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Master ThesisDepartment of Business Studies

MSc in Finance & International Business

Valuation of Holcim LtdA Building Materials Industry Based Company

Author: Christian RyfExam #: 402749Advisor: Baran Siyahhan, Associate Professor, PhDPlace, Date: Aarhus, July 2011

Master Thesis: Valuation of Holcim Ltd Christian Ryf

Abstract

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 esti-

mate 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 con-

struction activities were almost suspended. Sales and NOPLAT figures declined sharply

due to which Holcim Ltd was urged to introduce a rigorous austerity program. This pol-

icy helped to maintain the necessary competitiveness in the industry and is seen as ad-

vantageous 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 underval-

ued. 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 illus-

trates 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

I


approach turns out to be positive showing a value of CHF 60.3 million when incorporat-

ing an option to expand in the Indian market.

Table of Contents

Abstract..............................................................................................................................I

Table of Contents..............................................................................................................II

List of Figures...................................................................................................................V

List of Tables...................................................................................................................VI

1 Introduction..............................................................................................................1

1.1 History of Holcim Ltd....................................................................................1

1.2 Problem statement..........................................................................................1

1.3 Methodology...................................................................................................2

1.4 Limitations......................................................................................................3

2 Strategic Analysis.....................................................................................................4

2.1 External Analysis............................................................................................4

2.1.1 Global Building Materials Industry....................................................4

2.1.2 PESTEL Analysis...............................................................................7

2.1.3 Porter’s Five Forces..........................................................................13

2.1.4 Competitor Analysis.........................................................................17

2.2 Internal Analysis...........................................................................................22

2.2.1 Product Portfolio..............................................................................22

2.2.2 Value Chain......................................................................................25

2.2.3 Internal Success Factors...................................................................27

2.3 SWOT Analysis............................................................................................36

3 Historical Performance Analysis............................................................................38

3.1 Revenue Growth...........................................................................................38

3.2 Invested Capital............................................................................................40

II


3.3 NOPLAT.......................................................................................................41

3.4 Free Cash Flow.............................................................................................42

3.5 ROIC.............................................................................................................43

3.6 Financial Health and Capital Structure.........................................................44

3.7 Capital Market..............................................................................................45

4 WACC....................................................................................................................46

4.1 Cost of Equity...............................................................................................47

4.1.1 The Risk Free Rate...........................................................................47

4.1.2 The Market Risk Premium...............................................................48

4.1.3 The Beta............................................................................................48

4.2 Cost of Debt..................................................................................................51

4.3 Target Capital...............................................................................................51

5 DCF Approach.......................................................................................................52

5.1 Scenario Analyses and Valuations................................................................52

5.1.1 Base Case Scenario...........................................................................53

5.1.2 Worst Case Scenario.........................................................................55

5.1.3 Best Case Scenario...........................................................................57

5.2 Final Valuation.............................................................................................59

5.3 Checking Results..........................................................................................59

5.3.1 Sensitivity Analysis..........................................................................60

5.3.2 Multiple Analysis.............................................................................60

6 Real Options Approach..........................................................................................62

6.1 Comparison of the NPV and ROV approach................................................62

6.2 Drivers of Flexibility....................................................................................64

6.3 Option to Expand..........................................................................................65

6.3.1 Description of the Initial Situation...................................................65

III


6.3.2 Determination of Input Factors........................................................66

6.3.3 Valuation..........................................................................................69

7 Conclusion..............................................................................................................72

References.......................................................................................................................75

Appendix.........................................................................................................................79

IV


List of Figures

Figure 1: Market segmentation in 2009.............................................................................4

Figure 2: Cement consumption - CAGR by region from 1985-2008................................6

Figure 3: Sales by regions of Holcim Ltd and Lafarge S.A............................................18

Figure 4: BCG portfolio of Holcim Ltd’s product sections in 2010...............................24

Figure 5: Three Generic Strategies of Michael Porter.....................................................29

Figure 6: Product/Market matrix of Ansoff.....................................................................31

Figure 7: Group employees of Holcim Ltd by region.....................................................35

Figure 8: SWOT analysis of Holcim Ltd........................................................................36

Figure 9: Net Sales of Holcim Ltd from 2001-2010 (in million CHF)...........................38

Figure 10: Holcim Ltd’s sales development by region since 2001.................................40

Figure 11: Invested Capital of Holcim Ltd from 2001-2010 (in million CHF)..............40

Figure 12: NOPLAT of Holcim Ltd from 2002-2010 (in million CHF).........................41

Figure 13: Free Cash Flow of Holcim Ltd from 2002-2010 (in million CHF)...............42

Figure 14: Rolling beta (five years monthly returns)......................................................50

Figure 15: Event tree without flexibility.........................................................................70

Figure 16: Decision tree incorporating an option to expand...........................................71

V


List of Tables

Table 1: Market value/growth rate of the Building Materials Industry from 2005-2009. 5

Table 2: PESTEL analysis of Holcim Ltd at a glance.......................................................7

Table 3: The Five Forces of Competition of Holcim Ltd at a glance..............................13

Table 4: Head counts of CRH plc, Lafarge S.A. and Holcim Ltd...................................19

Table 5: Comparison of the capital base of CRH plc, Lafarge S.A. and Holcim Ltd.....20

Table 6: Changes in Net Sales of Holcim Ltd from 2001-2010......................................39

Table 7: ROIC of Holcim Ltd from 2002-2010..............................................................43

Table 8: Coverage & leverage ratio of Holcim Ltd from 2002-2010..............................44

Table 9: Capital Market information of Holcim Ltd from 2001-2010............................45

Table 10: WACC estimation of Holcim Ltd...................................................................46

Table 11: Adjusted betas of Holcim Ltd.........................................................................49

Table 12: Market capital structure of Holcim Ltd from 2002-2010................................52

Table 13: Key figures of base case scenario...................................................................54

Table 14: Key figures of worst case scenario..................................................................56

Table 15: Key figures of best case scenario....................................................................58

Table 16: Weighted stock price of Holcim Ltd...............................................................59

Table 17: Sensitivity analysis of the equity value...........................................................60

Table 18: Multiple analysis.............................................................................................61

Table 19: DCF calculation of the investment project in India........................................66

VI


1 Introduction

Holcim Ltd is a Swiss based company, which is active in the Building Materials Indus-

try and employs roughly 80’000 people. The company is one of the world’s leading sup-

pliers 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 mois-

ture-sensitive, and thus require special and expensive logistical handling, such expan-

sions are seen as favorable. From 1945 to 1970, North and Latin America had been cap-

tured 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. Fi-

nally, in May 2001, the group was renamed to today’s known Holcim Ltd and consis-

tently 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 In-

dian market. Additionally, the company acquired Aggregate Industries in the UK to en-

ter this market as well. Due to the fact that the Chinese economy is booming and is re-

sponsible for great cement consumptions, Holcim Ltd became the single biggest share-

holder 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 build-

ing 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

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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 counter-

acts 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 in-

sights into the market environment in which Holcim Ltd is active. After a short descrip-

tion of the Building Materials Industry, a PESTEL analysis will be performed. There-

after, 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 envi-

ronment 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 McKin-

sey. In the last part of the strategic analysis, a SWOT analysis will be performed sum-

marizing 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 an-

alyzing the historical performance from 2001 to 2010. Special attention is given to Rev-

enue 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 per-

formance analysis is obtained from the annual reports. The financial analysis will be fol-

lowed by an estimation of the weighted average cost of capital. To facilitate the calcula-

tion of the associated cost of equity, the CAPM model will be used. In order to deter-

2


mine 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 valua-

tion results. Consequently, three different scenarios are described and valued accord-

ingly. 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 flexi-

bility, 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 sig-

nificant 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 in-

vestment 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 Hol-

cim Ltd. Nevertheless, it will be mentioned where a note is relevant.

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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 ex-

ternal 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 de-

picted in Figure 1, 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 fa-

vorable segments are closely followed by aggregates and sand & gravel with revenues

of $139.6 billion and $93.8 billion respectively.

Figure 1: Market segmentation in 2009Source: 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 fi-

nancial 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 re-

1 Also known as Construction Materials Industry4


flected by the poor growth rate in the Building Materials Industry of 1.8% in 2009,

shown in Table 1. 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 con-

struction 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 ma-

terials recovers to reach $706.7 billion by the year 2015 (+31%).

Year Market valuein billion $ Growth

2005 444.12006 470.2 5.9%2007 502.8 6.9%2008 529.7 5.4%2009 539.3 1.8%

CAGR 05-09 5.0%

Table 1: Market value/growth rate of the Building Materials Industry from 2005-2009Source: 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 seg-

ment, 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 in-

vested 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 re-

pair 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

2 Business Monitor International Ltd (2011). Algeria Infrastructure Report Q1 2011 – Building Materials.3 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials.

5


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 2 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 Amer-

ica, 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 com-

panies.

Figure 2: Cement consumption - CAGR by region from 1985-2008Source: 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 ma-

turity. 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 aggre-

gates. 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

4 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials. 5 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials.

6


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 man-

agerial behavior. The PESTEL analysis is a framework helping to identify macroeco-

nomic 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, environ-

mental and legal future. The findings of Table 2 will be explained in more detail in the

following sequence.

External Factor Findings Effect on industry

Political Governmental stimulus programs Globalization State capitalism

Favorable Favorable Compounding

Economic

Low interest rates Growing fear of inflation in emerging markets Strong Swiss France Recovering GDP rates

Favorable Compounding Compounding Favorable

Socio-Cultural Improvement of global poverty level Ongoing urbanization Low social governmental spending

Favorable Favorable Compounding

Technological

Multi-functional materials Improvements in terms of waste recycle/reduction tech-

niques Enhancement of durability performance

Favorable Favorable

Favorable

Environmental High carbon dioxide emission Greater demand of cement than emissions are falling Emerging market growth

Compounding Compounding Compounding

Legal Internationalization of Business Growing awareness of greenhouse gases Innumerable/different laws in emerging countries

Compounding Compounding Compounding

Table 2: PESTEL analysis of Holcim Ltd at a glanceSource: Own design

2.1.2.1 Political Future

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 govern-

mental stimulus programs in the wake of the financial crisis and provided a needed 6 Hollensen, S. (2004). Global Marketing - A Decision-oriented Approach (Fourth Edition), p. 247

7


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 devel-

oped 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 in-

creasing, 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 espe-

cially in terms of expansions.

2.1.2.2 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 re-

viewed on a constant basis. This can be explained by the fact that strong investor ap-

petite might cause upside risks to emerging market. However, when talking about the

price level, the International Monetary Fund forecasts stable inflation rates in most

7 Office of National Intelligence, US Government (11/2008). Global Trends 2025 – A transformed World.8 Global Industry Analysts (01/2011). Manufacturing & Construction Report - World Building Materials Market to

Reach US$706.7.8


countries but companies should remain alert toward emerging markets. While inflation

rates in developed markets are below consensus, they are above in most emerging mar-

kets9. 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 fi-

nancial statements11. Finally and referring to Goldman Sachs analysts view (see Com-

modities 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 re-

current 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 at-

tractive growth potentials are to be found in the BRIC states with GDP growth forecasts

between 4.3% and 9.5% in 2012.

2.1.2.3 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 re-

duced to 1.4 billion people in 2005. Additionally, the proportion of people living in ex-

treme 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 attrac-

tiveness. 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 9 Goldman Sachs Global Economics (12/2010). Global Economics Weekly. Issue Nr. 10/43.10 Eiteman, D. K., Stonehill, A., & Moffet, M. H. (2010). Multinational Business Finance11 Eiteman, D. K., Stonehill, A., & Moffet, M. H. (2010). Multinational Business Finance, p. 344

9


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 liv-

ing near cities in 2009. Looking at China as the most populous country, this trend is ex-

pected 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 Mate-

rials 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 govern-

ments. 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 Build-

ing Materials Industry.

2.1.2.4 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 look-

ing 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 Mate-

rials Industry is subject to pressure from environmental organizations to improve pro-

cesses 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

12 United Nations (2010). Rethinking Poverty - Report on the World Social Situation 2010.13 http://www.worldbank.org/

10

http://www.worldbank.org/


competitive, manufacturers are engaged in developing multi-functional materials and

seek for efficient waste recycle and reduction techniques14. The latter is extremely im-

portant 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.

2.1.2.5 Environmental Future

Environmental factors include issues such as the level of pollution created by the prod-

uct 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 contrib-

utes to the global warming. The industry players themselves admit that the cement-pro-

duction 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 influ-

ence on the choice of the products, the emission reductions have their limits. Firstly, ce-

ment-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 14 GALE CENAGAGE Learning (11/2010). Strategic Developments in Construction Materials Industry.15 GALE CENAGAGE Learning (11/2010). Strategic Developments in Construction Materials Industry.16 The Economist (12/2007). Concrete Proposals Needed.

11


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.

2.1.2.6 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 In-

dustry 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. Further-

more, legal factors are gaining on importance due to the fact of the growing awareness

and sensitivity towards greenhouse gases. Especially in developed economies, for exam-

ple the European Union, governments restrict emissions from cement factories and fur-

ther jurisdictions are likely to follow suit19. More than that in countries such as Aus-

tralia, US and the UK, laws often restrict new quarry development which clearly com-

plicates 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 en-

acted, 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 Com-

petition, introduced by Michael Porter in 1980, is used to analyze the competitive struc-

ture of an industry. According to Porter, the state of competition depends upon five

17 http://www.worldbank.org/18 http://www.qfinance.com/sector-profiles/construction-and-building-materials19 The Economist (12/2007). Concrete Proposals.20 Hitt, M., Ireland, D., Hoskisson, R. (2005). Strategic Management: Competitiveness and Globalization, p. 52

12

http://www.qfinance.com/sector-profiles/construction-and-building-materials



competitive forces. Those are competitors, suppliers, buyers, substitutes and new en-

trants. 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 3 will be ex-

plained in more detail in the following sequence.

Competitive Force Findings Overall threat

New entrants

High sunk costs Special logistical handling required High volume production industry R&D/knowledge intense industry

Low

Rivalry Cyclical industry Low product diversification Necessary proximity to markets

High

Bargaining power of suppliers Energy intense industry Special machinery needed Special logistical handling required

High

Bargaining power of buyers A lot of small buyers Low switching costs Low-medium

Substitutes

Cement/aggregates basic material for Building Materials Industry

Legal regulations Substitutes to costly/no expertise

Low

Table 3: The Five Forces of Competition of Holcim Ltd at a glanceSource: Own design

2.1.3.1 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 trans-

portation 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 vol-

umes. According to the magazine “International Cement Review” (November 2008), it 21 Hollensen, S. (2004). Global Marketing - A Decision-oriented Approach (Fourth Edition), p. 10222 Hitt, M., Ireland, D., Hoskisson, R. (2005). Strategic Management: Competitiveness and Globalization, p. 54

13


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 Indus-

try 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 In-

dustry is under a constant pressure to reduce carbon dioxide emissions due to what cost

and knowledge intense R&D efforts are vital.

2.1.3.2 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 par-

tially 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 slow-

down 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 con-

fronted 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 ce-

ment 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 ri-

valry 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 compet-

itive. 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.

2.1.3.3 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 materi-

als such as cement and aggregate is energy intensive. Consequently, key suppliers to

23 Datamonitor (03/2010). Global Construction Materials. Reference Code: 0199-2030, p. 1214


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 ne-

gotiation 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 sup-

plier 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 de-

pendency of suppliers. Generally, the vital raw materials are sourced from their own

quarries. As an economy becomes more mature, vertical integration assumes greater im-

portance 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 eco-

nomically viable techniques as long-term solutions in order to efficiently use available

energy resources. On the one hand, such innovations reduce the “environmental foot-

print” of the processes and products and on the other hand lead to an increased produc-

tivity 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 sec-

tion manages a fleet of cement ships and floating terminals and is able to provide even

customized services to their business partners25.

2.1.3.4 Bargaining Power of Buyers

Mainly, products are sold to traders, wholesalers or directly to general contractors, ma-

son self-builder and civil engineering contractors, showing that buyers of building mate-

rials 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

24 Datamonitor (03/2010). Global Construction Materials. Reference Code: 0199-2030, p. 1325 www.holcim-trading.com26 Lipczynski, J., Wilson, J., Goddard, J. (2009). Industrial organization, p. 18

15

http://www.holcim-trading.com/


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. How-

ever, 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 indica-

tors 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.

2.1.3.5 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 com-

petitors within the industry is conducted. CRH plc and Lafarge S.A. are the largest com-

petitors 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.

2.1.4.1 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 sustain-

able construction methods and to increase competitive advantages through R&D activi-

ties.

27 Datamonitor (03/2010). Global Construction Materials. Reference Code: 0199-2030, p. 13

28 Lynch R. (2006). Corporate Strategy (Fourth Edition), p. 10316


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 re-

duce 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 La-

farge 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 de-

rived from such markets30.

2.1.4.2 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.

29 www.lafarge.com 30 www.crh.com/

17

http://www.crh.com/

http://www.lafarge.com/


Figure 3: 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 diversi-

fied 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, con-

struction accessories and produces glass and fencing products. The most striking differ-

ence, 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 gener-

ated in India and China). 24% of these revenues are obtained from the section Europe

Materials (cement, aggregates, ready mixed products, asphalt and lime), Europe Prod-

ucts (concrete, clay and building products) contributes 16% to the group revenues, and

finally 11% are obtained from Europe distribution (builders merchants and Do-It-Your-

self). The remaining 49% revenue stake is generated in America. America Materials

(Aggregates, asphalt, ready mixed concrete) accounts for 37% of the revenues, Amer-

ica’s Products for 10% (architectural products, glass, precast) and American Distribu-

tion (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 materi-

als such as cement and aggregates in terms of Holcim Ltd and Lafarge S.A., whereas 18


CRH plc focuses on several and clearly different footholds with a strategic focus on the

European and American market.

2.1.4.3 Resources

The scale and size of the company’s resources is an important indicator of its competi-

tive advantage. Generally, it can be stated that the Building Materials Industry is a hu-

man 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 employ-

ees can be recognized even though all show a cutback in the wake of the economic turn-

around since 2007. At that time, Holcim Ltd showed the slightest reduction in work-

force 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.

Personnel2010 2009 2008 2007 2006

CRH plc n.a. 79'822 93'572 92'033 93'572Lafarge S.A. 75'677 77'994 83'438 77'721 92'446Holcim Ltd 80'310 81'498 86'713 89'364 88'783

Table 4: Head counts of CRH plc, Lafarge S.A. and Holcim LtdSource: 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 mar-

ket. 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 cau-

tion. 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 mar-

ket 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 con-

crete products. Lastly, Lafarge S.A. shows the least presence within the industry main-

taining 1’960 plants, 1’720 of which are used to produce aggregates and concrete prod-

ucts.

19


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.

Total assets Total equity Equity ratioCRH plc 21'461€ 10'411€ 48.51%Holcim Ltd 35'407€ 16'897€ 47.72%Lafarge S.A. 42'494€ 18'224€ 42.89%Figures of 2010 in million €

Table 5: Comparison of the capital base of CRH plc, Lafarge S.A. and Holcim LtdSource: Annual reports of companies in 2010

As depicted in Table 5, 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 in-

creased 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 depen-

dent company showing an equity ratio of 48.51%, albeit with the smallest amount of eq-

uity in absolute terms with roughly 10.5 billion Euros.

2.1.4.4 Past Record of Performance

As stated by Richard Lynch (see Corporate Strategy, p. 103), past records of perfor-

mance 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 compa-

nies showed rising sales figures for five years until 2007 but subsequently suffered de-

cline 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. Neverthe-

less, 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 de-

picted 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

31 http://www.wirtschaftslexikon24.net20

http://www.wirtschaftslexikon24.net/


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 there-

fore 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 dis-

cussed in more detail. In addition, the product and customer base as well as the associ-

ated 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 cus-

tomers with the necessary goods in order to remain one of the world’s leading compa-

nies in the Building Materials Industry.

Cement 32 www.crh.com 33 Koller, T., Goedhart, M., & David, W. (2005). Valuation Measuring and Managing the Value of Companies, p. 76

21

http://www.crh.com/


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 Oil-

well Cement. However, the cement production is extremely resource and energy inten-

sive, since raw materials have to be secured and removed from quarries where signifi-

cant 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 emerg-

ing markets, cement production shows attractive growth prospects.

Aggregates

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 manufac-

turing 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, as-

phalt, 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 vol-

ume after water since it is an energy-efficient building material. One cubic meter con-

sists of approximately 300 kilograms of cement, 150 liters of water and 2 tones of ag-

gregates. 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.

34 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials, p. 835 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials, p. 64

22


Summing up, Holcim Ltd’s declared strategy is to build up and expand cement produc-

tion in emerging markets. In maturing economies, vertical integration becomes more

significant in order not to be dependent on stone material suppliers. Furthermore, Hol-

cim 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 ex-

ecutive 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 mar-

ket 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 genera-

tor), Problem child (Cash user), Dog (Cash neutral). The size of the bubbles indicates

the amount of revenues generated.

Figure 4: BCG portfolio of Holcim Ltd’s product sections in 2010Source: 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 competi-

tor. Furthermore, sales could be increased by 3.6%. This increase is the result of addi-

tional 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 36 Lynch R. (2006). Corporate Strategy (Fourth Edition), p. 131

23


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 mil-

lion 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 emerg-

ing countries develop towards maturing economies and thus invest more in infrastruc-

ture projects will further increase the demand of aggregates as mentioned in Chapter

2.1.1 (Global Building Materials Industry). Besides, the high barriers of entry act as nat-

ural 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 quanti-

ties 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 in-

vestments but with little chance to get a major profit earner and may absorb cash in or-

der to hold the position”. In contrast to the other two sections, this section is not “pro-

tected” 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.

37 J.P. Morgan (05/2010). Europe Equity Research – European Building Materials, p. 924


2.2.2 Value Chain

The value chain concept of Michael Porter illustrates the physical and technological ac-

tivities 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 en-

hanced 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 activ-

ities (production, marketing, sales/ service) of Holcim Ltd, it is striking that the produc-

tion-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 re-

sponded 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 ac-

quire 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 di-

verging customer requirements on the ground. Each region conducts its own and spe-

cific marketing efforts which is seen as a clear advantage and value adding by the man-

agement. 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 com-

pany 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 accord-

ing 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 of-

fering attractive and challenging jobs. Prospective managers and experts need to be edu-

38 Hitt, M., Ireland, D., Hoskisson, R. (2005). Strategic Management: Competitiveness and Globalization, p. 8825


cated 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 advan-

tage 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 en-

ergy efficiency, more efficient use of fuels and other resources. The focus is on renew-

able 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 manu-

facturing 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 (an-

nual report 2010, p. 20). Those maintenance improvements and the resulting cost reduc-

tion 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 ad-

vantages of scale in procurement have to be exploited more effectively (see annual re-

port 2010, p. 21). As a result, Holcim Ltd strives to establish a knowledge sharing plat-

form with access for all shareholders in order to be able to exchange knowledge and ex-

periences 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 interre-

lationship between different aspects of the corporate strategy since the effectiveness of

an organization lies in the interaction of several factors. According to Lynch (see Cor-39 Gibbert, M., Leibold, M. Probst, G. (2002). Five styles of Customer Knowledge Management, and how smart

companies put them into action.40 Hollensen, S. (2004). Global Marketing - A Decision-oriented Approach (Fourth Edition), p. 21

26


porate 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 ele-

ments 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 as-

pect of the 7-S framework is the relationship and interaction between the elements.

2.2.3.1 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 objec-

tive 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 in-

tention, 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 envi-

ronmental friendly handling of natural resources is “a cornerstone of the business pol-

icy”. Due to this business philosophy, Holcim Ltd is a forerunner in the use of new, en-

vironmentally sound technologies in the production process and is a leading user of al-

ternative fuels and raw materials (see annual report 2010, p. 41). In addition, the com-

pany 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.

41 Watermann, R. (1982). In Search of Excellence – Lessons from America’s Best-Run Companies.27


2.2.3.2 Strategy

Strategy is the route the company has chosen to maintain and build competitive advan-

tage 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 acquisi-

tions respectively strategic alliances, and where the local management has to take re-

sponsibility 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 fundamen-

tal basis of above-average performance in the long run is to achieve competitive advan-

tage. 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 com-

petitive scope looks at the size and composition of the market a company is targeting.

Competitive AdvantageLower Cost Differentiation

Broad Target 1. Cost Leadership 2. Differentiation

Narrow Target 3A. Cost Focus 3B. Differentiation Focus

Com

petit

ive

Scop

e

Figure 5: Three Generic Strategies of Michael PorterSource: Lynch R. (2006). Corporate Strategy (Fourth Edition)

42 Watermann, R. (1982). In Search of Excellence – Lessons from America’s Best-Run Companies.43 www.syngenta.com 44 Wit, B., Meyer, R. (2004). Strategy – Process, Content, Context (third edition).

28

http://www.syngenta.com/


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 tar-

get group where quality and innovation management are prevalent attributes with re-

spect to the production processes as explained in chapter 2.2.2 (Value Chain). This ex-

presses 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 exist-ing markets

Market development: The company seeks to sell its existing products into new markets

Product development: The company aims to introduce new products into ex-isting markets

Diversification: The company provides new products in new markets45 Lynch R. (2006). Corporate Strategy (Fourth Edition), pp. 791

29


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 earn-

ings by evening out cyclical fluctuations in individual markets. Quoting the annual re-

port 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. Be-sides, 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 im-portant to have high-grade, secure raw material reserves.

According to these statements, Holcim Ltd clearly follows a strategy of growth by intro-

ducing existing products in either existing or new markets. Since developed markets

show high competition and diversification towards existing products, a market penetra-

tion 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 In-

dustries 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 offer-

ings” 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 develop-

ment is a clear sign towards performance improvement and CO2 emission reduction.

Existing Products New Products

Existing Markets Market Penetration Product Development

New Markets Market Development Diversification

Figure 6: Product/Market matrix of AnsoffSource: Wit, B., Meyer, R. (2004). Strategy (third edition) – process, content, context

30


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 or-

der to fully exploit the overall market potential, the company is standardizing all its ma-

jor corporate processes which allow the local management to concentrate on market de-

velopment, cost efficiencies, training for staff, and nurturing community relations at a

local level. This decentralized local-local negotiation model intends to reduce negotia-

tions between the headquarters and the local branch management which in turn shortens

the decision making time.

2.2.3.3 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 oper-

ating units since each of it has the necessary entrepreneurial room for maneuver espe-

cially in terms of adaptive marketing programs and sales. The local branches are sup-

ported by the headquarters which provide the specific know-how and predefined param-

eters. According to Svend Hollensen (see Global Marketing, 2007, p. 656) such a struc-

ture is especially useful for companies that need fast and sufficient worldwide distribu-

tion. 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 obser-

vance 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 go-

ing 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 re-

46 Watermann, R. (1982). In Search of Excellence – Lessons from America’s Best-Run Companies.31


sponse 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.

2.2.3.4 Systems

The procedures that make the organization work47

Following a “global standards but local management” approach requires a balance be-

tween 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 system-

atic cross-sectoral comparisons, performance and reputational enhancements should be

achieved. According to Holcim Ltd, the ISO certification is the starting point in manag-

ing the performance for what reason the company gradually increased the implementa-

tion 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 environ-

mental friendly production affairs. Serving as an example, an expert team of the Interna-

tional 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 reputa-

tion 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 47 Lynch R. (2006). Corporate Strategy (Fourth Edition), pp. 79148 Wit, B., Meyer, R. (2004). Strategy – Process, Content, Context (third edition)

32


they are able to detect discrepancies in the overall system at an early stage and are there-

fore able to avoid major reputational damages.

2.2.3.5 Style

The style of leadership adopted49

Holcim Ltd is a truly international company and offers a multi-cultural working envi-

ronment with more than 60 nationalities represented across the world in 2010. As it has

been mentioned in chapter 2.2.3.3 (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 ad-

vance 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.

2.2.3.6 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 7 shows the employee devel-

opment and indicates the regional growth strategy which Holcim Ltd has been follow-

ing:

49 Lynch R. (2006). Corporate Strategy (Fourth Edition), pp. 79150 Watermann, R. (1982). In Search of Excellence – Lessons from America’s Best-Run Companies.

33


Figure 7: Group employees of Holcim Ltd by regionSource: Own design

Since 2004, the overall employees’ growth amounts to an increase of 71.2% and addi-

tional 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 com-

panies in 2006, Holcim Ltd counts 27’528 additional workforces in this region. How-

ever, 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.

2.2.3.7 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”. Hol-

cim 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 chal-

lenging 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.

51 There are no further details in the annual report or on the homepage explaining this fact52 Watermann, R. (1982). In Search of Excellence – Lessons from America’s Best-Run Companies.

34

2010 2004 %-change highest valueEurope 19'690 14'980 31.4% 2008: 23'557North America 6'668 5'249 27.0% 2006: 11'268Latin America 12'710 10'676 19.1% 2008: 13'548Africa Middle East 2'213 4'621 -52.1% 2005: 05'318Asia Pacific 38'172 10'644 258.6% 2007: 38'133Corporate 857 739 16.0% 2008: 11'110Total 80'310 46'909 71.2% 2007: 89'364


2.3 SWOT Analysis

The SWOT analysis depicted in Figure 8 will summarize the strengths and weaknesses

coupled with the opportunities and threats from the internal and external analysis con-

ducted in this chapter. Whereas the former two points focus on the internal organization,

the latter points focus on the external organization53.

Figure 8: SWOT analysis of Holcim LtdSource: Own design

Strength

Holcim Ltd follows a strategy of diversification on three products in emerging, matur-

ing 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, Hol-

cim Ltd constantly develops new products/mixtures with higher durability, sustainabil-

ity and an improved ecological balance sheet in order to meet the growing expectations

from shareholders towards greenhouse gas reduction. Finally and due to “Holcim Trad-

ing”, 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 sup-

plier power.

Weakness

Due to the fact that cement and aggregates are high-volume production products, Hol-

cim Ltd has build up high capacities of those products. In the wake of the financial cri-

sis, prices suffered a drop due to the declining demand of construction building materi-

als 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 mate-

53 Lynch R. (2006). Corporate Strategy (Fourth Edition), pp. 45035


rials and services” such as ready-mix concretes and asphalt, even though the competi-

tion in this area is much higher. As such, margins are clearly lower as opposed to the ce-

ment 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 cus-

tomer 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. Es-

pecially 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 partner-

ship) as seen in chapter 2.1.3.1 (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 grow-

ing 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 36


process and revenues. Lastly, as explained in chapter 2.1.1 (Global Building Materials

Industry), there is a clear link between GDP of a country and the consumption of ce-

ment 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 pub-

lished figures of the annual consolidated financial statements of Holcim Ltd. The re-

ports 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 go-

ing forward. Figure 9 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 9: 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

54 http://laudanum.net/geert/files/1037064960/37

http://laudanum.net/geert/files/1037064960/


changes in revenues are to be found in products sold, in the company structure (acquisi-

tion/divestitures) and in currency translation effects. The development of each factor is

shown in Table 6, highlighting the strongest results in green and the weakest ones in

red.

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 CAGR '01-'10Products 1.2% -0.8% 2.1% 7.2% 10.1% 8.9% 8.1% 4.3% -10.0% -2.1% 2.9%Change in structure 2.7% 2.9% 0.4% 0.8% 28.3% 19.5% 3.2% -1.1% 0.8% 5.4% 6.3%Currency translation effects -3.0% -6.8% -5.6% -3.1% 1.4% 1.3% 1.6% -10.2% -6.8% -0.9% -3.2%Total change in Net Sales 0.8% -4.6% -3.2% 4.9% 39.8% 29.8% 12.9% -7.0% -16.0% 2.5% 6.0%

Table 6: Changes in Net Sales of Holcim Ltd from 2001-2010Source: 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 declin-

ing 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 acqui-

sition (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 strik-

ing 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. Neverthe-

less, 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 10.

55 Calculated according to numbers on http://www.indexmundi.com/g/g.aspx?c=sz&v=71&l=de38

http://www.indexmundi.com/g/g.aspx?c=sz&v=71&l=de


Figure 10: Holcim Ltd’s sales development by region since 2001Source: 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 over-

all 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 Hol-

cim 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 operat-

ing 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 in-

creased from CHF 20.6 billion in 2003 to CHF 41.8 billion (+103%) in 2007 as depicted

in Figure 11.

Figure 11: Invested Capital of Holcim Ltd from 2001-2010 (in million CHF)Source: Own design

39


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-oper-

ating income is removed from taxes. Consequently, the ratio focuses on operating in-

come generated by operating capital and shows the total cash available for distribution

to financial capital contributors.

Figure 12: NOPLAT of Holcim Ltd from 2002-2010 (in million CHF)Source: Own design

As Figure 12 shows, NOPLAT almost quadrupled up to CHF 4.8 billion in the eco-

nomic 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.

56 Penman, St. (2007). Financial Statement Analysis and Security Valuation (Third Edition), p. 3440


3.4 Free Cash Flow

FreeCash Flow(FCF )=C−I ,

where C is equal to cash flow from operations and I is equal to cash investment in oper-

ations. FCF is described as the after-tax cash flow available to all investors. If opera-

tions 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 in-

vesting 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 proper-

ties, plants and equipments. Thus, a positive free cash flow might even be seen as fail-

ing 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 13: Free Cash Flow of Holcim Ltd from 2002-2010 (in million CHF)Source: Own design

As has already been mentioned in chapter 3.2 (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 13, 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 high-

est FCF figure can be observed in the year 2010, when improved revenue figures re-

sulted 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 perfor-

mance. For investors it is inevitably to state ROIC, since this is the key driver of value.

ROIC= NOPLATInvestedCapital

=(1−Cash Tax Rate ) × EBITARevenues

× RevenuesInvested Capital

41


Following the equation above, if an asset is included in invested capital, the income re-

lated 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.

(in million CHF) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010NOPLAT n.a. 1'238 1'401 1'733 3'384 4'071 4'837 1'924 2'378 1'772Invested Capital 22'441 21'160 20'664 20'720 32'757 39'043 41'842 38'956 42'437 38'375ROIC (Avg.) n.a. 5.7% 6.7% 8.4% 12.7% 11.3% 12.0% 4.8% 5.8% 4.4%

Table 7: ROIC of Holcim Ltd from 2002-2010Source: Own design

Analyzing Table 7 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 downgrad-

ing by Fitch and Moody’s to a triple B rating is a comprehensible consequence and will

be further explained in chapter 3.6.

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 rigor-

ous 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 fur-

ther reduced by CHF 2.5 billion. Having improved the cost structure and reduced the in-

vested 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 ex-

amined in Appendix 5.

42


3.6 Financial Health and Capital Structure

In Table 8, the adjusted EBITA/Interest coverage ratio and the Debt/Total Market Capi-

talization 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 oper-

ational cash flow. The second traditional ratio measures how much of a company’s en-

terprise value is “claimed” by debt holders. Even though debt capital is generally avail-

able at a cheaper rate than equity capital, high debt leverages may lead to financial dis-

tress, 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 com-

pany may be in trouble reimbursing interest obligations57.

Coverage/Leverage 2002 2003 2004 2005 2006 2007 2008 2009 2010Adjusted EBITA/Interest payable 3.3 3.8 4.3 3.8 5.2 6.9 3.8 3.8 3.3Debt / Total Cap (Market) 46.8% 48.3% 40.2% 43.8% 36.2% 33.7% 54.0% 41.0% 39.0%

Table 8: Coverage & leverage ratio of Holcim Ltd from 2002-2010Source: 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 bil-

lion 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 im-

prove 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 8. 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. Fur-

57 Koller, T., Goedhart, M., & David, W. (2005). Valuation Measuring and Managing the Value of Companies, p. 487

58 http://in.reuters.com/article/2011/03/23/idINWLA61852011032359 Debt to total capital (market value) 60 http://pages.stern.nyu.edu/~adamodar/

43

http://pages.stern.nyu.edu/~adamodar/

http://in.reuters.com/article/2011/03/23/idINWLA618520110323


thermore, the average market leverage of all listed companies at the Swiss Stock ex-

change 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 cov-

erage ratio of around 3 thus justifies a triple B rating.

3.7 Capital Market2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Market Capitalization (in mill. CHF) 14'461 9'959 11'588 15'750 20'578 28'252 31'973 15'894 26'330 23'108Stock Price High (CHF) 79 77 59 70 90 103 126 111 81 85Stock Price Low (CHF) 52 40 37 56 69 78 102 40 28 60Dividend per share (CHF) 1.00 1.00 1.15 1.25 1.65 2.00 3.30 2.25 1.50 1.50

Table 9: Capital Market information of Holcim Ltd from 2001-2010Source: 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 contin-

ued to put pressure on the stock. In 2010, it is stated that although the Swiss Market Ex-

change 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 lev-

els 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 61 http://www.treuhaender.ch/GetAttachment.axd?attaName=1587a06_0627.pdf

44

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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% com-

pared 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.

WACC=DV

kd (1−T m )+ EV

ke

In order to calculate the WACC of Holcim Ltd, three components have to be deter-

mined: cost of equity (k e¿, the after-tax cost of debt (k d(1−T m)¿ and the company’s tar-

get capital structure at market rates (DV

/ E

V¿.

As disclosed in Table 10, the best estimate for Holcim Ltd’s WACC is 7.26%. The oc-

currence 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.

2002 2003 2004 2005 2006 2007 2008 2009 2010 Ø best estimate Risk free rate (r f ) 3.2% 2.7% 2.7% 2.1% 2.5% 2.9% 2.9% 2.2% 1.6% 2.5% 2.0%Industry beta (β) 1.45 1.26 0.99 1.51 1.40 1.34 1.63 1.42 1.38 1.38 1.39Risk premium (E(R m )-r f ) 4.7% 5.2% 5.1% 5.8% 5.3% 4.9% 5.0% 5.6% 6.2% 5.3% 5.9%Cost of equity (k e ) 9.9% 9.2% 7.8% 10.8% 10.0% 9.5% 11.0% 10.2% 10.2% 9.8% 10.2%Cost of debt (k d ) 4.6% 4.2% 4.3% 4.9% 5.0% 5.1% 3.8% 4.4% 4.4% 4.5% 4.7%Debt/Enterprise value (D/V) 47% 48% 40% 44% 36% 34% 54% 41% 39% 43% 42.5%Equity/Enterprise value (E/V) 53% 52% 60% 56% 64% 66% 46% 59% 61% 57% 57.5%Marginal tax income (T m ) 38% 35% 31% 33% 28% 23% 21% 24% 28% 29% 29.0%WACC 6.62% 6.07% 5.86% 7.50% 7.65% 7.65% 6.68% 7.41% 7.45% 7.02% 7.26%

Table 10: WACC estimation of Holcim LtdSource: 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 eq-

uity for Holcim Ltd. This model decomposes the risk of a stock into two components –


63 Fama-French three-factor model or the arbitrage pricing theory could have been used as well45


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 diver-

sifiable. The CAPM model defines a stock’s risk as its sensitivity to the stock market

and looks as follows,

E ( Ri )=r f + βi [E ( Rm )−rf ]

where E ( Ri ) shows Holcim Ltd’s expected return, r f indicates the risk free rate, β i de-

picts Holcim Ltd’s stock sensitivity to the market and E ( Rm ) shows the expected return

of the market. Whereas the risk free rate and the market risk premium ( E ( Rm )−r f) 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 re-

mains 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 10.

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 (E ( Rm )−r f). 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


65 www.suedostschweiz.ch/wirtschaft/snb-wird-leitzins-laut-schweizer-okonomen-ebenfalls-erhohen46

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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 cho-

sen 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%. How-

ever, 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 10 and shows a value of 5.9%.

4.1.3 The Beta

According to the CAPM equation, β i is a measure of the systematic risk of a stock com-

pared 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,



68 Daves, p. E., (2000). Estimating Systematic Risk: The Choice of Return Interval.47


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 observa-

tions. 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 11, one can see the enormous distinctions among

the different beta types (daily, monthly, weekly) for Holcim Ltd.

Three years daily returns

Two years weekly returns

Five years monthly returns

Adj Beta 0.814 1.072 1.189R2 0.228 0.448 0.493SE of Beta 0.049 0.124 0.169T-Stat 1.963 1.984 2.000Upper 95% 0.817 1.353 1.620Lower 95% 0.626 0.862 0.943

Table 11: Adjusted betas of Holcim LtdSource: Own design

Standard errors of beta decrease in consequence of using more observations in an obser-

vation 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 14 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 be-

tween 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.

69 Daves, p. E., (2000). Estimating Systematic Risk: The Choice of Return Interval.70 Merton R., (1980). On Estimating the Expected Return on the Market71 Koller, T., Goedhart, M., & David, W. (2005). Valuation Measuring and Managing the Value of Companies, p.

30972 Black, F., Jensen, M., Scholes, M. (1972). The Capital Asset Pricing Model: Some Empirical Tests73 Improving estimates of beta with adj. beta = (0.33) + (0.67) Raw Beta; (Koller et al, Valuation, p. 314)

48


Figure 14: Rolling beta (five years monthly returns)Source: Own design

However, as stated in the theoretical outline and as it can be seen in Table 11, estimat-

ing 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 or-

der to improve the precision of cost of equity, industry betas have been used. Using in-

dustry 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 oper-

ating 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 in-

dicator 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 (

k d (1−T m )).

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

74 Koller, T., Goedhart, M., & David, W.(2005). Valuation Measuring and Managing the Value of Companies, p. 312

49


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 10.

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 10 results in cost of debt rates be-

tween 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 mar-

ket value of all claims against the enterprise value (market value of debt and equity). Fi-

nancial 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.

2002 2003 2004 2005 2006 2007 2008 2009 2010 ØDebt/Enterprise value (D/V) 47% 48% 40% 44% 36% 34% 54% 41% 39% 42.6%Equity/Enterprise value (E/V) 53% 52% 60% 56% 64% 66% 46% 59% 61% 57.4%

Table 12: Market capital structure of Holcim Ltd from 2002-2010Source: Own design

As shown in Table 12, 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

75 Koller, T., Goedhart, M., & David, W.(2005). Valuation Measuring and Managing the Value of Companies, p. 318

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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 manage-

ment 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 econ-

omy 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 assump-

tions 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 sce-

nario 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 pa-

rameters, 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 es-

timated 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

51


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 Eu-

rope and America are facing an ongoing price-pressure due to the reduced demand, rev-

enues are expected to grow in emerging markets such as India and China. As has al-

ready 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 rev-

enue 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. Conse-

quently, 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 im-

portant contribution to a favorable NOPLAT. However, the strong Swiss France com-

pared 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.

5.1.1.1 Valuation of Base Case Scenario

The moderate revenue growth in this scenario as well as the ongoing cost structure im-

provements due to reduced inefficiencies and fixed cost results in slightly increasing

NOPLAT figures as depicted in Table 13. The revenue growth as well as the EBITA

52


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%.

(in million CHF) 2011 2012 2013 2014 2015 2016-2025Revenue growth 3.5% 3.5% 4.0% 4.0% 4.5% 5.0%EBITA margin 14.1% 15.3% 15.9% 16.4% 17.0% 17.0%NOPLAT 2'314 2'593 2'790 2'992 3'228ROIC 6.0% 6.7% 7.1% 7.5% 8.0% 8.2%FCF 2'497 2'053 2'159 2'378 2'505WACC 7.26% 7.26% 7.26% 7.26% 7.26% 7.26%

Table 13: Key figures of base case scenarioSource: 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 bil-

lion. 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 ex-

cess 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 li-

abilities. 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 operat-

ing 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.


78 Ongoing-operating provisions are not included since they are taken into account in the CF calculation79 Input factors for the to the Black and Scholes model are to be found in the annual report 2010, p. 185

53


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 mat-

ter 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 produc-

tion 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 ef-

fects 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 reduc-

tion 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 trans-

lation effects.

5.1.2.1 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 14, 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

54


2015 and kept stable afterwards due to adjusted production processes. However, de-

creasing revenues and at the same time higher production costs inevitably lead to de-

creasing NOPLAT figures as shown in the figure below. A reduced NOPLAT and sta-

ble 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 con-

stantly exceed total revenues, pushing the company into severe financial difficulties.

(in million CHF) 2011 2012 2013 2014 2015 2016-2025Revenue growth 2.5% 2.0% 1.0% -2.0% -1.0% 1.0%EBITA margin 15.9% 16.0% 15.5% 13.2% 11.3% 11.3%NOPLAT 2'581 2'644 2'578 2'172 1'850ROIC 6.8% 7.0% 6.8% 5.8% 5.0% 5.0%FCF 3'221 2'517 2'664 2'843 2'113WACC 7.26% 7.26% 7.26% 7.26% 7.26% 7.26%

Table 14: Key figures of worst case scenarioSource: 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 oper-

ating value of CHF 17.8 billion for the worst case scenario. Excess marketable securi-

ties 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 provi-

sions 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

80 Ongoing-operating provisions are not included since they are taken into account in the CF calculation55


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 con-

sequence, 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 discov-

ery 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 in-

creased sales figures after 2015. Besides, the improved cost side affects NOPLAT posi-

tively. Since the invested capital will remain at the same level as for the base case sce-

nario, ROIC figures will improve significantly, showing a higher operating efficiency

and making the company more attractive for investors.

5.1.3.1 Valuation of Best Case Scenario

The best case scenario valuation follows the same logic as for the valuation of the other

two scenarios. Table 15 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 re-

quires 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 expe-

riencing 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

56


production. The higher the spread between these two figures, the more it works to the

advantage of the company and investors.

(in million CHF) 2011 2012 2013 2014 2015 2016-2025Revenue growth 4.0% 5.5% 5.5% 5.5% 6.5% 7.0%EBITA margin 14.2% 16.3% 16.3% 18.4% 19.0% 19.0%NOPLAT 2'332 2'820 2'976 3'517 3'861ROIC 6.1% 7.3% 7.5% 8.6% 9.3% 9.3%FCF 2'399 1'857 1'990 2'645 2'727WACC 7.26% 7.26% 7.26% 7.26% 7.26% 7.26%

Table 15: Key figures of best case scenarioSource: 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 invest-

ments 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 16:

Scenario Weight Stock Price in CHFBase Case 70% 71.24Worst Case 15% 12.54Best Case 15% 144.96Weighted Stock Price 100% 73.49

Table 16: Weighted stock price of Holcim Ltd

81 Ongoing-operating provisions are not included since they are taken into account in the CF calculation 57


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 out-

standing 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 enter-

prise 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 compa-

rable 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 per-

centage points and holding all other drivers constant reveals that the overall equity value

might be altered significantly.

-2% +2% -2% +2%Revenue growth -5.8 8.0 -25% 34%Adj. EBITA margin -9.5 9.5 -41% 41%ROIC -10.4 6.5 -45% 28%WACC 132.7 -17.0 570% -73%

Change in equity value in %Change in equity value in CHF bn

Table 17: Sensitivity analysis of the equity valueSource: Own design

As shown in Table 17, 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 ex-

58


plained 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 con-

tinuing 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 com-

pany.

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. Overes-

timating 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 delib-

erately not been calculated since these results are affected by a company’s capital struc-

ture which leads to false conclusions. The resulting multiples are presented in Table 18.

EV/Sales 2011(e) EV/Sales 2012(e) EV/EBITDA 2011(e) EV/EBITDA 2012(e) Holcim Ltd 1.68 1.57 7.97 7.00Cemex SA 1.26 1.18 7.30 6.29CRH PLC 0.83 0.79 8.25 7.02Lafarge SA 1.75 1.64 7.71 6.96Peer Group (Building Materials Industry) 1.49 1.37 7.55 6.76

Share price in CHF based on Lafarga SA multiples 63.96 64.55 54.71 58.09Share price in CHF based on peer group multiples 44.57 42.72 52.13 54.40

Table 18: Multiple analysisSource: 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 anal-

82 CV t=NOPLAT t+1(1− g

ROIC)

WACC−g

83 Lui, J., Nissim, D., & Thomas, J. (2002). Equity Valuation Using Multiples.84 www.infinancials.com

59

http://www.infinancials.com/


ysis, 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 lev-

els 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 expecta-

tions 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 tech-

nique 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 criti-

cism 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 fu-

ture 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 Ger-

many revealed that more than 50% of the investment decisions within a company con-

tain flexibility. That reveals the importance of the innovative Real Option Valuation

(ROV) approach. This approach follows the idea of the financial option theory and re-

search in this area is among topics of great importance in Finance.

85 Brosch, R. (2008). Portfolios of Real Options. 86 Leslie, K., Michaels, M. (1997). The real power of real options, p. 1187 Vollrath, R. (2003). Die Berücksichtigung von Handlungsflexibilität bei Investitionsentscheidungen, p. 68

60


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 demon-

strated, 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 5, 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 speak-

ing, the NPV can also be seen as the difference between the present value of an ex-

pected 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 posi-

tive. 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 in-

put factors are seen as static and do not change over time. However, the NPV can fluc-

tuate widely if the forecasted input factors are wide of the market. Thus, the NPV ap-

proach 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 Op-

tion 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 deci-

sions 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

88 Leslie, K., Michaels, M. (1997). The real power of real options, p. 1689 Koller, T., Goedhart, M., & David, W. (2005). Valuation Measuring and Managing the Value of Companies, p.

54361


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 inte-

grated information in the future reveals value, the investment will be pursued. Other-

wise, 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, Profes-

sors 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 con-

stant, 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 de-

cisions 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 ex-

pected 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 influ-

enced by any player directly. As a result, all players are exposed in the same way to a

90 Leslie, K., Michaels, M. (1997). The real power of real options, p. 691 Leslie, K., Michaels, M. (1997). The real power of real options, p. 6

62


change in this lever. Fifthly, the management is able to improve the option value by re-

ducing the present value of the cost structure. Sixthly, an extension of the option’s dura-

tion 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 con-

straints 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 ini-

tial 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 ex-

clusivity 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 im-

portance 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 develop-

ment 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 leav-

ing 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

92 Leslie, K., Michaels, M. (1997). The real power of real options, p. 793 Damodaran, A. (2002). Investment Valuation, p. 806

63


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 In-

dian 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 environ-

mental 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 6.2 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:

Year 2011 Year 2012 Year 2013 Year 2014 Year 2015 Year 2016 Year 2017Average price per ton in CHF 1.0% (growth rate) 86.40 87.26 88.14 89.02 89.91 90.81Cement sales in t tons 8.0% (growth rate) 10'564 11'409 12'322 13'307 14'372 15'522Revenue 912'715 995'589 1'085'989 1'184'597 1'292'158 1'409'486- Costs of Goods Sold -304'585 -332'241 -362'408 -395'315 -431'210 -470'363- Admin Expenses -258'310 -281'765 -307'349 -335'256 -365'697 -398'903- Other operating expenses -125'126 -136'488 -148'881 -162'399 -177'145 -193'230EBITDA 224'694 245'096 267'351 291'626 318'106 346'990- Tax -67'408 -73'529 -80'205 -87'488 -95'432 -104'097- Investment -1'701'632FCF 157'286 171'567 187'145 204'138 222'674 242'893Discount factor 0.847 0.717 0.607 0.514 0.436 0.369Continuing Value 2'700'310PV of FCF in t=0 133'208 123'060 113'686 105'025 97'024 1'086'107Cumulated PV of FCFs t=2011, …, 2017 1'658'110 1'957'813 1'826'791 1'708'135 1'601'120 1'505'094 2'943'203NPV in TCHF -43'522

30.0%

18.08%

amounts in TCHF

33.4%28.3%13.7%

Table 19: DCF calculation of the investment project in IndiaSource: 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 approxi-

94 www.indiainbusiness.nic.in/industry-infrastructure/industrial-sectors/Cement.htm95 www.equitymaster.com/research-it/sector-info/cement/96 www.aggregateresearch.com/articles/22160/Holcim-now-has-a-simple-majority-in-ACC-and-Ambuja.aspx

64

http://www.aggregateresearch.com/articles/22160/Holcim-now-has-a-simple-majority-in-ACC-and-Ambuja.aspx

http://www.equitymaster.com/research-it/sector-info/cement/

http://www.indiainbusiness.nic.in/industry-infrastructure/industrial-sectors/Cement.htm


mately 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 calcu-

lated. 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 4. Overall, this cash inflows and outflows re-

sult 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 op-

tion 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 fluctua-

tions 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 gov-

ernmental 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 applica-

97 Rai, S., Dwivedi, S. (2011). Impact of Global Recession on the Indian Cement Industry, p. 3998 www.business.mapsofindia.com/india-tax/corporate-rate.html99 www.tradingeconomics.com/india/government-bond-yield

65

http://www.tradingeconomics.com/india/government-bond-yield


tion 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 reli-

able 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 es-

timated by simulations. According to Professor Damodaran, a standard deviation in firm

values of 54.57% in the Building Materials Industry is reasonable. However, since mar-

ket data from the Indian cement market is available, a Monte-Carlo-Simulation is intro-

duced 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 19 Table 19: 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 volatil-

ity of the cash flow. The following equation was used to calculate the corresponding

volatility of the price and the quantity.

σ=∑t=1

n

rt−ln ( xTlow

X 0)

2√T

rt stands for the annual growth rate of 1% for the price or 8% for the quantity sold, re-

spectively. 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. xTlow

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 X 0 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 acquisi-

100 Ernst, D., Schneider, S., Thielen, B. (2006). Unternehmensbewertungen erstellen und verstehen, p. 260

101 ICICISecurities (04/2008). Equity Research - India Cement Sector. 66


tion stake which results in a quantity of 10.500 million tons. Solving the above men-

tioned 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.

lim ¿up [ P2017 ]=P2012 e∑r t+2σ √T=86.40 e5 ×1%+2×13.98 %√5=CHF 169 . 75¿

lim ¿down [P2017 ]=P2012 e∑ rt−2 σ √T=86.40 e5 ×1 %−2 ×13.98 %√5=CHF 48 .60¿

lim ¿up [ P2016 ]=P2012 e∑r t+2 σ √T=86.40 e4 × 1%+2 × 13.98%√4=CHF 157 .33¿

lim ¿down [P2016 ]=P2012 e∑ rt−2 σ √T=86.40 e4 ×1 %−2× 13.98% √4=CHF 51 .40¿

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 19. 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 nor-

mal 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.

E [ ln(PV 2012

PV 2011 )]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 simula-

tion can be examined in Appendix 12.67


6.3.3 Valuation

Having calculated all input factors, the next step in the valuation process of the real op-

tion is to model an event tree. The event tree simply shows how the value of the under-

lying asset (cash flow) develops over time facing different up or down movements.

Year 2011 Year 2012 Year 2013 Year 2014 Year 2015 Year 2016 Year 201717'033'188

11'552'6657'835'531 7'835'531

5'314'405 5'314'4053'604'466 3'604'466 3'604'466

2'444'709 2'444'709 2'444'7091'658'110 1'658'110 1'658'110 1'658'110

1'124'604 1'124'604 1'124'604762'756 762'756 762'756

517'335 517'335350'880 350'880

237'982161'410

all values in tCHF

Figure 15: Event tree without flexibilitySource: Own design

Figure 15 illustrates the value of the underlying assets of the project for each of next

seven years. As shown in the DCF calculation in Table 19, 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 formu-

las102:

Up Movement (u )=eσ √T=e0.388√1=1 .4744

Down Movement (d )=1u= 1

1.4744=0 . 6782

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 in-

corporate 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 manage-102 Cox, J., Rubinstein, M., Ross, S. (1979). Option Pricing: A Simplified Approach.

103 Upward probability=( [1+R k ]T−d )

(u−d )=

([ 1+.188 ]1−0.6782 )(1.4744−0.6782 )

=0.6311

68


ment has the option to expand in the Indian market by investing another CHF 100 mil-

lion. 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.

Year 2011 Year 2012 Year 2013 Year 2014 Year 2015 Year 2016 Year 201718'636'507

12'615'5878'533'808 8'519'084

5'767'098 5'753'5013'892'193 3'879'637 3'864'912

2'622'028 2'610'432 2'596'8351'761'910 1'751'202 1'738'646 1'723'921

1'169'912 1'158'317 1'144'720766'313 753'757 739'032

490'322 476'724300'692 285'968

169'43677'551

all values in tCHF

Figure 16: Decision tree incorporating an option to expandSource: 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:

upward probability (q )=1+r f −d

u−d=1+8.29 %−0.6782

1.4744−0.6782=0 .5083

downward probability (1−q )=1−0.5083=0 .4917

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:

Value of decision point t=Upmovement t+1∗q+down movement t+1∗(1−q)

1+r f

Value of decision point2016=18.636∗0.5083+8.519∗0.4917

1+0.0829=12 .615

69


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 in-

creased 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 Ap-

pendix 13.

Solely conducting the NPV method, the managerial flexibility would have been as-

sumed 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 In-

dian 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 Lim-

ited. This emphasizes the importance of incorporating and analyzing the value of flexi-

bility in investment projects.

7 Conclusion

Strategic Analysis

This analysis reveals that Holcim Ltd is one of the big players within the Building Ma-

terials Industry and clearly follows a strategy of growth with ongoing expansions espe-

cially 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 ex-

pected to increase. Hence, this strategy is seen as advantageous. Furthermore, the com-

pany 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 posi-

tioning 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 70


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 im-

provements 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

71


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 underval-

ued. 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 Hol-

cim 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 sen-

tient 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 fac-

tors 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 al-

ready 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 invest-

ment 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 empha-

sizes 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 con-

clusion 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.

72


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pure.au.dkpure.au.dk/portal/files/38900131/7._master_thesis_final_… · web viewthe company is...

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