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I was definitely too eager to upgrade my view on Cemex (NYSE:CX ) back in September. Although demand remains healthy in most of the company’s key operating areas, more challenging comps and fierce cost inflation took a bigger bite in the second half than I expected. With that, the shares have lost about 30% of their value and significantly underperformed peers/comps like Buzzi ( OTCPK:BZZUY), Cementos Argos ( OTCPK:CMTOY), Heidelberg ( OTCPK:HDELY), Holcim ( OTCPK:HCMLY), and Martin Marietta Materials ( MLM)

I do have some concerns about demand in Mexico in 2022 and costs clearly remain a key issue, but I think the share price weakness overstates the case. With a strong U.S. market and what I believe to be underrated opportunities in Europe, I think Cemex is set for some good years ahead even with the impact of lower margins. Below $9, I think these shares are worth another look.

Cemex definitely posted disappointing results to end the year, although it may be worth remembering that the full-year results still ended up being quite a bit better than what the Street was expecting at the start of 2021. In any case, while I understand the weakness in EBITDA (higher costs, delayed pricing actions), the weakness in revenue is a little more of a yellow flag to me and something to monitor.

Revenue rose more than 3% in U.S dollar (or USD) terms, and 5% in like-for-like (or lfl) organic terms, but still missed by 3%. Overall cement volume declined 3% on an lfl basis, while price rose 9% in local currencies, and ready-mix volume rose 1% with a 4% improvement in price.

Gross margin declined 110bp from the year-ago period to 30.1%, while EBITDA rose 3% as reported and closer to 4% in lfl terms. That was 9% weaker than expected, with margin declining 10bp YoY and 160bp QoQ to 18%.

Sales rose 8% in the U.S. on flat cement volume and 4% growth in ready-mix, while pricing rose 6% and 5%, respectively. EBITDA declined 7%, with margin down 250bp to 15.9%. In Mexico, revenue rose 3% lfl, with cement volumes down 4% and ready-mix up 2% and pricing flat in local currency for cement and up 7% for ready-mix. EBITDA declined 8% lfl, with margin down 320bp to 28.9%.

At this point there has been no let up in costs. Management warned back in October that costs were heading higher, largely on the back of higher energy prices, and management is looking for another 19% hike in energy costs per ton.

The good news, such as it is, is that the company has put through price increases and has more on the way, though there is some time lag between the pricing actions and the benefit in the reported financials. The U.S. market remains very tight, leading to increased imports, and I don’t think there will be much push-back on pricing. Mexico, too, should be able to absorb higher prices, though I do have some concerns that lower-cost producers could undermine some of Cemex’s pricing power here.

I have few real concerns about the demand outlook for Cemex in its U.S. operations. Residential housing remains healthy, and commercial construction should improve as the year goes on. The U.S. infrastructure bill will also help over time, but “over time” is an important point, as it will take years to fully implement the bill and translate the funding into actual projects and cement consumption.

In the meantime, the U.S. market remains tight. Cemex has redirected production from its plants in Mexico to serve the U.S. market and imports are now around 20% of the U.S. market and likely to head higher in the coming years (Cemex management believes it will hit 25% in 2025), as there hasn’t been a lot of activity in terms of building substantial new capacity.

I’m also bullish on opportunities in other markets, including Europe and some smaller Cemex markets like Colombia. I believe construction/public works in Europe can surprise to the good over the next couple of years, driving better volumes and pricing, with supplies being limited by decarbonization efforts (carbon costs pushing some less-efficient plants to close and limiting imports).

The market that concerns me more right now is Mexico. Strong remittances from the U.S. is good news for demand in the informal construction sector, but I have some concerns about recent economic weakness in Mexico and its impact on commercial construction. Public works projects including the Maya Train and airport projects like Tulum should help, but I’m still concerned that volumes could disappoint in 2022, or at least in the first half of the year, making pricing actions a little more challenging.

My thesis on Cemex is basically this – demand for cement in the U.S. is high and heading higher, with only limited incremental capacity to serve that demand, and demand is likewise improving in Europe with limited incremental capacity there as well. Mexico is a near-term worry, but underlying demand should be okay. Costs are a threat, but management’s efforts to improve efficiency should help, as should price hikes.

With all of that, revenue should grow above the long-term trend line for at least the next three years, with EBITDA margins around 20% or higher and above the trend of the last five-plus years. Longer term, I’m expecting revenue growth of around 4% and mid-to-high single-digit FCF margins, though lower for the near term on increased cost pressure.

Long-term discounted cash flow is only of limited use when valuing materials companies, but Cemex does seem to be undervalued on that basis. I also use a mixed EV/EBITDA approach that blends a multiple on the next 12 months’ EBITDA with a multiple on my estimate of “full-cycle” EBITDA, with that multiple informed in large part by interest rates in Mexico (there’s a tight long-term correlation between Cemex forward multiples and the Mexico 10-year bond).

With a blended forward multiple of 6.75x, Cemex looks undervalued below $8.50/ADR, and I get a similar result with my DCF approach. Clearly the market is well below that point. I understand the concerns about recent underwhelming performance and the risk that future pricing actions won’t be enough to offset cost inflation, but I think the market is taking an overly conservative view now and these shares are worth another look.

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