Heidelberg Materials: Lower Volume Is Expected In 2024 (HDELY)

In early 2023, our team decided to lower expectations on the real estate market, moving Heidelberg Materials and Holcim to a neutral status and publishing two analyses on potential headwinds. These reports were called Less Optimism About Real Estate and Maturing Cycle. Despite that, Heidelberg Materials’ stock price increased by 20%, exceeding our target price set at €75 (OTCPK:HLBZF, OTCPK:HDELY). For this reason, today, we are back analyzing the company with a 12-month visible period forward-thinking view. At the Lab, no other sentence has defined the 2023 real estate market as much as the mortgage rate lock-in effect. This phenomenon was evident in the Western economies and brought the entire industry to a standstill, with downward pressure on home sales and construction materials inventory levels.

Real Estate Market Update

Looking at the Heidelberg primary market, with the ECB intervention, which increased interest rates to control the escalation of inflation, mortgage demand suffered a sharp decline due to increased financial costs, which influenced house prices and caused a more significant increase in rental prices. Aside from the residential market, European commercial real estate prices are falling even faster, with a particular emphasis on Germany. Heidelberg’s home market is in winter, and no end is in sight. According to Savills’ latest Residential Market report, Q3 2023 data on residential investments in Germany continue to remain at an all-time low. As reported, to put the German market into perspective, in the first nine months of 2023, around 26,100 apartments have changed hands with a minus 52% versus the same period last year. On a high-level consideration, this mix of elements has led the German real estate market into a tunnel. As a reminder, Germany represents the largest real estate investment market on the old continent, representing around a fifth of national economic production and one job in ten. Unlike Italy, Germany is a country of large builders and developers, where small ownership is less widespread and fragmented. The property is often owned by real estate conglomerates that rent and manage the properties. What has also happened to Signa cannot go unnoticed. The parent company Signa Holding, with 27 billion in real estate assets and projects under development worth an additional €25 billion, declared bankruptcy in November. Both the increase in interest rates, which has made the debt more complicated to repay, and the crisis in the real estate sector are weighing on the group. Aside from the German market, lower construction volumes are recorded in all Western economies with no expectation from the US to the UK, followed by Italy and France (all markets where the company has a strong presence).

Heidelberg Materials New Forecast

In our estimates, higher-for-longer interest rates will continue to impact construction activity negatively. Here at the Lab, we are still bearish on the revenue outlook for construction companies, including Heidelberg, into 2024. We still forecast lower volume into H1 and should recall that we are already well into a volume downturn. On a positive note, even if on 12-month estimates, we highlight three positive factors: 1) concrete is usually produced when it is consumed, so destocking activities are more limited; 2) looking at the recent quarter, Heidelberg Materials pricing power is more resilient than expected (approximately 30% ahead of pre-COVID-19 levels) and 3) there are ROIC improvement under the current management.

Our team already commented on the impressive H1 results; the company (once again) increased its yearly guidance in Q3. In our estimates, we anticipate an EBITDA increase of 2/3% per year, and we said that we were below management’s EBITDA long-term target. The company projects a 22%, while we see an EBITDA margin in the 19%/20% level.

In the Q3 analyst call, the CEO indicated no change in volume trends for October, with favorable price/cost comps into year-end. Our sales estimate anticipates a 2024 turnover in the €21.5 and €22 billion range. Against an uncertain macroeconomic backdrop, we see two potential upsides: Mitchell benefits with a combination of cost and plan efficiency and opportunistic M&A bolt-ons. Beyond earnings, capital allocation takes the company’s center stage. The balance sheet offers optionality, but the management didn’t close the door to relatively high-priced deals. This might be negative on execution risk. As a reminder, Italcementi was a very pricey acquisition. On a negative note, decarbonization requirements have increased in Europe, and CCUS and CO2 reduction projects remain uncharted territory. Given the Q3 debt level, with robust FCF estimates and a buyback completed, we continue to project a year-end net debt of €4.8 billion. Our 2024 main assumptions do not imply a price acceleration, but we anticipate a stick price level. On a reverse basis, a solid pricing assumption supports this valuation, and to value Heidelberg Materials on this level, the company should achieve an EBITDA margin of 20% in a mid-cycle environment. That said, post-Q3 results, we should revise our 2024 estimate upwards. With volume declines, we anticipate a 2024 EBITDA level of €4 billion and a margin of 18.3%. Considering no major acquisition, CAPEX is set at €1.1 billion in 2024, and D&A is at €1.3 billion. We arrive at an adjusted EPS estimate of €10.55.

Source: Heidelberg Materials Q3 results presentation

Conclusion and Valuation

The shares now reflect earnings upgrades and recent overreliance presents a wrong entry point. Considering lower volume assumptions for most geographies, especially in Europe and the US, we are not chasing estimates of our 2024 and 2025 EBITDA, and our price target is unchanged. We believe valuation looks inexpensive on an EV/EBITDA, but an upside rating remains distant until more delivery on decarbonization materializes. To support our valuation and on our P/E target (unchanged) set at 7x, we believe a fair valuation at €75 per share. In our estimates, we are not forecasting an additional buyback, but we are raising the company’s dividend by 15% from €2.6 to €3 per share. Before moving on with a rating update, we await a volume recovery and earnings sustainability. Downside risks include value-destructive M&A, energy cost price, industrial plan utilization focusing on Mitchell ramp-up, real estate building cycles, and higher-for-longer rates.

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