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Paving the way for growth at Martin Marietta

admin | July 26, 2019

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

A solid second quarter at Vulcan Materials bodes well for closest peer Martin Marietta Materials, who reports results 7/30/2019. Vulcan’s 2Q results were underscored by good growth in aggregates shipments, which is Martin Marietta’s largest business unit, and was their key growth driver in 1Q. MLM bonds in the 7-year part of the curve could outperform those of VMC if they post another solid quarter of growth.

Relative value on the curve

After strong fiscal 1Q results due to pent up and demand and favorable weather conditions and its closest peer (Vulcan Materials – VMC – Baa3/BBB/BBB-) posting a solid 2Q this week, Martin Marietta Materials (MLM-Baa3/BBB+/BBB) looks poised for another quarter of solid growth. As such, there is value in the 7-year part of the curve, where MLM 3.45% 6/1/27 bonds are currently trading around at +143 bp (3.51% yield/ +151 bp g-spread). The VMC 3.9% 4/1/27 bonds are trading at +133 bp (3.41% yield/ +143 bp g-spread). In the 30-yearr part of the curve, the trading relationship is reversed with MLM trading roughly 5 bp through VMC (Exhibit 1). MLM is set to report 2Q results on 7/30/19.

Exhibit 1: MLM vs VMC 7-year to 30-year curve

Source: Bloomberg, Amherst Pierpont Securities

Aggregates driving growth

VMC’s 2Q results were underscored by good growth in aggregates shipments (up 4% year over year) and pricing (up 5.9% year over year), which translated to improved profitability per ton (up 11% year over year). Aggregates is MLM’s largest business unit, representing nearly 56% of revenues and 63% of gross profit. Aggregates was the key growth driver for MLM’s 1Q results having posted volume and pricing growth of 12.5% and 4%, respectively. Higher shipment and production levels in aggregates provided for improved operating leverage. Coupled with higher prices, MLM witnessed a 550 bp margin expansion (to 18%) in 1Q for the unit. The strong margin performance more than offset margin declines in cement, ready mixed concrete and asphalt/paving. That said, MLM was able to post combined gross margin growth of 140 bp (to 15.2%) during the quarter.

Exhibit 2: MLM revenues and gross profitability by business (1Q19)

Source: MLM company reports

Aggregates continue to benefit from robust growth in public construction demand, particularly highways, driven by funding provided by the Fixing America’s Surface and Transportation Act (FAST). Furthermore, state and local funding initiatives for streets and highways are also fueling demand. All of MLM’s top 10 states, which accounted for roughly 85% of total building material revenues in 2018, have introduced incremental transportation funding measures in the last five years.

Leverage improving after Bluegrass acquisition

MLM’s leverage ticked up to 3.3x after the close of the Bluegrass acquisition in April 2018. Bluegrass was MLM’s second largest acquisition in its history and helped to provide MLM with a stronger foothold in the mid-Atlantic and Southeast regions, both of which have been witnessing strong construction growth. As of 1Q19, leverage declined to 2.7x primarily due to EBITDA growth. Management targets a leverage ratio of 2.0x-2.5x and has noted that they plan to return to their leverage range by year end 2019, as debt reduction remains a priority for cash use. As of 3/31/19, MLM had $360 million of short term debt consisting of $300 million maturing on 12/20/19 and some debt outstanding under the revolver. Should MLM repay the $300 million of debt maturing in December, leverage would fall comfortably within its target range (~2.3x). MLM is estimated to generate ~$540 million of free cash flow for the rest of the year, which is more than enough to cover dividends of roughly $90 million and repay the maturity.

Moody’s revises outlook to stable

MLM’s outlook was recently revised to stable from negative at Moody’s due to the improved leverage since the close of Bluegrass. The stable outlook incorporates the expectation for further deleveraging over the next 12 months to the mid-2.0x range. Moody’s has noted that they believe MLM is committed to maintaining a strong credit profile and its IG ratings. Moody’s also notes that the rating reflects the company’s solid operating margins and consistent strong free cash flow. According to Moody’s, MLM’s ratings could be upgraded should the following metrics be sustained throughout the construction cycle: adjusted operating margin over 18%, adjusted debt/EBITDA below 2.5x, adjusted debt/book capitalization below 30%, adjusted EBIT/interest expense above 6.0x, and retained cash flow as a percentage of net debt above 35%.

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