital Management, LLC may hold any securities mentioned on this blog and may buy or sell these securities at any time. For a full accounting of Alluvial’s and Alluvial personnel’s holdings in any securities mentioned, contact Alluvial Capital Management, LLC at firstname.lastname@example.org.