What is the fair value of Holcim Ltd, a Swiss based building materials company? This is the central question of the following paper. Before the valuation will be performed, one has to understand the strategic and the financial background of Holcim Ltd to estimate input factors for the subsequently used Discounted Free Cash Flow (DCF) model. The strategic analysis reveals that the company is one of the big players within the Building Materials Industry and clearly follows a strategy of growth. In terms of the products, Holcim Ltd focuses its sales efforts on cement and aggregate products due to the high operating margins and the prevailing barriers of entry for competitors. The company largely increased their market presence in the Indian and Chinese market.
Whereas the share of sales from the Asian Pacific market was at 9.4% in 2001, it grew to roughly 36% in 2010. However, the investments have mainly been financed by cheap debt capital which resulted in high debt to market ratios up to 54%. The associated leverage problematic has been experienced by Holcim Ltd in the wake of the financial crisis, showing interest coverage ratios which were reduced by more than half between 2007 and 2010. Holcim Ltd suffered from the hard hit of the financial crisis since construction activities were almost suspended. Sales and NOPLAT figures declined sharply due to which Holcim Ltd was urged to introduce a rigorous austerity program.
This policy helped to maintain the necessary competitiveness in the industry and is seen as advantageous by the management for the expected economic upswing of the coming years. On the basis of the strategic and financial analysis the Discounted Cash Flow valuation is conducted revealing a fair value of CHF 73.49 per share of Holcim Ltd. This shows that the traded share price of CHF 68.20 at the Swiss Market Index is slightly undervalued. Furthermore, the sensitivity analysis of the DCF value manifests that the model is highly sentient towards changes in input factors such as revenue growth rates, adjusted EBITA margins, ROIC rates and most of all towards changes in WACC. This fact illustrates the importance of a precise and conservative determination of these input factors for the DCF model in order not to overestimate the fair value of a company. The final Real Option Valuation (ROV) at the end of the paper makes clear that incorporating flexibility in the valuation of an investment project may have positive effects. Whereas the DCF approach shows a negative net present value (NPV) of -43.5 million, the ROV approach turns out to be positive showing a value of CHF 60.3 million when incorporating an option to expand in the Indian market. Table of Contents
List of Figures
List of Tables
Holcim Ltd is a Swiss based company, which is active in the Building Materials Industry and employs roughly 80’000 people. The company is one of the world’s leading suppliers of cement and aggregates. This line of industry is highly exposed to economic fluctuations. Thus, Holcim Ltd will form the base to perform a case study as Master Thesis with regards to a corporate valuation process. 1.1 History of Holcim Ltd
In 1912, today’s Holcim Ltd was founded as “Aargauische Portlandcementfabrik Holderbank-Wildegg” in Switzerland. Very quickly it became obvious that domestic markets could only offer limited opportunities for expansion. Thus, already in the early 1920s, Holcim started investing in other European countries, as well as in Egypt, Lebanon and South Africa. Due to the fact that cement products are heavy and moisture-sensitive, and thus require special and expensive logistical handling, such expansions are seen as favorable. From 1945 to 1970, North and Latin America had been captured as new markets followed by ventures in the emerging markets of the Asia-Pacific region.
Throughout the 1980s, Holcim continued its expansion route to sustain its growth plans across the world by intensifying business activities in Eastern Europe. Finally, in May 2001, the group was renamed to today’s known Holcim Ltd and consistently continued along the expansion path they had taken until then. Hence, Holcim Ltd entered into a strategic alliance with Gujarat Ambuja Cements to participate in the Indian market. Additionally, the company acquired Aggregate Industries in the UK to enter this market as well. Due to the fact that the Chinese economy is booming and is responsible for great cement consumptions, Holcim Ltd became the single biggest shareholder of Huaxin Cement Co. Ltd. The most recent market entry was undertaken in Australia through the acquisition of Cemex Australia. The basic purpose of this strategic move was to expand its aggregates and ready-mix concrete business in this market. 1.2 Problem statement
The central question of this paper is to determine the fair value of the Swiss based building materials company Holcim Ltd. Before the valuation will be performed, it is crucial to understand the strategic and the financial background of Holcim Ltd. Not until then, the company will be evaluated on the basis of the Discounted Cash Flow approach in order to assess the fair price of the firm. Furthermore, a Real Option Valuation (ROV) will be conducted. This approach counteracts the traditional valuation methods which lack to incorporate managerial flexibility in the decision making process of an investment project. Due to the fact that Holcim Ltd has made considerable R&D efforts, the uncertainty of these future outputs have to be taken into account as well. The effects of the managerial flexibility for Holcim Ltd will be analyzed by using an option to expand in the Indian cement market. 1.3 Methodology
At the beginning of the thesis, a strategic analysis will be conducted which is divided in an external, internal and a final SWOT analysis. The external analysis shall give insights into the market environment in which Holcim Ltd is active. After a short description of the Building Materials Industry, a PESTEL analysis will be performed. Thereafter, Porter’s five forces model is used to gain a deeper understanding of the industry and the competitive environment. The external analysis is completed by a competitor analysis of the main two competitors of Holcim Ltd. Being aware of the macroeconomic factors influencing Holcim Ltd, the next step of the thesis is to study the internal environment of the company itself. Particular attention has to be paid with regards to the products of the company and its global presence. Furthermore, the value chain concept of Michael Porter illustrates the physical and technological activities that a company performs in order to generate value for their shareholders. Furthermore, internal success factors of Holcim Ltd will be defined using the 7-S framework established by McKinsey. In the last part of the strategic analysis, a SWOT analysis will be performed summarizing the strengths and weaknesses coupled with the opportunities and threats of the Swiss based company.
The next part of the thesis will be an in-depth investigation of the financial health by analyzing the historical performance from 2001 to 2010. Special attention is given to Revenue Growth, Invested Capital, NOPLAT, Free Cash Flow, ROIC, the Capital Structure and the share price development over the last ten years. The data for the historical performance analysis is obtained from the annual reports. The financial analysis will be followed by an estimation of the weighted average cost of capital. To facilitate the calculation of the associated cost of equity, the CAPM model will be used. In order to determine the beta factor and the market risk premium of the model, stock and index returns are needed. The required data is obtained from the data provider Bloomberg. Having performed the strategic and the financial analysis and being aware of the cost of capital, a DCF valuation approach will be modeled to estimate the fair value of Holcim Ltd. Due to the fact that the economic future is only predictable to a certain extent but mainly remains unsure, it is important to conduct and think through different scenarios in which macro- and micro-economic factors are altered in order to influence the valuation results.
Consequently, three different scenarios are described and valued accordingly. At the end of the DCF valuation part, the results will be checked upon their logic by conducting a sensitivity and a multiple analysis. Given the shortcomings of the NPV approach in valuing an investment project, the final part of the thesis will be to conduct a Real Option Valuation. After a theoretical outline of the differences between a NPV and a ROV approach and the possible drivers of flexibility, a possible investment situation will be analysed that Holcim Ltd might be facing in the near future. Flexibility will be introduced by an option to expand in the Indian market with an already patented product. Due to the fact that volatility has the most significant affect on the value of an option, a Monte-Carlo-Simulation will be conducted to estimate the uncertainty of the expected cash flow. The value of flexibility for the investment project will be shown using an event and decision tree. 1.4 Limitations
The following paper will assesses the consolidated financial statements of Holcim Ltd from 2001-2010 and does not contain an assessment of the different subsidiaries. The valuation is performed using publicly available data. No company internal data was available for the thesis. This also applies for the modeled example in the last part of the paper in terms of the ROV approach. The example is built on available market data in order to largely approximate a real case scenario. The idea of assessing a R&D project of Holcim Ltd was abandoned due to the fact that no data about a general process or the cost structure has been available. Even Mr. Binit Sanghvi from the Office for Investor Relation of Holcim Ltd was not allowed to make any information publicly available. Lastly, the paper does not contain an assessment of the used accounting policy of Holcim Ltd. Nevertheless, it will be mentioned where a note is relevant. 2 Strategic Analysis
2.1 External Analysis
In order to assess the future development of Holcim Ltd, it is important to take a closer look at the strategic environment where the company has its business activities. The external analysis of the market environment will be conducted by looking at the overall market size and growth potential of the Building Materials Industry1. 2.1.1 Global Building Materials Industry
The building materials market includes all manufacturers of cement,
aggregates, sand, gravel, concrete and bricks and generated total revenues of $539.3 billion in 2009. Overall, the cement and brick production are seen as the most lucrative markets. As depicted in Figure , brick sales accounted for $150.3 billion of the total market revenues, equivalent to a share of 27.9% of the Building Materials Industry. According to the analysis conducted by Datamonitor, the cement segment contributed revenues of $147.2 billion in 2009, which is equivalent to a market share of 27.3%. These two revenue favorable segments are closely followed by aggregates and sand & gravel with revenues of $139.6 billion and $93.8 billion respectively.
Figure : Market segmentation in 2009
Source: Datamonitor (see Industry Profile of Global Construction Materials, March 2010, p. 8) The Building Materials Industry showed attractive growth rates over the last five years, which is illustrated by a compound annual growth rate (CAGR) of 5.0% from 2005-2009. This growth was mainly driven by strong construction activities and continuous industrialization due to the growing population, increasing urbanization and the need for further infrastructure in regions such as China and India. Growth in the building industry is closely connected to construction activities. The financial crisis had enormous negative impacts on the activities in the Building Materials Industry, especially in developed markets. Without the necessary financial support, many construction projects are simply not feasible. The economic imbalance is reflected by the poor growth rate in the Building Materials Industry of 1.8% in 2009, shown in Table . Although the production and consumption of building materials fell sharply in 2009, the first half of 2010 already showed a surge in production again. These recent growth figures can be attributed to the strong rebound in demand for construction activities in emerging markets, the short-term effects of government stimulus packages as well as the restocking of inventories2. If we believe in the report of Global Industry Analysts Inc. (January 2011, p. 1), growth in the world market for building materials recovers to reach $706.7 billion by the year 2015 (+31%).
Table : Market value/growth rate of the Building Materials Industry from 2005-2009 Source: Datamonitor (see Industry Profile of Global Construction Materials, March 2010, p. 9) Since Holcim Ltd has its business activities mainly in the cement and aggregate segment, the following sequence will deal more precisely on these markets. According to J.P. Morgan (see Europe Equity Research, 19. May 2010, p. 8) the cement market is seen as the most attractive one due to high operating margins and high returns on invested capital. However, not all cement markets across the globe are equally attractive. Over the long run, cement consumption tends to be bigger and the supply much more attractive in emerging markets than in developed countries. This has to do with a clear link between the growth domestic product (GDP) and the cement consumption. As GDP per head increases above $3’000, cement consumption increases substantially. Once the GDP per head exceeds $25’000, a cap in terms of volume consumed per capita will be reached. From then on, the demand shifts away from construction and expansion to repair and maintenance, where much smaller volumes of cement are needed. Besides, the largest 20 cement-consuming nations consumed 76% of all cement consumed globally in 2008. By far the largest consumer was China, consuming 45%, followed by India, USA and Russia with 5.9%, 3.1% and 2.0%, respectively3. Between 1985 and 2008, the global cement consumption enhanced by 6.6% every year, mainly as a result of the emergent markets in Asia.
Whereas Asia consumed 35% of the total cement production in 1985, this figure had almost doubled to 67.5% in 2008. In contrast, Western Europe and North America showed significant declines in terms of cement consumption from 23.5% to 7.9% and from 12.1% to 3.8% in the same period. Figure shows the cement consumption CAGR by region from 1985-2008 and emphasizes the attractiveness of emergent markets, such as Asia, Africa, Eastern Europe, Middle East and Latin America, depicting growth rates of more than 3.5%. In the wake of the financial crisis, the consumption of cement has been reduced. Due to the ongoing production of cement, the excess supply resulted in lower prices and consequently reduced sales revenue for companies.
Figure : Cement consumption – CAGR by region from 1985-2008
Source: J.P. Morgan (see Europe Equity Research, 19. May 2010, p. 40) In contrast to the cement market, the aggregate market focuses on more mature markets since the demand for aggregates increases in-line with a market’s development and maturity. According to Heidelberg Cement, infrastructure projects use more than 10 times as much of aggregates that residential projects require which emphasizes the intention of the big players to participate and invest in more mature markets in terms of aggregates. Additionally, it is also less risky to be active in mature markets since regulations, environmental and labor standards are much more regulated. By now, aggregates are mainly attractive where it is a scarce resource. This is the case for the US, the UK and Australia since regional laws often restrict new quarry development. It is therefore not surprising that Asia-Pacific, North America and Western Europe accounted for 82% of the total world aggregates demand in 20074. Also, the costs of transporting aggregates double the required sales price if it is trucked 20 miles rather than used next to the quarry5. Hence, proximity to the market has a favorable effect on prices and thus often provides a competitive advantage. Nevertheless, over the long run emerging markets are seen as the most attractive markets in terms of aggregates supply since those markets are on the path from emerging to more developed markets due to what the numbers of infrastructure projects will be growing. Consequently, it is favorable for companies to seek and secure long term and attractively priced quarries in emerging markets. 2.1.2 PESTEL Analysis
Nowadays, many factors in the macro-environment have an effect on the overall managerial behavior. The PESTEL analysis is a framework helping to identify macroeconomic factors that may affect the whole industry, a certain market or the company. It is a useful tool to understand factors that may have an influence on the industry growth or decline, attractiveness and the direction of a company6. The acronym PESTEL stands for six different categories – political, economic, socio-cultural, technological, environmental and legal future. The findings of Table will be explained in more detail in the following sequence. External Factor
Effect on industry
Governmental stimulus programs
Low interest rates
Growing fear of inflation in emerging markets
Strong Swiss France
Recovering GDP rates
Improvement of global poverty level
Low social governmental spending
Improvements in terms of waste recycle/reduction techniques
Enhancement of durability performance
High carbon dioxide emission
Greater demand of cement than emissions are falling
Emerging market growth
Internationalization of Business
Growing awareness of greenhouse gases
Innumerable/different laws in emerging countries
Table : PESTEL analysis of Holcim Ltd at a glance
Source: Own design
Political future refers to governmental policies, actions and positions and to the degree of intervention in the economy. Such governmental interventions may have significant effects on the cost structure, revenues and the market behavior of companies within an industry. The political influence had proven to be positive with regards to the governmental stimulus programs in the wake of the financial crisis and provided a needed boost for the tumbling building materials sector. According to J.P. Morgan (see Europe Equity Research, 19. May 2010, p. 36) these packages were certainly of a large enough scale in many countries to have a significant impact on the economy. Whereas in developed markets infrastructure projects accounted for approximately 15% of the stimulus packages, developing markets infrastructure projects accounted for roughly 50%. The detailed information on global stimulus packages can be examined in Appendix 1. There is an ongoing trend towards further globalization in the industry, though, political factors are and will continue to affect the industry. Especially in emerging markets, where a lot of construction activities are at work and where the overall prosperity is increasing, building and infrastructure projects are increasing. However, it has to be stated that BRIC-states (Brazil, Russia, India and China) are not following the western liberal model for self-development but instead are using the so-called state capitalism, where a system of economic management gives a prominent role to the state7. This shows that governments in such countries have higher and sometimes unpredictable influences putting a certain pressure on the Building Materials Industry and especially on foreign companies. Such unpredictable political situations have to be taken into account especially
in terms of expansions. Economic Future
Economic development is influenced by factors such as interest rates, economic growth measured by real GDP, inflation and exchange rates. Changes of such parameters can have major impacts on a firm’s strategy. It is to be noted that the overall health of the global economy and the level of demand for building materials are directly connected. Nevertheless, developed regions like North America and Europe bear the brunt of the slowdown while developing countries, given their relatively higher national savings at both the government and household levels, witnessed a relatively cushioned impact8. The monetary policy in most mature economies is expected to remain supportive by continuing their current, low interest rate strategy. However, while most countries now approach growth potential again, these governmental supporting activities have to be reviewed on a constant basis. This can be explained by the fact that strong investor appetite might cause upside risks to emerging market. However, when talking about the price level, the International Monetary Fund forecasts stable inflation rates in most countries but companies should remain alert toward emerging markets. While inflation rates in developed markets are below consensus, they are above in most emerging markets9. Furthermore, there is much discussion about exchange rates. Since the start of the financial crisis, the Swiss Franc appreciated substantially against the Euro and Dollar. Despite the best efforts in research of economists, there is no evidence that exchange rate volatility does have significant impacts on international trade volumes10, which is clearly in favor of the highly diversified business activities of Holcim Ltd. However, the strong Swiss Franc poses translation exposures which arise when financial statements of foreign subsidiaries must be restated in the parent’s reporting to prepare consolidated financial statements11. Finally and referring to Goldman Sachs analysts view (see Commodities and Strategy Research, December 2010, p. 1) the outlook in terms of the global GDP looks relatively optimistic. According to their statements, the combination of recurrent growth signs, especially in emerging markets, along with moderate inflation rates reflects significant spare capacity at a global level. Having had a negative GDP of -0.6% in 2009, which in turn was followed by an increase of 4.9% in 2010, Goldman Sachs expects real global GDP to rise by
4.6% in 2011 and by 4.8% in 2012 and implies a positive economic future with regards to the Building Materials Industry. The most attractive growth potentials are to be found in the BRIC states with GDP growth forecasts between 4.3% and 9.5% in 2012. Socio-Cultural Future
Changes in social trends may have an impact on the demand of a company’s product. The social future is thus determined by health, safety and the overall quality of life. If one looks at the global poverty level published by the United Nations (see Report on the World Social Situation 2010) clear signs of improvements can be discovered. Whereas in 1981 1.9 billion people were living with less than $1.25 a day, this figure was reduced to 1.4 billion people in 2005. Additionally, the proportion of people living in extreme poverty was down by half to 26% in 2005. Obviously, such great enhancements of poverty levels in countries are largely connected to growth levels and market attractiveness. Countries or regions that have experienced strong growth during the last two decades have managed to reduce poverty levels, particularly in urban areas. Thus, it is not surprising that countries such as India, China and East Asia have contributed to this success story in a positive way. Yet, there are also countries in the world that could not manage to reduce the poverty level such as Sub-Saharan Africa, Latin America, the Middle East, Northern Africa as well as Central Asia12, having their roots in the primary sector. Nevertheless, due to the ongoing growth and economic upswing in many poor regions, more and more people are moving into urban areas. Whereas 42.5% of the world population had been living in urban regions in 1989, approximately 50% are living near cities in 2009. Looking at China as the most populous country, this trend is expected to continue: The urban population will be growing to 850 million in 2015 (430 million in 2001) and the number of cities with over 100’000 people will reach the level of over 1’000 by the year 2015 (630 in 2001)13. Despite the good future prospects especially in emerging markets for the Building Materials Industry, it has also to be stated that the report on the world social situation in 2010 shows that in several developing countries the level of social spendings remained below levels attained in the 1970s. This is characterized by deteriorated infrastructures in areas such as health and education. Since improvements in health are positively connected
to the economic development, public health services should be a key aspect of governments. Since no governmental efforts have been undertaken in this respect, there are no construction projects to be undertaken and thus impose a negative impact for the Building Materials Industry. Technological Future
Technological factors include innovation from research and development, advances in automation, and the rate of technological advances. New technologies can reduce costs or lead to further innovation due to improved quality aspects or new products. By looking at the Building Materials Industry one can see that the majority of materials such as cement and bricks cannot be differentiated effectively. However, the production costs remain high for a majority of construction materials, especially for cement, due to the high energy requirement to produce the high-volume product. Thus, the Building Materials Industry is subject to pressure from environmental organizations to improve processes in order to reduce the dioxide emissions in the production process. Consequently, the industry made great efforts to test and use new material combinations as substitutes for conventional raw materials. Since the Construction Materials Industry is highly cost competitive, manufacturers are engaged in developing multi-functional materials and seek for efficient waste recycle and reduction techniques14. The latter is extremely important for companies within the Building Materials Industry, where several million tons of alternate fuels and raw materials are needed. In terms of product innovation, companies gear to enhance the durability performance of the products which reduces the maintenance and repair costs of construction works. Industry leaders thus state that even slight alterations in the production process will entail large-scale measures to reduce the environmental footprint and costs. Nevertheless, further research approaches need to be undertaken in order to optimize the commercial viability of new substitutes, in order not to lose reputation or even market shares in this volume and cost competitive industry15. Environmental Future
Environmental factors include issues such as the level of pollution created by the product and recycling considerations as well as possible environmental legislative changes. Especially cement producers like to point
out that their product is the most widely used material after water; unfortunately, it is also one of the most polluting ones. As well as for the heating-process and the chemical reaction of the production process, large amounts of carbon dioxide exhaust gases are produced which in turn negatively contributes to the global warming. The industry players themselves admit that the cement-production accounts for approximately 5% of the world’s emissions of greenhouse gases. This is twice the amount attributed to aviation. Consequently, the biggest players within the industry have all pledged to cut the emissions for each ton of cement they produce. Holcim Ltd could already reduce the emissions per ton by 16% in 2006 compared to 199016. Even though environmental standards and energy-efficient ratings have an influence on the choice of the products, the emission reductions have their limits. Firstly, cement-producers have been continually improving the carbon dioxide blow out for over a century not leaving large scope for further reductions and secondly, firms do not see ways to alter the basic chemistry of cement. The difficulty of the environmental issue is compounded by the fact that the demand for cement is growing faster than the emissions per ton are falling. This obviously leads to an overall increase in emissions. Bearing in mind that the building industry is to a large extent present in emerging markets such as India and China, the environmental aspect will become a serious issue in the future. By now, China is the third largest consumer of coal and oil in the world. Due to the fact that much of the production and the equipment for the production of building materials is both inefficient and highly polluting, China is unfortunately the second largest causer of greenhouse gas emissions17. Legal Future
Legal factors are related to the legal environment in which a company operates. It can be argued that there are huge difficulties when companies of the Building Materials Industry are moving outside their own national playground since every country has its own planning laws, building materials laws, and building regulations and poses a real challenge for multinational companies. Thus, many cross-border building projects are carried out as joint ventures until the company has acquired the necessary knowledge and experience in the new jurisdictions of the corresponding market/region18.
Furthermore, legal factors are gaining on importance due to the fact of the growing awareness and sensitivity towards greenhouse gases. Especially in developed economies, for example the European Union, governments restrict emissions from cement factories and further jurisdictions are likely to follow suit19. More than that in countries such as Australia, US and the UK, laws often restrict new quarry development which clearly complicates the market entry/enlargement. As for emerging countries and especially for China, such restrictions respectively requirements in terms of environmental matters are not the greatest worry for building materials companies. However, companies may face several legal obstacles as a result of innumerable laws, which are constantly newly enacted, and because many contractual obligations are not followed as agreed upon. The effects of such risks, which arise in the normal course of business, are not foreseeable but have to be taken into account somehow in the valuation of a project. 2.1.3 Porter’s Five Forces
An industry is seen as a group of firms producing products that are close substitutes. In the course of competition, these firms influence one another20. The Five Forces of Competition, introduced by Michael Porter in 1980, is used to analyze the competitive structure of an industry. According to Porter, the state of competition depends upon five competitive forces. Those are competitors, suppliers, buyers, substitutes and new entrants. Together, they determine the long-run profit potential of an industry and shall be used to define the position of Holcim Ltd21. The particular points of Table will be explained in more detail in the following sequence. Competitive Force
High sunk costs
Special logistical handling required
High volume production industry
R;D/knowledge intense industry
Low product diversification
Necessary proximity to markets
Bargaining power of suppliers
Energy intense industry
Special machinery needed
Special logistical handling required
Bargaining power of buyers
A lot of small buyers
Low switching costs
Cement/aggregates basic material for Building Materials Industry Legal regulations
Substitutes to costly/no expertise
Table : The Five Forces of Competition of Holcim Ltd at a glance Source: Own design
Threat of New Entrants
When examining the Building Materials Industry more closely, one can elaborate that it is an energy and capital intensive industry, especially when setting up or acquiring new production plants. These high sunk costs cannot be recovered if the firm would close down or exit the market and thus act as a barrier to entry for competitors. Besides, since cement-products are heavy and moisture-sensitive, it requires a special and extremely expensive logistical handling. Consequently, market leaders’ organizational structure is decentralized and subsidies are maintained all over the world in order to reduce transportation costs and to encounter the necessary proximity to the market. Needless to say that a company needs to have a sound capital base in order to gain access to quarries and to pursue an expansion strategy. Furthermore, Holcim Ltd as one of the big industry players is able to make use of economies of scale as entry barriers, where
the cost of manufacturing each unit declines when the quantity during a given period increases22. Especially in terms of costs, it is uneconomical to produce cement products in low volumes. According to the magazine “International Cement Review” (November 2008), it is estimated that a 5 million tons cement plant can produce cement at a much lower cost (around $25/tonne) than a smaller one ($43/tonne). Since the Building Materials Industry has a cyclical nature, the recent economic downturn along with the reduction in growth rates might discourage new entrants as well. Lastly, the Building Materials Industry is under a constant pressure to reduce carbon dioxide emissions due to what cost and knowledge intense R;D efforts are vital. Rivalry among Competing Firms
Companies within the Building Materials Industry are exposed to cyclical, seasonal and sometimes unpredictable economic conditions as experienced over the last four years. In addition, the products and strategic orientation of market players are similar to each other, since they have little opportunities for significant diversifications. Consequently, competitors must compete for market revenues based on prices23. This also explains partially the ongoing R;D activities within the industry in search of high quality and eco-efficient products due to which production costs might be reduced. The economic slowdown over the last four years has contributed negatively to this price war situation as well and even intensified the rivalry in the market. Besides, when a company enters a market by acquisitions of quarries respectively manufacturing facilities, sunk costs are high. Since the production of cement is done in large volumes, companies may be confronted with an overproduction problematic. As a result, prices in the markets would be falling and rivalry increases even more. As has been mentioned before, the global cement consumption in Asia accounted for 67.5% in 2008 and the twenty largest cement consuming nations consumed the 76% of cement. This has also a great impact on the rivalry between competing firms since proximity to the market is central. As a result, prices for quarries and factory locations in the top 20 locations get increasingly competitive. According to J.P. Morgan (see Europe Equity Research, 19. May 2010, p. 38), this concentration is even expected to continue and will have further impacts on pricing trends. Bargaining Power of Suppliers
The vertical downstream implementation of quarries and plants in foreign countries is vital in order to reduce supplier power, since stone materials are key in order to produce Holcim Ltd’s products. Furthermore, the production and the supply of building materials such as cement and aggregate is energy intensive. Consequently, key suppliers to that industry are companies providing fuels such as oil, gas and coal. As for the building materials market, this fuel markets are mostly dominated by a small number of large scale and highly vertically integrated companies24 with the necessary financial and negotiation strength, which clearly increases the supplier power. Furthermore, suppliers of quarrying machineries are important to the industry as well. Since the market for such machineries is highly specialized, the number of suppliers is rather low. Consequently, their supplier power can be seen as enhanced due to their unique selling position. Lastly, the products provided by Holcim Ltd are heavy and often moisture-sensitive and require special treatment in terms of transportation. Special treatment usually enhances the supplier power, which can also be applied for the transport industry. Holcim Ltd is aware of these facts and precautions were taken in order to reduce the dependency of suppliers. Generally, the vital raw materials are sourced from their own quarries. As an economy becomes more mature, vertical integration assumes greater importance for Holcim Ltd. Because of the high degree of regulation, securing guaranteed reserves of raw materials is of major strategic importance (see annual report 2010, p. 22). Besides, energy costs also depressed the cement margin of Holcim Ltd in 2010. Therefore, the company strives for renewable energy sources and innovative and economically viable techniques as long-term solutions in order to efficiently use available energy resources. On the one hand, such innovations reduce the “environmental footprint” of the processes and products and on the other hand lead to an increased productivity and lower costs in the manufacturing process (see annual report 2010, p. 31). Lastly, Holcim Ltd founded a Holcim-Trading section. Among others, one purpose is to be as much independent as possible towards transportation of goods. Therefore, this section manages a fleet of cement ships and floating terminals and is able to provide even customized services to their business partners25. Bargaining
Power of Buyers
Mainly, products are sold to traders, wholesalers or directly to general contractors, mason self-builder and civil engineering contractors, showing that buyers of building materials are highly fragmented. Thus, companies such as Holcim Ltd can sell their products to a large number of relatively small buyers, which leads to a low buyer power26. Buyer power is further reduced due to the fact that building materials such as cement, ready-mix concrete and aggregates are key basic materials for the construction industry. However, the analysis of Datamonitor shows (see Industry Profile of Global Construction Materials, March 2010, p. 13) that “the product quality and price are the major indicators for the prospective buyer who is prone to switch to new solutions as long as price and quality of the product are competitive”. This indicates that the overall brand loyalty within the Building Materials Industry can be seen as rather low. However, since there are many small buyers, this impact will be leveled out. Threat of Substitute Products
Cement and aggregates are seen as the basic materials for the construction industry where emergent markets offer attractive and high growth prospects. Nevertheless, as markets mature customer needs will broaden and some products of Holcim Ltd may be substituted with other materials such as plastics, glass, steel, wood and others. However, it is in the interest of companies such as Holcim Ltd that certain construction projects have to follow clear building regulations and often require specified materials such as cement or aggregates. Hence, theoretical substitutes may be too costly, time-consuming or difficult to use in practice27. 2.1.4 Competitor Analysis
Following the Five Forces Model of Porter, a competitor analysis of the leading competitors within the industry is conducted. CRH plc and Lafarge S.A. are the largest competitors for Holcim Ltd in terms of revenue and thus will be analyzed regarding their objectives, their available resources, their performance in the past and their current products and services28. Objectives
In terms of the strategic direction, Lafarge S.A. and Holcim Ltd have great similarities. Both companies are seeking growth opportunities in emerging markets such as India and China and are accelerating innovation in order to meet the need for more sustainable construction methods and to increase competitive advantages through R;D activities. Lafarge S.A. is a French company with its headquarters in Paris and was founded in 1833. The group is present in 78 countries all over the world (in contrast to Holcim Ltd not in Australia) and orients the development of its businesses towards fast-growing markets. Starting in the 1990s, Lafarge S.A. established solid positions in emerging markets through a combination of acquisitions and organic growth. By now, more than 60% of Lafarge’s workforce is employed in Asia, Africa, Central and Eastern Europe, the Mediterranean Basin, the Middle East and Latin America. The company invests heavily in these markets29. In order to meet the quality requirements placed on products, Lafarge S.A. also stresses the importance of people development and the endeavor to reduce costs in order to remain competitive among the big players within the industry. CRH plc is an Irish Company with its headquarters in Dublin and is formed through the merger of Cement Ltd and Roadstone Ltd in 1970. As opposed to Holcim Ltd and Lafarge S.A., CRH plc focuses its business on the European and the American market and is present in 35 countries. It is CRH’s strategic intention to be an international leader in building materials delivering by sticking to the core business in the industry (cement & aggregates) and by investing at “home”. The company therefore follows the principle of being the low cost market leader in their markets. 85% of CRH plc’s revenue is derived from developed nations in Europe and North America. Even though the focus lies on developed markets, CRH plc started to develop overseas by an acquisition of 26% shares of a Northeastern Chinese plant and a 50% stake of an Indian company in order to create platforms for future growth. In 2009, 15% of the company’s revenues are derived from such markets30. Products
As for the strategic direction, Lafarge S.A. and Holcim Ltd have a similar portfolio structure with a clear focus on cement and aggregates. For both companies, there is a clear focus on cement and aggregates contributing roughly 70% to the net sales revenue. In contrast to the Swiss based
company, the French competitor also provides gypsum as a product. Holcim Ltd and Lafarge S.A. also differ considerably when looking at the markets sales.
Figure : Sales by regions of Holcim Ltd and Lafarge S.A.
Source: Own design
Whereas both companies show equal sales efforts compared to its total sales in Europe and North America, Lafarage has a stronger focus on the African & Middle East market with approximately 25.5% sales revenue as compared to 5.5% of Holcim Ltd. However, Holcim Ltd shows a stronger focal point on Latin America and Asian markets, with a 10% higher sales-focus for both countries. When analyzing the products of CRH plc it is noticeable that it is a much more diversified portfolio as opposed to the other two companies. As well as cement, aggregates and concrete products, CRH plc also provides asphalt, lime, clay, building products, construction accessories and produces glass and fencing products. The most striking difference, though, is that the Irish based company runs professional builders merchants and so-called Do-It-Yourself stores. Totally, the company operates roughly 900 stores in Europe and America. However, a meaningful comparison in terms of the main products with the other two competitors is not portrayable, due to the fact that there are no sales revenue by products disclosed by CRH plc in the annual report. The report merely shows that 51% of the revenues are generated in Europe (incorporating revenues generated in India and China). 24% of these revenues are obtained from the section Europe Materials (cement, aggregates, ready mixed products, asphalt and lime), Europe Products (concrete, clay and building products) contributes 16% to the group revenues, and finally 11% are obtained from Europe distribution (builders merchants and Do-It-Yourself). The remaining 49% revenue stake is generated in America. America Materials (Aggregates, asphalt, ready mixed concrete) accounts for 37% of the revenues, America’s Products for 10% (architectural products, glass, precast) and American Distribution (national and regional markets) contributes 2% to the overall sales revenue of the company. Overall, the product analyses shows the clear global focus towards the key basic materials such as cement and aggregates in terms of Holcim Ltd and Lafarge S.A., whereas CRH plc focuses on several and clearly different footholds with a strategic focus on the European and American market.
The scale and size of the company’s resources is an important indicator of its competitive advantage. Generally, it can be stated that the Building Materials Industry is a human capital intense industry and ongoing employee-training is vital in order to achieve the necessary quality standards. As for the three companies, large numbers of employees can be recognized even though all show a cutback in the wake of the economic turnaround since 2007. At that time, Holcim Ltd showed the slightest reduction in workforce by only 9.5% compared to CRH plc by 14.7% and Lafarge by even 18.1%. All three companies employ around 80’000 personnel in 2009.
Table : Head counts of CRH plc, Lafarge S.A. and Holcim Ltd
Source: Own design
Proximity to the markets is a clear advantage in the Building Materials Industry since transportation costs can be reduced and an immediate implementation of customer needs is possible. Furthermore, and as a result of vertical downstream implementation of quarries and plants in foreign countries, supplier power can be reduced. Therefore, the number of sites shows the activity and presence of a company within a certain market. Yet, the expressiveness of the number of sites is limited since all three companies are following their own strategy with a different global approach on the one hand and different products focus on the other. Especially for aggregates concrete products, more plants are required. Bearing that in mind, the numbers have to be interpreted with caution. Nevertheless, it gives an idea of the overall company presence within the Building Materials Industry. As such, CRH plc shows by far the biggest presence within the market with roughly 3’700 plants and stores. Holcim Ltd follows the Irish company with approximately 2’200 factories, 2’050 of which are used to produce aggregates and concrete products. Lastly, Lafarge S.A. shows the least presence within the industry maintaining 1’960 plants, 1’720 of which are used to produce aggregates and concrete products. In terms of resources, the capital base, the equity portion as well as the equity ratio are important figures emphasizing the size and independence of a company. Generally, it is assumed that a high equity ratio is in favor of the
financial stability31. Hence, the higher the yield risk of a company, the higher the equity portion should be.
Table : Comparison of the capital base of CRH plc, Lafarge S.A. and Holcim Ltd Source: Annual reports of companies in 2010
As depicted in Table , Lafarge S.A. can be seen as the largest company with the most resources at its disposal. Besides, if we look at the past five years, the company even increased its assets base by roughly 43%, a clear indicator of its growth strategy. Holcim Ltd and CRH plc also showed an overall increase of its total assets by 28% respectively 17% over the past five years. Looking at the shareholders total equity, all companies show figures between 42% and 49% in 2010. CRH plc can be seen as the least dependent company showing an equity ratio of 48.51%, albeit with the smallest amount of equity in absolute terms with roughly 10.5 billion Euros. Past Record of Performance
As stated by Richard Lynch (see Corporate Strategy, p. 103), past records of performance may be a poor indicator for future events. However, those figures are easily to perceive in annual reports and show the general situation of the company. Looking at the performance figures of the main competitors within the Building Materials Industry, the economic dependence of the companies’ sales is clearly expressed. All three companies showed rising sales figures for five years until 2007 but subsequently suffered decline in sales as a result of the slowdown of the construction activities. By 2010, Holcim Ltd and Lafarge S.A. were able to return to sales levels which were a little bit higher than in 2006. In contrast, CRH plc still suffers from ongoing drop in sales. Nevertheless, CRH plc can be identified as the overall predominant company in terms of sales revenue with its peak at 20’922 million EUR in 2007. Looking at the operating profit margins, Holcim Ltd and Lafarge S.A. consistently depicted two-digit figures displaying operating profit margins between 18.57% (2007) and 12.10% (2010) respectively 18.67% (2007) and 13.41% (2010). Even though CRH plc has the highest sales revenue, the company was only able to generate operating profit margins between 9.97% (2007) and 4.06%. These low operating margins might be caused by the strategic direction towards the more competitive and
developed markets Europe and America, in order to be the low cost market leader by investing at “home”32. Furthermore, the company focuses on much more products at the same time and therefore loses cost advantages due to smaller production volumes. Lastly, earning-per-share (EPS) figures show a similar result as the operating profit margins. All companies showed its highest figure in 2007. Analyzing the earnings per share figures of 2010, it is striking that their value is roughly a quarter of what it used to be in 2007 for all three companies. That clearly shows the helplessness towards such unpredictable economic conditions as faced recently. Besides, it is noticeable again that Lafarge S.A. shows the best EPS-results of € 10.37 (2007) and € 2.89 (2010) closely followed by Holcim Ltd with values of € 9.01 (2007) and € 2.67 (2010), whereas CRH plc shows significantly worse values of € 2.37 (2007) and € 0.61 (2010). Nevertheless, earning-per-share figures need to be taken with a pinch of salt. This with respect to so-called “EPS games”, in which corporations try to meet short-term EPS targets at almost any cost, for the fear of missing analysts’ expectations33. 2.2 Internal Analysis
In the following section, the internal values and principles of Holcim Ltd will be discussed in more detail. In addition, the product and customer base as well as the associated value chain are portrayed. 2.2.1 Product Portfolio
After having analyzed the external situation of the industry, one has to take a closer look at the internal environment of Holcim Ltd. For the Swiss based company, the focus clearly lies on the production and distribution of cement and aggregates since they are key basic materials for the construction industry and show high operating margins. Overall, the company has three well established product lines – Cement; Aggregates; Other construction materials and services – in order to provide all markets and customers with the necessary goods in order to remain one of the world’s leading companies in the Building Materials Industry. Cement
Cement comprises clinker, cement and other cementitious materials and consists of limestone and clay that are heated to approximately 1’450
degrees Celsius. The cement powder then acts as binding material when mixed with water, sand and gravel or crushed stone to make concrete. By adding different quantities of core elements, one is able to modify the properties of the cement and to produce a wide choice of customized solutions for special applications, for example Portland Cement, White Cement or Oilwell Cement. However, the cement production is extremely resource and energy intensive, since raw materials have to be secured and removed from quarries where significant investments in terms of plants and machineries have to be made. Thus, Holcim Ltd constantly strives to improve eco-efficiency from the manufacture of the product to lower costs and to reduce environmental pollution. Due to growing prosperity in emerging markets, cement production shows attractive growth prospects.
Aggregates include crushed stone, gravel and sand where the production process centers on quarrying and sorting the raw material. This product is mainly used in the manufacturing of ready-mix concrete, concrete products and asphalt, as well as for road building and railway track beds. Like the production of cement, the one of aggregate requires significant capital investments for a significant amount of time. However, scarcity in certain Western European and North American markets leads to attractive margins34. Other construction materials and services
This section provides products such as ready-mix concrete and concrete products, asphalt, construction and paving, trading and other products and services. In order to be able to provide the requested mixture by the customers, materials from section Cement and Aggregates are needed. Concrete is the second most consumed commodity by volume after water since it is an energy-efficient building material. One cubic meter consists of approximately 300 kilograms of cement, 150 liters of water and 2 tones of aggregates. Asphalt is a construction material used primarily for road paving. Due the fact that the market of these products tends to be fiercely price competitive, they show the lowest operation margin35. Summing up, Holcim Ltd’s declared strategy is to build up and expand cement production in emerging markets. In maturing economies, vertical integration becomes
more significant in order not to be dependent on stone material suppliers. Furthermore, Holcim Ltd aims to establish ready-mix concrete businesses in major urban centers. Lastly, as markets mature and customer needs broaden products such as aggregates, asphalt and concrete are required and need to be supplied within short delivery times. As Anthony W. Miles stated (see The Boston Consulting Group on Strategy, 1986, p. 265) the portfolio concept asserts that one of the primary responsibilities of the chief executive is to make decisive investment choices for the benefit of shareholders. To make choices there must be alternatives. Hence, when talking about the product portfolio it is important to look at it with respect to market growth, respectively to market shares, in order to analyze the balance of the product portfolio. For Holcim Ltd’s product, this will be done on the basis of the Boston Consulting Group model (BCG), in which the market growth is used as a picture of how attractive the market is and in which the relative market share describes how large the market share of Holcim Ltd is relative to its biggest competitor. Depending on these two measurements, the different products are inserted in one of four quadrants of the matrix36: Star (Cash neutral), Cash Cow (Cash generator), Problem child (Cash user), Dog (Cash neutral). The size of the bubbles indicates the amount of revenues generated.
Figure : BCG portfolio of Holcim Ltd’s product sections in 2010 Source: Own design
The cement section is categorized as “cash cow” because of its high relative market share. Holcim Ltd, as one of the market leaders in the cement industry, roughly sold 136.7 million tons cement which is 1.1 times the quantity of the second largest competitor. Furthermore, sales could be increased by 3.6%. This increase is the result of additional sales in group regions “Asia Pacific”, “North America” and “Africa-Middle-East”. Bearing in mind the high barriers of entry and the growing demand for cement in emergent markets, further growth prospects are to be exploited following the economic downturn. Thus, further mergers respectively acquisitions of strategically important quarries/manufactories will be important in the future. Looking at the aggregate section, the market growth rate of roughly 10.1% to 157.9 million tons is striking in 2010. This growth is due to
significant gains in Latin America but also due to the consolidation of Holcim Australia into the group. This quantity equals a relative market share of about 0.7 times the amount of the market leader. According to the BCG model, the aggregate section is categorized as the “problem child” (definition: it might be difficult to generate substantial cash). However, looking at the EBITDA-margin of 12% compared to the total group revenues, it can be stated that this section is clearly adding value to the company. Furthermore, the fact that more and more emerging countries develop towards maturing economies and thus invest more in infrastructure projects will further increase the demand of aggregates as mentioned in Chapter Global Building Materials Industry (Global Building Materials Industry). Besides, the high barriers of entry act as natural obstacles in what way substantial cash will also be generated in the future. Finally, the section “other construction materials and services” depicts a market growth rate of approximately 6% in 2010. Especially ready-mix concrete increased its quantities sold by 9.8% to 45.9 million cubic meters. The strongest growth rates are to be identified in maturing/developed markets such as Australia, North and Latin America, Canada, Mexico and Chile. By contrast, the volume of asphalt declined by 3.6% to 10.6 million tones. This equals a relative market share of about 0.6 times the quantity of the market leader. Consequently, the last section is rated at the edge of “problem child” and “dog”. According to the BCG-model definition, “this section requires considerable investments but with little chance to get a major profit earner and may absorb cash in order to hold the position”. In contrast to the other two sections, this section is not “protected” by high barriers of entry and consequently markets tend to be fiercely price competitive. Due to concrete’s limited setting time economies of scale do not lead to significant advantages indicating the importance of proximity to markets37. Overall, the third section is only able to generate approximately 5% of the groups operating profit and rather acts as section of strategic importance to get closer to the end-consumer as it is said by Holcim Ltd. 2.2.2 Value Chain
The value chain concept of Michael Porter illustrates the physical and technological activities that a company performs in order to generate value
for their shareholders. The value chain by Porter is divided into two types. Whereas primary activities describe the physical creation of the product, support activities provide the necessary assistance for the primary activities to take place38. Hence, a value chain analysis seeks to determine opportunities within the company’s operations, where value for customers can be enhanced and costs can be lowered in order to maximize the margin. As for Holcim Ltd, the key objective is the creation of value with great importance to sustainable development at an economic, ecological and social level. The illustration of Holcim Ltd’s value chain can be examined in Appendix 2. Looking at the primary activities (production, marketing, sales/ service) of Holcim Ltd, it is striking that the production-facilities are decentralized to the corresponding market locations. As such, the company has the necessary proximity to the market and is able to cut logistical costs. However, Holcim Ltd anticipated the economic slowdown at an early stage and responded to the financial crisis by closure of plants in the US and Europe due to the lack of profitability. In terms of marketing activities, Holcim Ltd made great efforts to acquire new company sites in emerging markets such as India and China. The aim of the acquisition was to correspond directly to the specific market needs and addresses diverging customer requirements on the ground. Each region conducts its own and specific marketing efforts which is seen as a clear advantage and value adding by the management. Lastly, an important advantage has been gained in terms of sales and service activities. By creating the “Holcim Trading” section, Holcim Ltd turned out to be a worldwide leader in the trading of cementitious products and provides exporting and importing services to third parties and to Holcim group companies. Like that the company is able to offer qualified trading services such as the design and construction of import and export terminals, the handling of construction building materials as well as consulting services in logistics and engineering and offers customized solutions according to customer needs. As aforesaid, each primary activity needs the necessary assistance by support activities in order to be able to create value. Thus, Holcim Ltd aims to attract the best staff by offering attractive and challenging jobs. Prospective managers and experts need to be educated continually and extensively to prepare for future responsibilities. Regular training at all levels is a continuous
process and ensures that employees develop their potential in the best possible way (see annual report 2010, p. 21). A further competitive advantage is seen with regards to R&D projects. Holcim Ltd strives to enhance benefits to customers through innovative and sustainable system solutions. Innovation efforts in the field of process technology are aimed at improving cost management due to greater energy efficiency, more efficient use of fuels and other resources. The focus is on renewable energy sources as long-term solutions to reduce CO2 emissions which clearly strengthen the competitiveness and creates added value for customers (see annual report 2010, p. 32). In order to be able to strengthen the position in the market, Holcim Ltd started a close collaboration with leading Swiss research institutes (Paul Scherrer and the Swiss Federal Institute of Technology). The aim of this collaboration is to perform long-term oriented research in terms of concentrated solar energy in the cement manufacturing process in order to reduce the emission and to conserve natural resources. In terms of the company’s infrastructure, a great deal of effort has been made to reduce fixed costs which resulted in an impressive reduction of CHF 1.2 billion since 2009 (annual report 2010, p. 20). Those maintenance improvements and the resulting cost reduction will have a positive impact on Holcim Ltd’s future performance. Lastly, Holcim Ltd is aware that it has to coordinate service and support functions more closely in order to maximize the shareholders value. Trends and changes in customer needs in the Building Materials Industry have to be identified at an earlier stage and advantages of scale in procurement have to be exploited more effectively (see annual report 2010, p. 21). As a result, Holcim Ltd strives to establish a knowledge sharing platform with access for all shareholders in order to be able to exchange knowledge and experiences immediately which helps to improve products and services39. 2.2.3 Internal Success Factors
To analyze the internal environment, the 7-S framework established by McKinsey in the early 1980s is applied. The framework can be regarded as the roots from which the firm’s different activities come from40. The purpose of the model is to show the interrelationship between different aspects of the corporate strategy since the effectiveness of an organization lies in the interaction of several factors. According to Lynch (see Corporate Strategy,
2006, pp. 791) the framework has no obvious starting point since all seven elements are equally important and are interconnected. A distinction has to be made with regards to hard elements such as strategy, structure and systems and soft elements such as the style, skills, staff and shared values within a company. Due to the fact that hard facts are more tangible and definite, they gain greater attention. The critical aspect of the 7-S framework is the relationship and interaction between the elements. Shared Values
Shared Values are superordinate goals and are the core values of the company that are evidenced in the corporate culture and the general work ethic41. Holcim Ltd’s vision is to provide foundations for society’s future. The superior objective for all branches is to create value under adherence of sustainable development at an economic, ecological and social level (see annual report 2010, p. 26). Following this intention, Holcim Ltd strives to secure the company’s long-term success and continuity. Holcim Ltd’s mission is to be the world’s most respected, reliable and attractive partner in the Building Materials Industry and to create value for their entire stakeholders. Since the manufacture of cement requires substantial amounts of energy, an efficient and environmental friendly handling of natural resources is “a cornerstone of the business policy”. Due to this business philosophy, Holcim Ltd is a forerunner in the use of new, environmentally sound technologies in the production process and is a leading user of alternative fuels and raw materials (see annual report 2010, p. 41). In addition, the company shows a great commitment towards the communities where the plants are located and is taking social responsibility in order to be a well-respected employer. Finally, the management of Holcim Ltd established a motto that has to be followed in all group companies to be able to keep up with the pace of growth of Holcim Ltd in recent years: “Strength.Performance.Passion.”
Strength stands for being a solid partner based on the integrity of the people, the global leadership and competence. Performance stands for delivering on their promises to each other and to their stakeholders, and for providing the best solutions for their customers. Passion stands for
embodying dedication and commitment and caring about everything Holcim Ltd does. Strategy
Strategy is the route the company has chosen to maintain and build competitive advantage over the competition42. The world population is constantly growing and is expected to reach 9 billion people in 205043, equivalent to an increase of 50%. Therefore, the Building Materials Industry is likely to profit from this development as well, since a lot of new infrastructure and real estate projects are to come. A clear strategic orientation in the long run is therefore vital for Holcim Ltd. As stated in the annual report 2010, Holcim Ltd’s paramount objective is to secure its share of future global growth and thus bases its strategy on three central pillars – Focusing on the core business; Geographic diversification; Local management but global standards. In short and explained in more detail below, Holcim Ltd follows a global differentiation strategy, whereby market shares should be gained through acquisitions respectively strategic alliances, and where the local management has to take responsibility for their actions following standardized major corporate processes. The first strategic statement – Focusing on core business – will be analyzed using the “Three Generic Strategies” model of Michael Porter. As a result, one is able to define Holcim Ltd’s’ relative position within the industry. According to Porter, the fundamental basis of above-average performance in the long run is to achieve competitive advantage. On the one hand, it might be achieved through “cost leadership”, where a company sets out to become the low-cost producer in its industry. On the other hand, competitive advantage can be achieved through a “differentiation” of the products, where a company seeks to be unique in its industry which is honored by buyers44. Furthermore, the competitive scope looks at the size and composition of the market a company is targeting.
Figure : Three Generic Strategies of Michael Porter
Source: Lynch R. (2006). Corporate Strategy (Fourth Edition) Holcim Ltd is seen as one of the world’s leading provider of building materials. Cement and aggregates are clearly high-quality products being innovation and application driven and requiring capital-intensive production processes.
With ~67% net sales arising from cement and aggregates, Holcim Ltd clearly focuses on these two core businesses in more than 70 countries worldwide. As such, this line of business addresses a broad target group where quality and innovation management are prevalent attributes with respect to the production processes as explained in chapter Value Chain (Value Chain). This expresses the intention of Holcim Ltd to follow a “differentiation” strategy with regards to cement and aggregate products. While cement and aggregates are the basis of the business, other products such as ready-mix concrete, concrete, mortar or asphalt bring Holcim Ltd closer to the end-consumer. Since this product line is much smaller and not as revenue important as the other two products, in can be inferred that it addresses much less customers and its competitive scope is narrow targeted. According to Porter, this differentiation focus strategy occurs, when the organization focuses on a specific market place and develops its competitive advantage by offering products especially developed for that45. This statement can be backed up by the one of Holcim Ltd that concrete mixtures often need to be adjusted with regard to different countries due to different climatic conditions. Even though this product line is gaining on importance as a result of the growing population, it is for now classified as a strategy of “differentiation focus”. Analyzing the second strategic statement – Geographic diversification – the product/market growth matrix originated by Ansoff will be applied. This model implies that the attempt of a company to grow depends on whether it provides new or existing products in new or existing markets. According to Ansoff, the following four growth strategies are portrayable: Market penetration: The focus lies on selling of existing products into existing markets Market development: The company seeks to sell its existing products into new markets Product development: The company aims to introduce new products into existing markets Diversification: The company provides new products in new markets
Holcim Ltd is one of the most globally active companies within the Building Materials Industry. The broad-based presence makes a major contribution toward stabilizing earnings by evening out cyclical fluctuations in individual markets. Quoting the annual report 2010 of Holcim Ltd, the following statements can be drawn in terms of the market strategy: Emerging
markets: Focus on building up and expanding cement production. Maturing economies: Vertical integration becomes more significant. Besides, Holcim follows the aim of establishing ready-mix concrete businesses in major urban centers. Developed markets: The range of products is even more diversified in those markets and includes aggregates, asphalt and concrete products. Because of the high degree of regulation in industrialized nations, it is strategically important to have high-grade, secure raw material reserves. According to these statements, Holcim Ltd clearly follows a strategy of growth by introducing existing products in either existing or new markets. Since developed markets show high competition and diversification towards existing products, a market penetration strategy has to be followed. In order to be able to profit from local know-how and experience in mature markets, Holcim Ltd acquires competitors such as Aggregate Industries in the UK or Cemex Australia. Furthermore, the Swiss based company also strongly intends to enter new but very attractive emergent markets by entering strategic alliances with for example Gujarat Ambuja Cements in India or Huaxin Cement Co. Ltd in China. Such alliances can be interpreted as a market development strategy. Lastly, Holcim Ltd aims to “gain competitive advantages through differentiated product offerings” by launching products such as Holcim Optimo or CEMROC. The company adopts a strategy to invest in R&D of new products/processes. Such a product development is a clear sign towards performance improvement and CO2 emission reduction.
Figure : Product/Market matrix of Ansoff
Source: Wit, B., Meyer, R. (2004). Strategy (third edition) – process, content, context The third strategic statement mentioned in the annual report is “Local management but global standards”. Each branch shows local roots and must be geared to the conditions and needs of the specific market. Business activities differ from country to country and thus require strong local presence and awareness of the customs and its behavior. In order to fully exploit the overall market potential, the company is standardizing all its major corporate processes which allow the local management to concentrate on market development, cost efficiencies, training for staff, and nurturing community relations at a local level. This decentralized local-local negotiation model intends to reduce negotiations between the
headquarters and the local branch management which in turn shortens the decision making time. Structure
The way the organization is structured and who reports to whom46 Holcim Ltd is organized following a geographical structure where the success lies in the competence of the local management teams. The operating units in around 70 countries are under line management of eight Executive Committee members, which are assisted by four Corporate Functional Managers. The organizational chart of Holcim Ltd can be examined in Appendix 3. Holcim Ltd aims to get the right balance between the local responsibility and the global leadership. The continued success has its origins in the autonomy of these regional operating units since each of it has the necessary entrepreneurial room for maneuver especially in terms of adaptive marketing programs and sales. The local branches are supported by the headquarters which provide the specific know-how and predefined parameters. According to Svend Hollensen (see Global Marketing, 2007, p. 656) such a structure is especially useful for companies that need fast and sufficient worldwide distribution. As such, Holcim Ltd is able to respond easily and quickly to market demands in the appropriate regions. However, coordination tasks on a corporate level and the observance of the corporate identity must be respected. Overall, Holcim Ltd shows flat hierarchical structures. This geographically oriented structure necessitates a clear regulation of competences, starting at a group level and going down to the group companies. Consequently, decisions should be based on expert knowledge, the necessary cost awareness and they should be made with a quick response to market needs. As stated in the annual report 2010, regions, countries and local sites are assisted by service centers at the regional level and by central corporate staff units at a group level in order to pool energies more efficiently. Systems
The procedures that make the organization work47
Following a “global standards but local management” approach requires a balance between a strong and consistent management behavior and local market needs. Therefore, Holcim Ltd makes use of the ISO management system standards across all corporate, regional and local sections. By setting up
group-wide standards and conducting systematic cross-sectoral comparisons, performance and reputational enhancements should be achieved. According to Holcim Ltd, the ISO certification is the starting point in managing the performance for what reason the company gradually increased the implementation of different ISO management systems since 2002. As has already been mentioned, all sections have to follow clear guidelines in key areas of the business not just in terms of financial and human resources matters but also towards technological and environmental friendly production affairs. Serving as an example, an expert team of the International Union for Conservation of Nature (IUCN) and Holcim Ltd are at work since 2007 to organize and adapt the management system in order to help safeguard biodiversity in mining areas. Moreover, the company has developed high standards of corporate governance in order to ensure sound strategic actions and management behavior that is geared to long-term success. Corporate governance standards are seen as tasks that are intended to supervise the behavior of the top management48. The ultimate goal of the guidelines set out by the company is to ensure the economic success and to maintain and strengthen the reputation of the company. As for the ISO-Standards, corporate governance guidelines not only put the focus on business risks but also on the social responsibility of managers. Finally, the company also underlines the importance of an internal Audit section as an independent body. This section monitors the results and the effectiveness and efficiency of the internal management and control systems. Consequently, the Audit Committee and the Executive Committee will be informed directly about their findings. Needless to say that the internal audit enjoys a high strategic importance within the company, since they are able to detect discrepancies in the overall system at an early stage and are therefore able to avoid major reputational damages. Style
The style of leadership adopted49
Holcim Ltd is a truly international company and offers a multi-cultural working environment with more than 60 nationalities represented across the world in 2010. As it has been mentioned in chapter Structure (Structure), the company’s philosophy is to leave each regional operating unit its necessary entrepreneurial and innovational freedom. Thus, the company
strives for an open and collaborative corporate environment where free-flow of information and personnel development is central and as such benefits from best practice experiences from other regional sections. As a result, the company clearly supports global knowledge sharing and strongly encourages international transfers. In addition, employee objectives must be defined in advance in order to educate and advance people further. The following statement from Tom A. Clough, a member of the Executive Committee backs up this idea (see Investor/Analyst Capital Market Event 2007, p. 8): “Dialogue supports the cascading of group objectives from the operational roadmap down to individuals and enables everyone to identify their contribution to their company and the group’s results”. A clear dialogue is defined as a) setting individual objectives; b) reviewing individual performance; c) defining individual development plans. Moreover talented managers and experts need to be developed by a need to be trained by a hand-on approach, where a lot of responsibility gets transferred from their superior. Such a responsibility and independence driven business style shall encourage employees to identify themselves strongly with the company. Staff
The pool of people who need to be developed, challenged and encouraged50 People are the base for success in every company. Hence, Holcim Ltd strives to offer its employees an attractive working environment with international perspectives where an individual career planning is supported effectively. Figure shows the employee development and indicates the regional growth strategy which Holcim Ltd has been following:
Figure : Group employees of Holcim Ltd by region
Source: Own design
Since 2004, the overall employees’ growth amounts to an increase of 71.2% and additional 33’401 employees. A large proportion of this increase is due to the expansion-strategy in the Asia-Pacific market. With the consolidation of the acquired Indian companies in 2006, Holcim Ltd counts 27’528 additional workforces in this region. However, it is striking that all regions reduced headcounts as a result of the financial crisis whereby the number of employees in some regions have been halved as compared to their highest value (North-America, Africa-Middle-East). Lastly, it is noticeable that the
number of employees in Africa-Middle-East has been reduced by 52.1% since 2004 to 2’213 employees, even though the company states “favorable conditions” in the group region Africa-Middle-East51. Skills
Not just the collection of skills that the organization has but the particular combinations that help it to excel52 As Holcim Ltd states in the annual report 2010, “success is based on good people”. Holcim Ltd is making many efforts to successfully enhance the skills of each individual. To motivate employees over the long term, the company strives to offer attractive and challenging jobs with development potential. Encouraging employees and demanding achievement from them is the fundamental philosophy that brings Holcim Ltd forward. However, the company is well aware that the most skilled employees are of no use if there is no best practice sharing and no regular training. Hence, Holcim Ltd ensures that all employees develop their know-how and skills in the best possible way with regular trainings at a continuous process and has developed tools that enable the group to rapidly spread the expertise on-hand. 2.3 SWOT Analysis
The SWOT analysis depicted in Figure will summarize the strengths and weaknesses coupled with the opportunities and threats from the internal and external analysis conducted in this chapter. Whereas the former two points focus on the internal organization, the latter points focus on the external organization53.
Figure : SWOT analysis of Holcim Ltd
Source: Own design
Holcim Ltd follows a strategy of diversification on three products in emerging, maturing and developed markets and focuses mainly on cement and aggregates. They are seen as key building materials for the industry and show high operating margins even though those products reveal a capital, knowledge and R&D intense nature. Furthermore, Holcim Ltd constantly develops new products/mixtures with higher durability, sustainability and an improved ecological balance sheet in order to meet the growing expectations from shareholders towards greenhouse gas reduction. Finally and due to
“Holcim Trading”, the company is logistically independent in what way transportation costs for the moisture-sensitive and heavy products can be reduced, which in turn reduces the supplier power. Weakness
Due to the fact that cement and aggregates are high-volume production products, Holcim Ltd has build up high capacities of those products. In the wake of the financial crisis, prices suffered a drop due to the declining demand of construction building materials which in turn led to large excess capacities in the industry. As a result, Holcim Ltd was urged to close down plants and introduced an austerity program in order to reduce operating costs. Furthermore, the company is still focusing on “other construction materials and services” such as ready-mix concretes and asphalt, even though the competition in this area is much higher. As such, margins are clearly lower as opposed to the cement and aggregates industry. However, those products are necessary in order to be closer to the end-consumer. This is clearly important when markets mature and customer needs broaden and seeking for more specific products. Opportunity
Bearing in mind that the world population is to grow by 3 billion people within the next 40 years, the potential for expansion of the Building Materials Industry is enormous. Especially BRIC states are expected to experience a significant population growth. Due to the sound global strategic position of Holcim Ltd and its intact capital structure, the company is in a good position to continue its expansion strategy in order to acquire the necessary market/regional knowledge of its competitor. Furthermore, partnerships with other companies within the industry are conceivable as well. Such expansion strategies are clearly gaining on importance for both sides (buyer/seller and in terms of a partnership) as seen in chapter Threat of New Entrants (Threat of New Entrants), in which the positive effect of economies of scales is described. Lastly, efficient and environmental friendly handling of natural resources is a cornerstone within the Building Materials Industry. Finding a mixture/production process, in which carbon dioxin emission is significantly reduced, will lead to a first mover advantage within the industry. Besides, less emissions will also go along with less energy costs with regards to the production process
and is clearly in favor of the company’s overall cost structure. Threat
As mentioned in the PESTEL model, the Building Materials Industry is highly exposed to energy providing companies (coal, fuel, gas) due to fact that the production process requires a lot of energy. Consequently, growing prices would lead to higher production costs and would affect customers badly. Additionally, the demand for cement is growing faster than the emissions per ton are falling posing a clear threat to the environment. This situation could lead to production restriction in the future what would have impacts on sales revenue of companies. Furthermore, even higher efforts and spending in terms of R&D have to be undertaken to improve products. Being highly active in emerging markets also bears the threat of unknown and unpredictable governmental actions and policies. Hence, production capacities might be reduced or employees might be largely influenced by the governments what would have negative impacts on the production process and revenues. Lastly, as explained in chapter Global Building Materials Industry (Global Building Materials Industry), there is a clear link between GDP of a country and the consumption of cement and aggregate products. In terms of an economic slowdown this would lead to a reduction in sales revenue again. 3 Historical Performance Analysis
The historical performance analysis is based on ideas from Koller et al. (see Valuation, 2005, pp. 159) and is divided into seven subchapters. The results are based on the published figures of the annual consolidated financial statements of Holcim Ltd. The reports are in accordance with the International Financial Reporting Standards (IFRS). The detailed calculations of each subchapter can be examined in Appendix 4. 3.1 Revenue Growth
Revenue growth within a company is directly tied to long-term growth in cash flow. As such, analyzing historical revenue growth is vital to assess the potential for growth going forward. Figure depicts Holcim Ltd’s net sales from 2001-2010 and reveals that the highest revenue has been generated in 2007 with more than CHF 27 billion. Even though the economy slid into a recession as a result of the dotcom bubble burst in 200054, Holcim Ltd
experienced just slight revenue decreases and was even able to more than double revenues from 2003 to 2007. However, in the wake of the financial crisis and the resulting credit crunch, Holcim Ltd suffered from fewer orders and declining prices in the Building Materials Industry. After reporting reduced revenue figures two times in a row, the company’s revenue increased to CHF 21.6 billion in 2010 again.
Figure : Net Sales of Holcim Ltd from 2001-2010 (in million CHF) Source: Own design
However, the year-to-year revenue growth can sometimes be misleading and has to be analyzed in more detail. Referring to Holcim Ltd, the three main factors influencing the changes in revenues are to be found in products sold, in the company structure (acquisition/divestitures) and in currency translation effects. The development of each factor is shown in Table , highlighting the strongest results in green and the weakest ones in red.
Table : Changes in Net Sales of Holcim Ltd from 2001-2010
Source: Own design
As described in the Strategic Analysis, the Building Materials Industry is dependent on economic trends and thus suffers in post crisis periods. This is shown in terms of declining net sales of products in the year 2002 as well as 2009 and 2010. Nevertheless, over the past 10 years the company depicts a compound annual growth rate (CAGR) of 2.9%, which is higher than the compounded inflation rate of 1.09%55 over the last 10 years in Switzerland. Nevertheless, due to the economic exposure, global diversification is one of the key strategic goals of Holcim Ltd. As such, the adopted merger and acquisition (M&A) path is necessary in order to gain knowledge from competitors on the one hand, and on the other hand, to achieve an increase in net sales due to new market shares. This approach can be considered as positive when looking at the increased net sales figures up to 28.3% and a CAGR of 6.3% since 2001. Lastly and less satisfactory is a CAGR of -3.2% in terms of currency translation effects. These revenue reductions are the result of the translation of foreign operations into the group reporting. It is striking that especially in post crisis years, as after the dotcom bubble (2003/2004) and the financial crisis (2008/2009),
the strong Swiss France poses a severe handicap. Nevertheless, with regard to the overall changes in net sales, a positive CAGR of 6.0% can be identified since 2001. The ongoing M&A activities can also be deduced when looking at the geographical revenue spread in Figure .
Figure : Holcim Ltd’s sales development by region since 2001 Source: Own design
Over the last 10 years, the Asia Pacific revenues almost quadrupled for Holcim Ltd whereas net sales from Latin America and Africa-Middle-East are almost halved. The European market remained more or less stable, representing the second largest revenue generating market by now. Furthermore, it is striking that the company derived 57% of its revenues from cement, which is equivalent to 83% of its operating profit. Another 10% of Holcim Ltd’s revenue is derived from aggregates, contributing 12% to the overall operating profit. Although the “other material” section accounts for 33% sales, only 5% operating profit is derived from it. Overall, this clarifies the strategic focus of Holcim Ltd towards high margin products such as aggregates and cement, whereas the “other material” section is used to get closer to the end-consumer. 3.2 Invested Capital
Without a strong capital base, the undertaken growth path of Holcim Ltd would not be portrayable. Invested Capital is more broadly defined as operating assets minus operating liabilities and is equal to debt plus equity where goodwill and intangible assets are included. After 2003, major values are added to the overall invested capital of Holcim Ltd mainly due to the intensified M&A growth path. Consequently, the capital base increased from CHF 20.6 billion in 2003 to CHF 41.8 billion (+103%) in 2007 as depicted in Figure .
Figure : Invested Capital of Holcim Ltd from 2001-2010 (in million CHF) Source: Own design
Looking at the annual reports of Holcim Ltd, it becomes clear that especially “Property, Plant and Equipment” as well as “Goodwill” steadily increased due to heavy acquisition activities in the UK, in India and in the US in 2005 and 2006. The reduction of invested capital in 2008 can be explained by the
disposal of plants in South Africa, Venezuela and Egypt. Lastly, even though Holcim Ltd sold a Nigerian subsidiary in 2009, the total invested capital increased due to the incorporation of an Australian factory. 3.3 NOPLAT
When it comes to profit in the annual reports, net income is reported as the “bottom line” measure of value added to shareholders’ equity56. However, net income does not include profits available to both debt holders and equity holders. Thus, Net Operating Profit Less Adjusted Taxes (NOPLAT) is a more powerful parameter where any non-operating income is excluded from profit and effects of interest expenses and non-operating income is removed from taxes. Consequently, the ratio focuses on operating income generated by operating capital and shows the total cash available for distribution to financial capital contributors.
Figure : NOPLAT of Holcim Ltd from 2002-2010 (in million CHF) Source: Own design
As Figure shows, NOPLAT almost quadrupled up to CHF 4.8 billion in the economic prosperous time between 2002 and 2007. In the wake of the financial crisis, the overall Building Materials Industry experienced a reduction in orders, which resulted in reduced revenues. The cost structure could not be improved significantly due to the high fixed costs within this industry. Consequently, the NOPLAT decreased by roughly 60% within one year in 2008. In order to stay competitive and to ensure the Going Concern of the company, Holcim Ltd has undergone an austerity program which resulted in the disposal of unprofitable plants and also in a reduction of personnel. For that reason, the NOPLAT figure could be kept more or less stable after 2008. 3.4 Free Cash Flow
where C is equal to cash flow from operations and I is equal to cash investment in operations. FCF is described as the after-tax cash flow available to all investors. If operations generate more cash than they use for investments, free cash flow is positive and vice versa. The formula above illustrates that a firm decreases its free cash flow by investing and increases it by liquidating or reducing its investments. As such, a negative
cash flow is not a “weakness” since growth firms need to invest cash into new properties, plants and equipments. Thus, a positive free cash flow might even be seen as failing if it is the result of decreasing investments. However, cash is seen as one of the most important figures to investors since it is a “hard” and “tangible” figure. As a result, a meaningful middle course has to be followed by a company in terms of investment in operations and free cash flow figures.
Figure : Free Cash Flow of Holcim Ltd from 2002-2010 (in million CHF) Source: Own design
As has already been mentioned in chapter Invested Capital (Invested Capital), Holcim Ltd invested heavily into new plants, quarries and facilities abroad in 2005, 2006 and 2009. It is therefore not surprising that the FCF-figures, as shown in Figure , depict a negative movement for these years. Despite the effects of the financial crisis, FCF in 2008 has reached the second highest value over the last nine years. This result can be explained by the fact that Holcim Ltd undertook divestments in the corresponding year. The highest FCF figure can be observed in the year 2010, when improved revenue figures resulted in a high gross cash flow and no considerable acquisition took place. 3.5 ROIC
Return on Invested Capital is a measurement of a company’s core operating performance. For investors it is inevitably to state ROIC, since this is the key driver of value.
Following the equation above, if an asset is included in invested capital, the income related to that asset should be taken into consideration for NOPLAT as well. Furthermore, it is recommendable to use the average invested capital of one year where goodwill is included, since profit is measured over an entire year. The equation clarifies that ROIC is driven by its ability to maximize profitability (EBITA), optimize capital efficiency (invested capital) or maximize taxes.
Table : ROIC of Holcim Ltd from 2002-2010
Source: Own design
Analyzing Table one can see a steady increase of ROIC until 2007. Especially during the economic upswing in 2005-2007 the average ROIC shows low two digit numbers, even though the amount of invested capital at that time was increased heavily. Such a business model of growth is heavily sensitive to economic downturn as faced after 2007 for a cyclical company as Holcim Ltd. Whereas the Invested Capital remained almost at the same level, NOPLAT collapsed heavily by -63.4% in 2008 and -50.8% in 2009, both compared to the NOPLAT in 2007. Hence, it is not astonishing that the average ROIC diminished in value to an unattractive rate of 4.4% in 2010. Thus, the downgrading by Fitch and Moody’s to a triple B rating is a comprehensible consequence and will be further explained in chapter Financial Health and Capital Structure. Holcim Ltd faced rough times after the financial crisis hit the economy. Orders were low, prices of products got reduced due to the low demand and the company faced a constant upward pressure on costs. Having already suffered enormous decreases in ROIC, Holcim Ltd started to cut back fixed costs by CHF 1.2 billion in 2009 and 2010 in order to improve the EBITA and thus NOPLAT margin. As consequence of the rigorous cost management, net debt could also be reduced by CHF 1.2 billion in 2009, even though an Australian company was acquired in this year. In 2010, net debt could be further reduced by CHF 2.5 billion. Having improved the cost structure and reduced the invested capital, the company has laid the foundation for the coming economic upswing in order to improve ROIC significantly. Further details on operational drivers can be examined in Appendix 5. 3.6 Financial Health and Capital Structure
In Table , the adjusted EBITA/Interest coverage ratio and the Debt/Total Market Capitalization ratio are shown. The first-mentioned ratio is a straightforward indicator of a company’s ability to comply with its short term debt service obligations and measures how many times a company could pay its interest commitments out of its ongoing operational cash flow. The second traditional ratio measures how much of a company’s enterprise value is “claimed” by debt holders. Even though debt capital is generally available at a cheaper rate than equity capital, high debt leverages may lead to financial distress, especially when the market value of the company is changing dramatically. This distress situation is mostly caused by
liquidity problems due to the fact that the company may be in trouble reimbursing interest obligations57.
Table : Coverage & leverage ratio of Holcim Ltd from 2002-2010 Source: Own design
Fitch as well as Moody’s downgraded Holcim Ltd’s rating to a triple B in 2008. The downgrade is based on the deterioration of financial ratios and operating margins in 2008. While net financial debt could be reduced from CHF 13.8 billion to CHF 11.3 billion in 2010 as a result of a sound cash flow from operating activities and lower capital expenditures (see annual report 2010, p. 126), the rating agencies remained the rating at a triple B. This rating is at the bottom of investment-grade bond ratings and only two grades above the one of junk bonds. Fitch states that credit metrics will continue to improve gradually over the coming 24 months, after the strong deleveraging the group achieved since 200858. Those weak ratings of Holcim Ltd are underpinned when looking at Table . In order to continue the chosen M&A path, Holcim Ltd took up high debt amounts which are shown in leverages59 between 33.7% and 54.0% between 2002 and 2010. Comparing those figures to the average ratio of 21.7%60 of 49 US-companies within the Building Materials Industry in 2005, Holcim Ltd’s share of debt is considered to be too high. Furthermore, the average market leverage of all listed companies at the Swiss Stock exchange in 2005 and 2006 revealed ratios of 24.9% and 17.1%61. These results show the excessive proportion of debt capital at Holcim Ltd. Finally, the negative leverage effect is nicely portrayed when analyzing the coverage ratio. During economic prosperous times as in 2007, the ratio is 6.9 and more than double as high as in rough economic times as in 20010, in which the ratio was reduced to 3.3. This is a clear emphasize of the growing liquidity problematic when entering an economic downturn incorporating a high stake of debt capital. According to Koller et al. (see Valuation, 2005, p. 489) a coverage ratio of around 3 thus justifies a triple B rating. 3.7 Capital Market
Table : Capital Market information of Holcim Ltd from 2001-2010 Source: Own design
Holcim Ltd is listed at the Swiss Exchange SIX. Each share carries one voting
right and shows a par value of CHF 2.00 after the 5:1 split in 2001. Since Holcim Ltd is highly exposed to market fluctuations the stock is seen as a cyclical one, clearly illustrated in the decreasing market capitalization figures and the stock price level deviation of the post dotcom bubble crisis in 2001 and 2002. The highest stock price volatilities over the last 10 years can be seen in 2008 and 2009. It is reported in the annual report of 2009 that Holcim Ltd shares further declined largely because of insolvency fears across the industry. Although these concerns were unfounded in the case of Holcim Ltd, it continued to put pressure on the stock. In 2010, it is stated that although the Swiss Market Exchange recorded an upward trend at the beginning of 2010, the fear of a deteriorating European economy caused the markets to face high volatility and pressure on stock levels into the second half of the year 2010. Holcim Ltd’s shares could not withstand these widespread market uncertainties and experienced new price fluctuations after having reached the annual peak of CHF 85.00 at the end of April 2010 (see annual report 2010, p. 36/37). Lastly, when talking about dividends per share paid, Holcim Ltd follows the policy of distributing one third of the consolidated profits as dividends. Consequently, during the economic upswing from 2002-2007, dividend payments per share grew by 330% to CHF 3.30. Nevertheless, due to the difficult economic situation and the need to preserve liquidity, the general meeting decided to pay the dividend in shares in May 2009 rather than in cash and reduced the dividend payments to 1.50 CHF per share (-33.3% compared to 2008; -54.5% compared to 2007). 4 WACC
The weighted average cost of capital is the market based weighted average of the after-tax cost of debt and cost of equity and will further be used to discount the forecasted cash flow in the valuation part. WACC represents the opportunity cost that investors face for investing their funds in Holcim Ltd instead of other companies with similar risks62.
In order to calculate the WACC of Holcim Ltd, three components have to be determined: cost of equity (, the after-tax cost of debt ( and the company’s target capital structure at market rates (. As disclosed in Table , the best estimate for Holcim Ltd’s WACC is 7.26%. The occurrence of the results
will be explained in more detail in this chapter. Given the target WACCAT of 8% as disclosed in the annual report of Holcim Ltd, the calculated rate in this paper shows a reasonable value.
Table : WACC estimation of Holcim Ltd
Source: Own design
4.1 Cost of Equity
Due to the fact that expected rates of return are unobservable, the Capital Asset Pricing Model (CAPM) is used63 in this paper in order to estimate the corresponding cost of equity for Holcim Ltd. This model decomposes the risk of a stock into two components – systematic and non-systematic risk. Whereas the former risk is related to the overall market and cannot be avoided, the latter is specific to each individual stock and is diversifiable. The CAPM model defines a stock’s risk as its sensitivity to the stock market and looks as follows,
where shows Holcim Ltd’s expected return, indicates the risk free rate, depicts Holcim Ltd’s stock sensitivity to the market and shows the expected return of the market. Whereas the risk free rate and the market risk premium () are identical for all companies, beta values vary across industries and companies64. 4.1.1 The Risk Free Rate
The risk free rate is the theoretical rate of return of an investment not carrying any risk and shows the minimum interest rate an investor expects from a risk-free investment. Practically, though, investments at zero risk do not exist since every investment shows a certain risk factor. The most accurate risk free rates to use are governmental default-free bond rates. In practice, US companies use US Treasury Bonds whereas for European companies the German Eurobond will be used as an accurate risk free rate. Due to the fact that Holcim Ltd has its headquarters in Switzerland and borrows debt in Swiss France, the Swiss governmental bond portrays the best proxy. However, the question remains what maturity should be used. Since cash flows should be discounted using a bond with a similar maturity, the 10 year Swiss government bond has been chosen as a proxy of the risk free rate and is disclosed in Table . Due to the fact that National Banks started to raise
the base rates, the Swiss Bank is also expected to raise the rates of the governmental bonds65 wherefore a rate of 2.0% will be used as best estimate. 4.1.2 The Market Risk Premium
Generally, the market risk premium is estimated as the difference between the market rate and the risk free rate (). Sizing this difference is one of the most debated issues in finance since the ability of stocks to outperform bonds over the long run. But similar to a stock’s expected return, the expected return on the market is unobservable and so far, none of today’s models has gained universal acceptance since none of them could precisely estimate the market risk premium66. Following, historical excess returns of the S&P 500 index are measured and extrapolated. This specific index has been chosen since it is a well-diversified and value-weighted one. The Swiss Market Index has deliberately not been chosen due to the fact that the index is only represented by 20 companies and is heavily weighted towards the banking and chemical/drug industries. Besides, most well-diversified indexes (S&P 500, MSCI World) are highly correlated and the choice of whichever of them has little effects on the results67. Following the information above, the yearly average returns of the S&P 500 index are taken from 1981 until 2010, which results in an average index return of 8.85%. However, according to Brown, Goetzmann and Ross (see Survivorship Bias, 1995, pp. 853-873), statistical difficulties exist with regards to historical risk premiums. Even properly measured historical premiums cannot predict future returns since the observable sample will include only countries with strong historical returns. Following the suggestion of the authors, 1% “survivorship bias” is deducted from the long-term average of 8.85%, resulting in an average index return of 7.85%. The market risk premium for the cost of equity calculation is disclosed in Table and shows a value of 5.9%. 4.1.3 The Beta
According to the CAPM equation, is a measure of the systematic risk of a stock compared to the market as a whole. A company’s beta is estimated by conducting the market model regression analysis to show the volatility of the stock returns. Whereas a beta of less than 1 shows less risk of the stock return in comparison to the market index, a beta of greater than 1
shows a higher price volatility of the stock returns and thus more risk as opposed to the market index returns. Although the estimation of the raw beta of a company incorporates a lot of uncertainties, it also requires a great precision since large standard errors of the estimated beta increases the uncertainty of the cost of equity which might lead to misconceptions68. Generally, there is scientific disagreement with regards to the appropriate measurement period one has to use for the regression. Daves, Ehrhardt and Kunkel69 strongly recommend using three year daily returns to conduct the market model regression, since the standard errors get reduced by using more observations. Besides, Robert Merton70 argues that beta figures are improved as returns are measured more frequently. Scientists argue, however, empirical problems make high-frequency beta estimation unreliable and especially problematic, when the stock is rarely traded and estimates of beta might be biased downward (systematic biases)71. Black, Jensen and Scholes72 state in their paper that data providers such as Standard & Poor’s and Value Line use five years monthly data to determine beta which originated as a rule of thumb. Looking at Table , one can see the enormous distinctions among the different beta types (daily, monthly, weekly) for Holcim Ltd.
Table : Adjusted betas of Holcim Ltd
Source: Own design
Standard errors of beta decrease in consequence of using more observations in an observation period. This finding is emphasized by a standard error of only 0.049 using three years daily returns as opposed to the standard error of 0.169 for the five years monthly returns. On the other hand it is also noteworthy that the statistical significance (R2) is clearly increasing the fewer observations are used in the observation period. This fact supports the idea of using the five years monthly returns in order to calculate the beta. The raw regression of the five years monthly returns is plotted in Figure to examine any systematic changes. It can be stated that Holcim Ltd’s stock risk has almost always been higher as opposed to the market index from July 2000 to April 2011, hovering between 1 and 1.4. The average adjusted beta73 of the five years monthly returns over this period is estimated to be 1.19, meaning that investing in the underlying stock is
riskier than into the S&P 500 index market portfolio.
Figure : Rolling beta (five years monthly returns)
Source: Own design
However, as stated in the theoretical outline and as it can be seen in Table , estimating a company’s beta is an imprecise process and often leads to unequal results. Thus, another approach is used in this paper to determine the best estimate of the beta. In order to improve the precision of cost of equity, industry betas have been used. Using industry betas instead of company specific betas improves the accuracy of the results. Companies of the same industry face similar operating risks what leads to similar operating betas. Nevertheless, the industry beta has to be adjusted for Holcim Ltd’s specific leverage of debt, since shareholders of a company with more debt face greater risks74. This is done by using the debt/market value ratio. Compared to the company’s specific betas, the industry betas are slightly higher and hover between 1 and 1.63. The average of the adjusted industry betas of 1.38 thus most closely corresponds to the betas when using the five years monthly returns of Holcim Ltd. The average industry beta, excluding the upper and lower outlier in 2008 (1.63) and 2004 (0.99), is 1.39 which will be used as a reasonable estimate of beta for the WACC. Further details on the calculation of the industry beta can be examined in Appendix 6. 4.2 Cost of Debt
Holcim Ltd is using various forms of debt, such as bonds, loans and other forms. The cost of debt therefore shows the overall interest rate for debt financing and acts as an indicator of riskiness for investors – the more risk is incorporated within a company, the higher the cost of debt will be. Due to the fact that interest expenses are deductible, the after-tax cost of debt is commonly indicated and used for the WACC estimation (). Generally, the yield to maturity of a company’s long-term debt is used as cost of debt. This rate is nothing else than a promised rate of return on a company’s debt, assuming all coupon payments are made on time and the debt is paid in full75. The yearly average costs of debt of Holcim Ltd are stated in the annual reports and depicted in Table . The average cost of debt from 2002 until 2010 is 4.5%, with its peak in 2007 at 5.1%. The lowest rate of 3.8%
in 2008 is the result of the global low interest environment. The cost of debt can also be calculated by using the risk free interest plus a yield spread according the rating of Holcim Ltd. Fitch as well as Moody’s rated the Swiss based company with a triple B. Following the suggestion of Professor Damodaran (see http://pages.stern.nyu.edu/~adamodar/), the corresponding default spread is 1.6%. Adding this spread to the yearly risk free rate as depicted in Table results in cost of debt rates between 3.2% and 4.8% and justifies the rates published by Holcim Ltd. Bearing in mind that the European Central Bank will be slightly increasing the interest rate level76, the Swiss National Bank is expected to change the rates as well. Thus, a cost of debt of 4.7% is included as the corresponding rate in terms of the WACC estimation. 4.3 Target Capital
Having calculated the after-tax cost of debt as well as the cost of equity, we still need to determine the capital structure in order to estimate the WACC. If the company would have to repay debt or equity right away, it would have to do so at the market value. Thus, to determine Holcim Ltd’s current capital structure, one has to measure the market value of all claims against the enterprise value (market value of debt and equity). Financial debt of Holcim Ltd includes bank loans, bonds, obligations under finance lease and derivative liabilities. The corresponding market values of financial liabilities are disclosed in the annual reports. Besides, the market value of equity is calculated using the market price of the stock multiplied by the number of outstanding shares at the year end.
Table : Market capital structure of Holcim Ltd from 2002-2010 Source: Own design
As shown in Table , the average debt proportion is 42.6%, revealing the high level of debt of Holcim Ltd. Furthermore, it is striking that in 2006 and 2007 the proportion of debt fell under 40% even though the absolute value of debt increased by 1.1%. This is the result of a booming economy and prospering stock markets, due to which the share price increased and led to a higher equity portion. The analyses of the preceding figures show that a dept/enterprise value between 40% and 45% looks reasonable for the future of Holcim Ltd. On one the hand, the management reduced the overall debt claims
during the post financial crisis in 2009 and 2010 in order to strengthen the liquidity. On the other hand and with the upswing of the economy ahead, the board of directors is confident of the group’s success in securing its share of future growth in the emerging markets. Following this, additional construction activities in Oceania are expected. This leads to the conclusion that further investments will soon be undertaken and further capital is needed. In times of low interest rates as facing right now, debt capital is a conceivable opportunity. 5 DCF Approach
In order to estimate Holcim Ltd’s fair value, the discounted free cash flow model (DCF) is applied, where the estimated operating cash flow is discounted by the WACC. 5.1 Scenario Analyses and Valuations
Prior to the valuation process, one has to identify different scenarios Holcim Ltd might be entering in the future. Due to the fact that the economic future is only predictable to a certain extent but mainly remains unsure, it is extremely important to conduct and think through different scenarios and to alter macro and micro economic factors influencing the valuation. The scenarios are derived from the information provided in the Strategic Analysis. Each scenario forecasts the short term economic future from 2011 to 2015 in detail which is followed by a ten year summary forecast based on more general assumptions until 2025. In order to be able to state the accurate share price of Holcim Ltd, a specific valuation process has to be followed whereby the input factors are altered according to the scenario description. Hence, the most influential parameters such as revenue growth, the cost structure as well as ROIC and NOPLAT growth rates are changed. All other parameters, for example tax and interest rates, are assumed to remain stable throughout all scenarios. It is also assumed that Holcim Ltd will keep the ratio of Net PPE (plant, property, equipment) as percentage of revenues at a constant level of 100% and that estimated operating cash flow streams are discounted at a constant WACC of 7.26%. The discounted free cash flow (FCF) will then be supplemented by the continuing value of the company in 2026 in each scenario. Thereof, non-operating items are added whereas non-equity claims are deducted. With regards to Holcim Ltd, the main two non-equity claims are debt and minority interests which are complemented by
capitalized operating leases, retirement liabilities, provisions and stock options for employees. Non-operating as well as non-equity items will be the same for all three scenarios. Finally, the resulting equity value will then be divided by the outstanding number of shares (2010: 327’086’376) in order to state the fair value Holcim Ltd. 5.1.1 Base Case Scenario
In the base case scenario it is assumed that the Swiss based company is steadily but slowly recovering from the hard hit of the financial crisis. Whereas the markets in Europe and America are facing an ongoing price-pressure due to the reduced demand, revenues are expected to grow in emerging markets such as India and China. As has already been mentioned in the strategic analysis, these markets have shown first signs of recovery. Due to the enormous spread of Holcim Ltd in these markets, the overall revenue is expected to increase at a moderate rate. Generally and as stated by Goldman Sachs, the global growth rates over the next years are estimated at 4% and 5%. In the course of this situation it is further assumed that the company holds onto the growth strategy in order to be able to strengthen the competitive market position in Asia and thus to secure the sound geographical diversification. Hence, strategically important quarries and plants will be acquired and new alliances have to be initialized. Consequently, further capital investments are needed, which means that the position such as working capital and PPE in the books will be enhanced. Besides the growth strategy Holcim Ltd has been following over the last years, the company also keeps up with the cost sensitive strategy and further strives to reduce inefficiencies and fixed cost within the company. As a result, EBITA margins will be improved which also makes an important contribution to a favorable NOPLAT. However, the strong Swiss France compared to the devalued Euro and the still ongoing weakening of the US Dollar clearly puts pressure on the business activities of Holcim Ltd. Due to the currency uncertainty, the negative translation effects over the last two years will be kept at the same level. Valuation of Base Case Scenario
The moderate revenue growth in this scenario as well as the ongoing cost structure improvements due to reduced inefficiencies and fixed cost results in slightly increasing NOPLAT figures as depicted in Table . The revenue
growth as well as the EBITA improvement is expected to stabilize at 5% and 17%, respectively, for the years to come after 2015. Overall, higher sales figures as a result of the recovering economy, further acquisitions and the improved cost structure result in improved ROIC figures. However, 2011 and 2012 depict lower ROIC than WACC figures resulting in an economic loss. As a result of the current growth strategy and the related investments, FCF are expected to decrease in 2012 and experience slight increases afterwards mainly caused by sales growth. The weighted average cost of capital will be kept at a constant rate of 7.26%.
Table : Key figures of base case scenario
Source: Own design
The operating value, which is composed of the discounted FCF as well as the present value of the continuing value of Holcim Ltd in 2026, is considered to be CHF 52.4 billion. This value has further to be adjusted by a mid-year adjustment factor77 of 0.704. This adjustment is needed in order to avoid the understating of the discount factor and results in an adjusted operating value of CHF 37.0 billion for the base case scenario. As has been mentioned in the introduction of this chapter, non-operating assets such as excess marketable securities of CHF 2.6 billion as well as financial investments of CHF 5.9 billion will be added to get the enterprise value of CHF 45.6 billion for this scenario. Finally, non-equity claims will be subtracted from the enterprise value. As such, the debt of Holcim Ltd is calculated to be CHF 14.7 billion, consisting of 83% long term liabilities. Furthermore, the company holds non-controlling ownership rights of more than CHF 5.4 billion in other companies, which are subtracted from the enterprise value as well. Additionally, the enterprise value is deducted by the capitalized value of operating leases of CHF 0.8 billion and the book value of retirement related liabilities of CHF 0.3 billion and provisions of roughly CHF 0.9 billion78. Lastly, dividend paying stock options with an estimated value of CHF 33 million are deducted as well79. This results in an equity value of CHF 23.3 billion. The resulting equity value divided by the outstanding number of shares results in a share price of CHF 71.24 for the base case scenario. Further details with regards to the calculation of the equity value of the base case scenario can be examined in Appendix 7. 5.1.2
Worst Case Scenario
In the worst case scenario it is assumed that the recovery from the economic downturn lasts longer than expected, especially in the key markets Europe and America. As a matter of fact, global growth rates are not as high as predicted by Goldman Sachs and will be between 2.5% and 3.5%. Furthermore, it is assumed that one of the competitors is able to launch a significantly eco and cost-improved cement product due to which sales from the main business driver – cement – are steadily decreasing after the year 2015. This eco-efficient product will additionally lead to even stronger governmental policies and restrictions. This situation leads to an overproduction due to the large scale production processes, to reduced prices and consequently to fewer revenues for Holcim Ltd. As a result of the newly launched product, Holcim Ltd will not be able to profit from the undertaken investments into new quarries and plants which will have negative effects on returns on invested capital. In the long run, this goes along with divestments, a loss in market shares and a clear weakening of the financial health of the company. In addition, Holcim Ltd might also face the problem of further above average increases of energy costs for the production process. This can be explained by a faster consumption of oil reserves as a consequence of the increasing population. Moreover, delivery reduction due to riots in oil-producing countries, such as the Mideast or North America might further increase the prices and put pressure on the cost side of Holcim Ltd. Finally, it is assumed in this scenario that the Swiss France will further be strengthened due to the ongoing economic downturn and the threatening inflation problematic in the US and the bailout questionability in Europe, which leads to further increased costs caused by translation effects. Valuation of Worst Case Scenario
The worst case scenario valuation follows the same logic as the base case valuation. In both scenarios, input factors are adjusted likewise. As shown in Table , revenues are expected to constantly decrease until 2015. Afterwards and as part of the new strategic positioning in the wake of the new eco-friendly producing competitor, the revenue growth is expected to be 1%. Furthermore, increased energy costs will affect the cost structure of
Holcim Ltd negatively in the long run. EBITA margins will get worse until 2015 and kept stable afterwards due to adjusted production processes. However, decreasing revenues and at the same time higher production costs inevitably lead to decreasing NOPLAT figures as shown in the figure below. A reduced NOPLAT and stable capital investments inevitably lead to reduced ROIC figures. Consequently, keeping WACC at a level of 7.26% over the long run and experiencing ROIC figures below 7% results in an economic loss year-by-year. This situation reveals that total expenses constantly exceed total revenues, pushing the company into severe financial difficulties.
Table : Key figures of worst case scenario
Source: Own design
The operating value, which is composed of discounted FCF as well as of the present value of the continuing value in 2026, is considered to be CHF 25.2 billion and has to be adjusted by the mid-year adjustment factor of 0.704. This results in an adjusted operating value of CHF 17.8 billion for the worst case scenario. Excess marketable securities of CHF 2.6 billion as well as financial investments of CHF 5.9 billion will be added in order to get the enterprise value of CHF 26.4 billion. As consequence, debt at the value of CHF 14.7 billion, consisting of 83% long term liabilities, and minority interests of more than CHF 5.4 billion will be subtracted from the enterprise value. Additionally, the enterprise value is also deducted by the capitalized value of operating leases of CHF 0.8 billion, a book value of retirement related liabilities of CHF 0.3 billion and provisions of roughly CHF 0.9 billion80. As for the base case scenario, the value of dividend paying stock options of CHF 33 million is going to be deducted, resulting in an equity value of CHF 4.1 billion. The equity value divided by the outstanding number of shares results in a share price of CHF 12.54 for the worst case scenario. Further details with regards to the calculation of the equity value of the worst case scenario can be examined in Appendix 8. 5.1.3 Best Case Scenario
In the best case scenario it is assumed that the economic downturn has been overcome and the upswing also affects the Building Materials Industry. The expected economic growth rate is between 5% and 6.5%. It is further assumed
that Holcim Ltd is able to profit from the first mover advantage of an eco-improved cement product due to which sales will be increased again after 2015 in all markets Holcim Ltd is present. As a consequence, Holcim Ltd will profit above average from the investments undertaken in emerging markets and will further strengthen sales figures. Thus, this situation clearly improves the cost side of the company. On the one hand, Holcim Ltd profits from economies of scope due to reduced energy consumption costs for the production process and on the other hand, the company will be able to profit from economies of scale due to the increased demand of this new eco-friendly product. The possibility of the discovery of new oil fields is also taken into consideration. This would lower the cost of goods sold in the long run even more. Lastly, it is assumed that the economic upswing will also have a positive impact on the strong Swiss France and will reduce the costs from translation effects of the global acting cement giant. The economic upswing as well as the market share growth will lead to significantly increased sales figures after 2015. Besides, the improved cost side affects NOPLAT positively. Since the invested capital will remain at the same level as for the base case scenario, ROIC figures will improve significantly, showing a higher operating efficiency and making the company more attractive for investors. Valuation of Best Case Scenario
The best case scenario valuation follows the same logic as for the valuation of the other two scenarios. Table shows that revenues are constantly increasing due to a faster upswing of the global economy until 2014. Thereafter, revenues are increasing again due to the launch of the eco-friendly product. Since the product is seen as a block buster, where Holcim Ltd is able to profit from the first mover advantage, the revenue increase will be kept stable at a rate of 7% in the long run. Besides, the new product requires less energy to be produced and Holcim Ltd will be able to profit from economies of scale due to the high demand. Hence, the cost side of Holcim Ltd will be improved significantly which is shown in the enhanced EBITA margin figures. Consequently, the forecast leads to increased NOPLAT figures. Bearing in mind that capital investments will be kept at a constant level, ROIC figures will be improved up to 9.3% after tax. Consequently, keeping WACC at a constant level of 7.26% over the long run
and experiencing ROIC figures over 7.3%, except for the year 2011, will result in an economic profit. This shows that generated operating revenues are higher than expenses for the production. The higher the spread between these two figures, the more it works to the advantage of the company and investors.
Table : Key figures of best case scenario
Source: Own design
Adding the discounted FCF’s and the present value of the continuing value in 2026 leads to an operating value of CHF 86.8 billion. Adjusted by the mid-year factor of 0.704, an adjusted operating value of 61.1 is assumed for the best case scenario. Thereof, excess marketable securities of CHF 2.6 billion as well as financial investments of CHF 5.9 billion will be added in order to get the enterprise value of CHF 69.7 billion. Debt at the value of CHF 14.7 billion as well as minority interests of more than CHF 5.4 billion will be subtracted from the enterprise value. Additionally, the enterprise value is deducted by the capitalized value of operating leases of CHF 0.8 billion, the book value of retirement related liabilities of CHF 0.3 billion and provisions of roughly CHF 0.9 billion81. Lastly, the value for dividend paying stock options of CHF 33 million is deducted as well. Overall, this results in an equity value of CHF 47.4 billion. The equity value divided by the outstanding number of shares results in a stock price of CHF 144.96 for the best case scenario. Further details with regards to the calculation of the equity value of the best case scenario can be examined in Appendix 9. 5.2 Final Valuation
As has been described, each scenario made use of other input factors, which are altered according to the economic scenario. Even though the base case scenario is seen as the most probable for the valuation of an accurate fair value of Holcim Ltd, the other two scenarios should be taken into consideration as well. Hence, each scenario is weighted with regards to an estimated probability of occurrence, which is shown in Table :
Table : Weighted stock price of Holcim Ltd
Source: Own design
The weight shows the assumed stock price of Holcim Ltd to be CHF 73.49. This value indicates a current undervaluation of the stock price traded at the Swiss Market Index of 8% (18.05.2001, 14:08; CHF 68.2). Multiplying the assumed stock price by the outstanding number of shares and add up non-equity claims of Holcim Ltd, it results in an enterprise value of CHF 46.3 billion. Consequently, the total assets of CHF 44.3 billion as shown in the annual report of the year 2010 are 4.6% lower than the calculated enterprise value. 5.3 Checking Results
According to Koller et al. (Valuation, 2005, p. 353), it is extremely important to check the results for its accuracy and its logic. This will minimize the possibility of valuation errors. Hence, a sensitivity analysis is conducted using the base case input factors to check whether the results are robust under altering assumptions. Furthermore, a multiple analysis is conducted by which Holcim Ltd’s multiples are compared to those of comparable companies, and to a formed peer group of the industry. 5.3.1 Sensitivity Analysis
As has already been mentioned, only the most influencing parameters have been changed in the scenario analyses. Hence, it is important to check whether the resulting values are robust under alternative assumptions. Changing one input factor by 2 percentage points and holding all other drivers constant reveals that the overall equity value might be altered significantly.
Table : Sensitivity analysis of the equity value
Source: Own design
As shown in Table , lowering revenue growth rates, adjusted EBITA margins or ROIC figures result in a lower enterprise value. Vice versa, the value is increased if the input factors are enlarged by two percentage points. It is striking that a change of two percentage points of the input factor leads to an altered equity value between -45% and +41%. Looking at value changes caused by altering WACC, the largest differences are detectable showing value changes of -73% and +570%. This sensitivity can be explained by the fact that the operating value of a company is to a large extent derived from the continuing value (base case: 60.4%). Bearing in mind the formula for the
continuing value82, a reduction of the WACC leads to a much smaller denominator which results in a significantly increased operating value and consequently in a bettered equity value. Overall, the sensitivity analysis leads to the conclusion that the valuation model used is robust and its logic correct. Besides, the analysis clearly reveals the sensitivity of changes in key input factors towards the overall equity value. This means that modest forecasting of input factors is advisable in order not to overestimate the value of a company. 5.3.2 Multiple Analysis
As discussed in the sensitivity analysis, the equity value as output of the DCF approach is highly sensitive towards input factors such as ROIC, growth rate and WACC. Overestimating these key factors leads to valuation mistakes. Thus, a multiple analysis tests the accuracy of the DCF value by comparing Holcim Ltd’s multiples versus these of the main three competitors respectively to a formed peer group of the industry, consisting of 10 companies. As suggested by Lui, Nissim and Thomas83, the analysis is conducted using forward looking sales and EBITDA figures84. Price-earnings multiples have deliberately not been calculated since these results are affected by a company’s capital structure which leads to false conclusions. The resulting multiples are presented in Table .
Table : Multiple analysis
Source: Own design
Except for two multiples – EV/Sales in 2011 and 2012 for Lafarge SA – Holcim Ltd shows higher values than the other three companies or the peer group. This indicates that Holcim Ltd’s enterprise value might be overvalued. According to the multiple analysis, the share price of Holcim Ltd has to be somewhere between CHF 42.72 and CHF 64.55. Consequently, the fair value would be traded at a discount between 12% and 42% as opposed to the calculated share price of CHF 73.49 resulting from the DCF model. However, whereas the results in the DCF approach are based on long term expectations, the multiple analyses only takes the forecasted sales and EBITDA figures for the years 2011 and 2012 into account. Bearing in mind that the short term economy forecast is done with the necessary aloofness, these key values of the formula are at rather low levels for Holcim Ltd in the long run. This
situation ultimately leads to reduced enterprise values and finally stock prices when using multiples of Lafarge SA or the peer group in order to calculate the enterprise value of Holcim Ltd using those multiples. Hence, the short sightedness of the multiple analyses leads to lower stock prices as opposed to the DCF approach. Since the economic upswing is already noticeable and growth expectations especially in emerging markets look bright, the calculated share price of CHF 73.49 is considered to be plausible and applicable. 6 Real Options Approach
So far, the focus for the determination of the fair value of Holcim Ltd has lain on the historical cost approach and the subsequent Discounted Cash Flow model. This technique is certainly one of the most commonly used valuation tools in Corporate Finance. However, there are also some shortcomings attached to this approach. A weighty criticism about the traditional valuation model is that it does not incorporate managerial flexibility. Managers are expected to alter plans and strategies in the wake of changes in the economic environment. Generally, future decisions are made contingent on how future uncertainty resolves85. Additionally, it is also important to incorporate the value of learning, since strategic decisions are rarely one-time events86. A survey conducted by Vollrath87 in 2000 among a sample of companies that have their headquarters in Germany revealed that more than 50% of the investment decisions within a company contain flexibility. That reveals the importance of the innovative Real Option Valuation (ROV) approach. This approach follows the idea of the financial option theory and research in this area is among topics of great importance in Finance. This section outlines the difference between the Net Present Value (NPV) and the ROV approach when valuing an investment project. Thereafter, the value of flexibility will be described in more detail before the Real Option Valuation approach will be demonstrated, using an example of an option to expand in the Indian market. 6.1 Comparison of the NPV and ROV approach
As it has been pointed out in chapter DCF Approach, the DCF model estimates returns and costs for business activities in the future. The value stream of cash flows will then be discounted by the weighted average cost of capital, which results in the NPV. More broadly speaking, the NPV can also be seen as
the difference between the present value of an expected cash flow (cash inflows) and the present value of fixed costs (cash outflows) of a project. Generally, an investment will only be undertaken as long as the NPV is positive. Due to the fact that the NPV analysis assumes a multi-year investment model against a fixed expectation of annual returns, the estimated NPV of an investment project is based on today’s view of the future economic development. All underlying input factors are seen as static and do not change over time. However, the NPV can fluctuate widely if the forecasted input factors are wide of the market. Thus, the NPV approach works best when there is a high degree of confidence about future cash flows. Even though the investments are recalculated every year, the mindset of taking one-time decisions on the basis of static investment plans tends to narrow the vision88. As opposed to the NPV approach, which currently shows a negative value, the Real Option Valuation approach may reveal a positive value for the company. The idea of the ROV approach started in 1977 with Stewart C. Myers’ publication of in the journal of Financial Economics “Determinants of Corporate Borrowing”. Myers showed that volatility and flexibility are not incorporated accurately in valuation approaches. The real option model thus tries to incorporate this lack and the value of learning of future events in the valuation. Flexibility and the value of learning mostly occur at individual investment decisions or on project levels such as in the production process, in marketing or in R;D. In order to analyze flexibility, one must be able to describe specific decisions manager could take in response to future events, describing the implications on the cash flow of those decisions89. The valuation using the real option approach recognizes the importance of uncertainty, which the NPV analysis assumes away. Flexibility in the ROV is reflected by the fact that a company has the option to expand, downsize or abandon a project in the future. Only if the corresponding option with the newly integrated information in the future reveals value, the investment will be pursued. Otherwise, an already started multi-year investment project can be aborted. However, the mindset of “fear of uncertainty/minimize investment” to “seek gains from uncertainty/maximize learning” opens up a wider range of possible actions90. Furthermore, Professors Dixit and Pindyck stated in 1995 that in order to make an intelligent investment choice “managers need to consider the value
of keeping their options open”91. Thus, real options are often seen as a strategic rather than a valuation tool since it takes the future development into account. 6.2 Drivers of Flexibility
As it has been mentioned, flexibility is the driver of the value in the real option model. The question remains, though, which factors can be influenced in order to change the flexibility and thus the value of the option. Totally, there are six factors affecting the value of a real option. By altering one of these levers and keeping all other factors constant, the value of the option changes. Overall, uncertainty raises the value of flexibility, which in turn increases the value of the option. The central idea behind the ROV is to exercise the option as long as its value is in the money or to back out if things turn out to be poor, meaning the value of the option is out of money. Firstly, it is one of the ultimate goals of a company to increase the level of uncertainty of the expected cash flow. By delaying an investment, the management can base its decisions on additional information due to which the value of the option gets increased. Secondly, when a company is able to increase cash inflows, the present value of expected cash flows will be increased. This situation contributes positively to the value of the option. Thirdly, the value lost over the duration of the option is seen as the value lost to competitors. For example, when a competitor enters the market with a new product, it will in turn profit from the first mover advantage. As a result of delaying an investment while a competitor enters the market, the option loses value. Fourthly, increased risk-free rates also boost the value of the option. However, this parameter cannot be influenced by any player directly. As a result, all players are exposed in the same way to a change in this lever. Fifthly, the management is able to improve the option value by reducing the present value of the cost structure. Sixthly, an extension of the option’s duration raises the flexibility and thus the value of the option as long as no competitor enters the market before with a similar investment idea. To sum up, the value of the option greatly depends on the internal and external constraints on the company. However, a project can be newly evaluated from one period to the next without having to undertake the total investment at the beginning of the project. Incorporating the value of flexibility and learning over time
thus make a real option a better valuation tool than the NPV approach92. 6.3 Option to Expand
Companies sometimes invest in projects because the investments allow them to make further investments or to enter the market with new products in the future. Thus, the initial investment is seen as a yielding option allowing the firm to invest in other projects. The second investment may add value to the company even though the NPV of the first investment is negative. The initial investment gives the company the right to expand and invest in a new project in the future. The option to expand will be evaluated at the time the initial project is analyzed. Following, the evaluation of an option to expand will be explained in more detail using an example Holcim Ltd might be facing in the Indian market in the near future. 6.3.1 Description of the Initial Situation
When valuing an option to expand, the management has to start defining the market and specify the competitive advantages the company believes will give some degree of exclusivity to undertake an investment in the target market93. As it has been mentioned in the strategic analysis, the Chinese and Indian markets have significantly gained on importance for the Building Materials Industry being the world’s first and second largest producer of cement. Analyzing the Indian market, one can see the enormous development by taking into account growth rates of 9-10% over the last five years. However, the per capita consumption in India is almost seven times lower than that of China leaving tremendous room for growth opportunities. Furthermore, the Indian market is also seen as an advanced market, which tries to use modern and latest technologies for the production of cement94. Not surprisingly, enormous consolidations have taken place with the top five players alone controlling over 60% of the total industry capacity95. In May 2011, Holcim Ltd increased its stake to 50.1% in ACC Limited and 50.002% in Ambuja Cements96, two large Indian cement producers. Being in the possession of the simple majority of these two companies, the Swiss based company is able to partially consolidate the business activities of these two subsidiaries in the balance sheet. Despite the opinion of some analysts, claiming Holcim Ltd will not increase its stake in its Indian subsidiaries any further, the
following ROV approach will analyze the value added if the remaining 49.9% of ACC Limited would be acquired. The example assumes that Holcim Ltd incorporates the right to invest a second amount to develop the production plant and to promote the already established and patented eco-efficient product called CEMROC in India. This product combines low CO2 emissions during the production process and shows exceptional resistance to chemical agents and aggressive environmental conditions. Due to the fact that the Indian market demands modern and latest technologies in terms of the production process and the products, this new development of Holcim Ltd might add further value if ACC Limited would be acquired on the whole. 6.3.2 Determination of Input Factors
In order to calculate the value of the option to expand, the input factors described in chapter Drivers of Flexibility have to be determined. Thus, a budget of the investment will be created to show the NPV of the initial investment, which looks as follows:
Table : DCF calculation of the investment project in India
Source: Own design
Assuming Holcim Ltd buys the outstanding stake of 49.9% in ACC Limited with an open market transaction in June 2011, the costs of the acquisition would total approximately CHF 1’702 million, which represents the value of the PV of fixed costs. Whereas the payment of the acquisition would be done in 2011, cash flow is expected to be generated starting in 2012. The overall runtime of the project is predicted to be six years, during which the company has a competitive advantage among other competitors due to the patented, eco-efficient product. On this basis, the cash flows will be calculated. According to analysts (see SCMS Journal of Indian Management, April-June 2009, p. 54), prices of cement will be slightly increasing over the next years, assuming a growth rate of yearly 1%. Due to the ongoing construction projects in India, cement sales are also expected to increase by up to 10%97. Thus, a moderate growth rate of 8% is used for the budgeting of the revenues. For the calculation of the costs of goods sold, administration expenses and other operating expenses, the average ratio revealed in the annual report of Holcim Ltd since 2002 will be used. With
regards to the ratios, the cost positions were set into relation to the revenue. As tax rate, the common rate of 30% in India will be taken98. Since this is a large investment in this emerging market and is thus connected to high risks, the minimal acceptable rate of return for investors is 18.08% and is used as the corresponding discount rate. This rate is 2.5 times the WACC as it has been calculated for Holcim Ltd in chapter WACC. Overall, this cash inflows and outflows result in a negative NPV of CHF 43.5 million. In the view of this negative NPV, Holcim Ltd is urged to reject the acquisition of the outstanding stake of 49.9% in ACC Limited. However, there are still three input factors left in order to estimate the value of the option and to assess the negative NPV calculated above. Looking at India’s government bond yield for 10 year notes since 2002, the rates were subject to considerable fluctuations showing rates between 4.95% and 12.26%. In June 2011, the rate was at a level of 8.29%99, which is used in the following valuation process. As opposed to the Swiss governmental 10 year bond rates, the Indian risk free rate is more than 2.5 higher and thus justifies the expected rate of return of 18% as it has been mentioned before. In terms of the value lost over the duration of the option, it is assumed that the patent on CEMROC incorporates the exclusive right to sell this eco-friendly product exclusively in the India market until 2017. As the last driver of the option, the uncertainty of the expected cash flow has to be estimated. This estimation is seen as the biggest challenge in the application of the Real Option Valuation since the volatility has the most significant affect on the value of the option100. However, since projects are not traded the estimation of a reliable value of uncertainty is difficult. Usually, the variance in values of publicly traded firms in the same business will be used or the uncertainty in the present value will be estimated by simulations. According to Professor Damodaran, a standard deviation in firm values of 54.57% in the Building Materials Industry is reasonable. However, since market data from the Indian cement market is available, a Monte-Carlo-Simulation is introduced showing a standard deviation of 38.8%. This value will be used in the subsequent ROV. Following, the Monte-Carlo-Simulation will be explained briefly. The simulation is modeled after the description of Antikarov and Copeland (see Realoptionen (2002), Das Handbuch für Finanz-Praktiker). In order to calculate the volatility
(standard deviation) of the cash flow, the general value drivers of Table Table : have to be defined. As key driver, revenue can be defined which is made up of price times quantity. Thus, we first have to calculate the volatility of these two factors in order to figure out the volatility of the cash flow. The following equation was used to calculate the corresponding volatility of the price and the quantity.
stands for the annual growth rate of 1% for the price or 8% for the quantity sold, respectively. In order to calculate the volatility of the price and the quantity of this project, one has to use appraisements for the upper and lower limit for both factors. is the placeholder for the lower value either in terms of price or quantity in 2017. The appraisement with regards to the price is the lowest value in the Indian cement market over the last 10 years, CHF 48.60101 per ton. As well as for the price, the lowest quantity produced by ACC Limited over the last 10 years is used and will then be multiplied by the potential acquisition-stake of 49.9%. This results in a quantity of 6.931 million tons. The placeholder stands for the current cement price of CHF 86.40 in India in June 2011 and the cement quantity sold of ACC Limited in 2010 multiplied by the acquisition stake which results in a quantity of 10.500 million tons. Solving the above mentioned equation shows a price volatility of 13.98% and a quantity volatility of 18.37%. Given these results, one is now able to calculate the upper and lower limit for the price and the quantity. The following equation shows how to calculate the upper and lower limit for the price in year 2017 and 2016. The same procedure will also be applied with regards to the calculation of the upper and lower limits in terms of the quantity.
With a probability of 95% (confidence interval of 95%), the prices and quantities have to lie within the calculated value ranges. The corresponding upper and lower limits with regards to prices and quantities can be examined in Appendix 10 and 11. Being aware of the upper and lower limit for both factors from 2012 until 2017, one is able to carry out the simulation, using the basic model in Table . For each year, two normal distributed random variables have to be defined using the annual growth rate with regards to the price, with a mean value of 1% and the calculated standard deviation of
13.98%. With regards to the quantity, a mean value of 8% and the standard deviation of 18.37% will be used. Executing 1000 simulations of the DCF model and altering each year’s growth factor for the price and the quantity randomly according to the normal distributed variables, the simulation shows an average present value (PV) of cash flow of CHF 1’976 million in 2012. Using the yield equation underneath, an average yield distribution of 10% is calculated.
Out of the 1000 simulations, the volatility of the yield distributions is estimated to be 38.8%. This value corresponds to the overall volatility of the investment project and will be used for the Real Option Valuation. The detailed yield distribution of the simulation can be examined in Appendix 12. 6.3.3 Valuation
Having calculated all input factors, the next step in the valuation process of the real option is to model an event tree. The event tree simply shows how the value of the underlying asset (cash flow) develops over time facing different up or down movements.
Figure : Event tree without flexibility
Source: Own design
Figure illustrates the value of the underlying assets of the project for each of next seven years. As shown in the DCF calculation in Table , the PV of the cash flow is expected to be CHF 1’658 million in 2011. This value builds the starting point of the event tree. In order to calculate the up and down movement of the underlying asset, one has to use the project volatility of 38.8% as it has been calculated in the Monte-Carlo-Simulation. The year-by-year movement will be calculated using the following formulas102:
Based on the DCF model in which a cost of capital of 18.08% has been estimated, the probability of an up movement in the event tree is 63.11%103 and the one of a down movement 36.89%. Having calculated the PV of the cash flow at the beginning and having modeled the event tree with the corresponding up and down movements, the next step will be to incorporate flexibility in the valuation process. By adding decision points to an event
tree, it becomes a decision tree. As it has been described in the initial situation, the management has the option to expand in the Indian market by investing another CHF 100 million. The money would be used to support the development of the production plant and the promotion of the already established and patented eco-efficient product CEMROC. Consequently, the associated cash flow is expected to grow by 10% on an annual basis. Taking the upward limb in the event tree which is modeled without flexibility, the value is CHF 17’033 million in 2017. With the option to expand, the value would be 17.033*1.1-0.1= CHF 18’636 million. Correspondingly, each value can be calculated for the year 2017.
Figure : Decision tree incorporating an option to expand
Source: Own design
To calculate the value at any given point on the tree, one has to start with the final branches of the year 2017 and work backwards by using the risk neutral probability method. The probability is calculated as follows:
The upward and downward probability will now be used in the risk-neutral pricing equation to calculate the value of the decision points from 2016 back to 2011:
Calculating backwards through time with the starting point in 2017, the PV of the project that has an option to expand is CHF 1’761 million in 2011. Bearing in mind that the initial investment of the project is CHF 1’701 million, the net present value increased from a negative value of CHF -43.5 million without flexibility to a positive value of CHF 60.3 million incorporating the option to expand. Hence, the option itself is worth CHF 103.8 million. The value of the option at each node can be examined in Appendix 13. Solely conducting the NPV method, the managerial flexibility would have been assumed away and the project would have been canceled because of the negative NPV. However, after having carried out the ROV incorporating the option to expand in the Indian market launching the eco-efficient product CEMROC, the conclusion that can be drawn is that Holcim Ltd should acquire the outstanding stake of 49.9% in ACC Limited. This emphasizes the importance of incorporating and analyzing the value of
flexibility in investment projects. 7 Conclusion
This analysis reveals that Holcim Ltd is one of the big players within the Building Materials Industry and clearly follows a strategy of growth with ongoing expansions especially in emerging markets. Due to the fact that the world population is going to increase significantly by approximately 3 billion people until 2050, construction works are expected to increase. Hence, this strategy is seen as advantageous. Furthermore, the company seeks alliances with competitors in new and unknown markets. On the one hand, resources can be spared and on the other hand, the expertise of the associates will be taken into account for the own process. Besides, the assessment of the strategic positioning also reveals that the European market acts as a safe haven contributing roughly one third to the overall sales volume of the company. In terms of the products it can be found that Holcim Ltd focuses on cement and aggregate products. Given the fact that these two products show high operating margins and high entry barriers for competitors, this strategy is seen as beneficial. However, the whole industry is exposed to changes in the overall economic situation, which is generally not protective. Thus, the austerity program as it has been experienced in the wake of the financial crisis has a particularly positive weight on the overall company identity and requires further attention. Based on the current knowledge of the production process in which non-renewable energy sources are inevitable, long-term and sustainable relationships with energy providers have to be maintained in order to ensure reasonable prices. Lastly, over the last twenty years, Holcim Ltd has been under constant pressure in terms of pollution control which will have more far reaching consequences in the future due to the globally increasing ecological awareness. As such, capital and knowledge intense R;D efforts in terms of eco-efficient products and production-processes, as well as the appropriate training and fostering of personnel, have to be carried on rigorously. Financial Analysis
When analyzing the historical financial performance of Holcim Ltd one can clearly see the economic dependence and the associated cyclical business
activities within the Building Materials Industry. In prosperous times, as experienced after 2004 until 2007, sales increased up to CHF 27 billion. Accordingly, NOPLAT figures steadily increased up to CHF 4.8 billion in 2007. However, in the wake of the financial crisis, construction activities were almost suspended. Consequently, sales were reduced by more than 25% in 2008 and NOPLAT figures even experienced a severe slump of 60%. The launched austerity program helped to maintain the necessary competitiveness in the industry. Having improved the cost structure and experiencing signs of recovery in sales figures, the company will emerge positively from the hard hit of the financial crisis. The improvements are to be shown in ROIC figures of the coming years. The fact that the Asian market gained in strategic importance is also revealed in sales figures. Whereas this region had contributed only 9.4% to the overall revenue in 2001, the proportion was almost tripled in 2010 while in the same period revenues increased. Furthermore, the growth strategy as it has been followed over the last decade is depicted when analyzing the figure of invested capital. Whereas it showed a value of CHF 20.4 billion in 2003, the invested capital rose sharply to CHF 42.4 billion. Unfortunately, these investments have mainly been financed by cheap debt capital which resulted in high debt to market ratios up to 54%. Holcim Ltd experienced the associated leverage problematic in the form of liquidity shortages in the wake of the financial crisis. This is illustrated when looking at the interest coverage ratios which fell by more than half from 2007 to 2010. As a matter of fact, the published triple B rating of Fitch as well as of Moody’s are seen as justifiable. DCF Valuation Approach
The resulting fair value out of the Discounted Cash Flow analysis for Holcim Ltd is CHF 73.49 per share. As opposed to the calculated fair value of Holcim Ltd, the share price traded at the Swiss Market Index in mid May of CHF 68.20 is slightly undervalued. Furthermore, the multiple analysis revealed that the fair price per share has to be somewhere between CHF 42.72 and CHF 64.55. However, since the multiple analysis only takes the forecasted sales and EBITDA figures for the years 2011 and 2012 of Holcim Ltd into account, the short sightedness of the analyses leads to lower stock prices as opposed to the DCF approach. Since the economic upswing is already
noticeable and growth expectations especially in emerging markets look bright, a share price around CHF 70.00 is considered to be applicable. Furthermore, the sensitivity analysis of the results reveals that the model is highly sentient towards changes in input factors such as the growth rates of revenue, the adjusted EBITA margin and the ROIC rate. The most influential change of the value of the DCF value is experienced by altering the input factor WACC. In turn, the estimated value of this figure is highly dependent on the used beta. Thus, the sensitivity analysis leads to the conclusion that a precise determination and a conservative estimate of the input factors for the DCF model are important in order not to overestimate the fair value of the company. Real Option Valuation Approach
Incorporating flexibility in terms of an option to expand in the Indian market by an already patented and clearly eco-efficient product appears to be favorable for the initial investment of Holcim Ltd. Whereas the NPV of the acquisition of the outstanding stake of 49.9% in ACC Limited is estimated to be CHF -43.5 million, the value of the investment project incorporating the option to expand is estimated to be CHF 60.3 million. Revealing a positive option value of CHF 103.8 million, this valuation approach emphasizes the importance of incorporating managerial flexibility in this investment project. By only executing the DCF valuation method, the project would have been canceled. However, after having carried out the ROV incorporating the option to expand, the conclusion that can be drawn is that Holcim Ltd should give the overall investment a try since value will be added by the follow up investment.
Annual Reports of Holcim from 2001-2010
Annual Reports of Lafarge S.A. from 2001-2010
Annual Reports of CRH plc from 2001-2010
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