SKAGEN Focus: finding treasure in the cement sector
The equity fund SKAGEN Focus has unearthed some undervalued cement companies.
Just 18 months ago not many people were interested in the Japanese cement company Taiheiyo Cement. Those analysts and investors still monitoring the company could hardly be called enthusiastic – following a wave of consolidation and capacity adjustments, the company had been dragged down by the low growth affecting the oligopoly made up of three players.
Nonetheless, the high conviction global equity fund SKAGEN Focus saw potential in the company. The portfolio managers' interest was aroused not least by the excessively negative sentiment around the company and lacklustre analyst coverage.
SKAGEN Focus does not add new names to the portfolio lightly. To gain a place among the holdings, a company must be highly undervalued and there must be catalysts that can trigger an increase of at least 50 percent in the share price. Of the world's more than 50,000 listed companies, only 35 handpicked investments can make their way into the portfolio.
Triggers to unlock value
The portfolio managers' investment hypothesis for Taiheiyo Cement included a normalisation of demand for building materials, supported by the upcoming Olympics in Tokyo in 2020 and opportunities to improve profitability.
Moreover, few people had noticed Taiheiyo Cement's operations on the west coast of the US via their new acquisitions. These provided attractive exposure which could contribute to the company's earnings; regardless of whether Clinton or Trump won the presidential election at the time, large investments were set to be made in infrastructure in the years to come.
Similar situation in South Korea
When SKAGEN Focus started buying Taiheiyo Cement stocks in August 2016, the share price was at 2800 yen. Since that time, the market has started paying attention to the company and has priced in improved demand and rising cement prices. By November 2017, the share price had risen to over 4700 yen, quickly approaching the target price set by the portfolio managers.* The team then began to slowly scale down the position.
Meanwhile, this autumn a similar interesting situation arose on the other side of the Sea of Japan. Something was due to happen in South Korea, where the cement industry had gone through a tough period with a lot of downward pressure on pricing and where the market is extremely fragmented.
"We see clear parallels between the Japanese cement market ten years ago and the current situation in South Korea," says David Harris, portfolio manager of SKAGEN Focus.
"There was overcapacity in the cement market which led to restructuring and fewer producers. Since then, the remaining players have been able to return to a more reasonable price level," he adds.
Tough period for South Korean cement
In October SKAGEN Focus bought into two South Korean producers which had long been on the portfolio managers' radar: Hanil Cement and Asia Cement. The share price of both companies was depressed and the shares were trading at a very large discount relative to the global cement sector.
In early 2017, Hanil Cement became the largest cement company in South Korea through the acquisition of its competitor, Hyundai Cement. Later in the year, there was the opportunity for further consolidation when Halla Cement came up for sale. Given the increased likelihood of further consolidation, SKAGEN Focus built up two positions, one in the market leader Hanil, and one in Asia Cement. Asia Cement was one of the smaller players in the market, but the one with the strongest balance sheet, which the portfolio managers deemed could play a decisive role.
Shortly after entering into the holdings, Asia Cement was named the preferred buyer of Halla Cement.
The news caused the share price of Asia Cement to skyrocket and since SKAGEN Focus bought the holding in October the share price has gained almost 50 percent.
The team has started to trim the position, in line with their philosophy of not owning companies whose share price reflects their intrinsic value.
Consolidation benefits all
The deal has recently gone through, giving Halla and Asia Cement a combined market position of around 20 percent, making the company the third largest player in the market after Hanil Cement. This type of consolidation benefits everyone. It has also been positive for our holding in Hanil Cement whose share price has gained more than 25 percent since we entered the position in October, according to David Harris.
At the end of November, Hanil Cement accounted for 2.2 percent of the SKAGEN Focus portfolio and the smaller player Asia Cement accounted for around one percent.
* The price is adjusted for the 1:10 split which was done in September 2017.