Economics Pulse: Construction Materials Update

The second quarter of 2015 was largely positive for the construction materials sector. Summit Materials is performing well in the public market place, stock performance has improved and volume indications are on the rise owing to the private sector. The one unknown that remains is whether Congress will produce legislation to address the long-term funding of our nation’s highway infrastructure.

Summit Materials’ stock has performed very well, through the end of June. It’s up more than 20 percent in its first three months of trading. The company’s management team remains quite proactive in the acquisitions market and has a notable piece of theHolcim/Lafarge divestiture program with the purchase of seven terminals located along the Mississippi River.

CM Index stock performance

While the index remains behind the broader market over a 10-year period and one-year period, the CM Index companies have vastly outperformed the broader market over the past six months. The successful IPO of Summit Materials, approval of the Holcim/Lafarge merger and belief that a highway bill would come out of the Senate are all factors in the rise to date.

Stock valuations for the top public companies have followed a strong trend line since the fall of 2008. When the enterprise value to EBITDA ratio rises to the levels of today, it implies that investors believe in the growth story for an industry. Because the stock market is a leading indicator of economic performance, this is a good sign in the near term for the materials sector.

Earnings through the second quarter of 2015 have been very similar to 2014. Given the harshness of the winter throughout the United States, this is likely a good sign for the year-end results and an expected increase in the fiscal year 2015 results is expected.

Operating performance

As illustrated in Figure 4, the last 12 months have seen positive earnings results for companies in the CM Index. We would expect an uptick for those companies involved in transactions requiring debt financing in the return on equity results, as long as they see positive results from those opportunities. The debt levels in Figure 8 remain a key discussion point among the public companies. Maintaining ratios that satisfy bank covenants is a key capital consideration as the Federal Reserve has indicated rates may begin to rise in 2015.

Market drivers

The outlook for residential construction remains strong and private sector construction is driving the earnings for materials companies in multiple markets. While consistently improving, the market remains a fraction of the highs in 2006-07.

A federal highway bill remains the most important consideration for the sector in the coming months. In late June, the Senate introduced another six-year funding plan that is slightly above historical levels of spending. If Congress cannot commit and passes another short-term bill to bridge the gap in funding, it will be the 34th time in the last six years that states and private companies reliant on highway funding will be forced to make decisions without a commitment from Congress.

The ability to forecast consistent spending and address major road infrastructure issues across the United States would greatly impact the outlook for the sector. As of press time, the current funding legislation was set to expire on July 31st and the Central Budgeting Office has warned that federal payments could be in danger if legislation is not completed.

Flow of investment capital

During the run-up to the housing crash in 2006-07, the United States was one of the most attractive markets for investment capital in the materials sector. With consistent cash flows, significant equipment assets and material reserves, the ability to assess risk and value the operations made the sector a prime target. Following the downturn, global capital found better alternatives in emerging markets and high growth markets like the BRICs (Brazil, Russia, India and China)

However, recent current events and the improvement in the U.S. economy have tilted the scales back toward the United States. According to data from the World Bank, China has experienced a reduction in its GDP growth rate from an average of more than 9 percent for the past 15 years to about 7 percent today.

The European Union has experienced significant challenges with growth and financing owing to the debt and employment challenges in Greece and Spain. Brazil has also experienced challenges due to the reduction in economic growth from 10 percent in 2010 to almost 0 percent today and to recent corruption allegations among some of their largest private companies.

The United States offers growth in residential construction, reasonable highway funding, qualified labor and a fragmented market that could still benefit from consolidation.

Recent announced transactions

The acquisition climate in the United State continues to be bolt-on transactions in highly strategic markets. The platform acquisitions have been limited owing to activity by the major international players on the significant divestitures from Holcim and Lafarge and the ongoing integration of Martin Marietta and Texas Industries.

George Reddin is a managing director with FMI Capital Advisors Inc., FMI Corp.’s investment banking subsidiary. He specializes in mergers and acquisitions and financial advisory services. www.fminet.com