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Highway spend driving strong aggregates growth
admin | November 1, 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.
After strong fiscal 1H results due to robust growth in public construction demand, particularly highways, Vulcan Materials Company (VMC) remains poised to post solid 3Q results when they report on 11/6/19. State-level funding increases signed into law over the past few years have led to a 21% increase in highway starts versus two years ago, which should support continued shipment growth into transportation-related end markets and favorable aggregates pricing. Martin Marietta Materials (MLM), VMC’s closest peer, posted strong 3Q results fueled by both aggregates shipments (up 12%) and aggregates pricing (up 5%). This bodes well for VMC and could tighten intermediate bond spreads between the two companies. The VMC 3.9% 4/1/2027 is currently trading at +129 bp g-spread, 6 bp behind MLM 3.45% 6/1/2027, though these bonds traded on top of each other in late July. Furthermore, VMC trades roughly 10 bp through MLM in 5yr CDS and nearly 15 bp through MLM in the 30-year part of the curve (Exhibit 1).
Exhibit 1. VMC vs MLM curve
Source: Bloomberg; Amherst Pierpont Securities
An aggregates focus
VMC remains the largest aggregates producer in the United States with MLM ranked second. While similar in size from a top line perspective, VMC generates roughly 74% of its revenues from aggregates compared to 50% at MLM. While product diversification tends to be viewed more favorably, we note that when it comes to aggregates, being keenly focused on the segment is actually a benefit. The reason behind this view lies in aggregates pricing. Over the past 40 years, aggregates pricing has continued to grow regardless of where we are in the cycle. Even when demand fell nearly 34% in the most recent economic downfall, pricing continued to increase. Pricing elasticity in aggregates is due to its high barriers to entry coupled with its flexibility in production capacity. Producing aggregates is a mechanical process of crushing, thereby allowing producers to take capacity up or down very quickly at minimal cost.
Exhibit 2. Aggregate price/demand 1979-2018
Note: Demand in billions of tons. Price is indexed (1982=100). Source: BLS and VMC estimates.
Strong state transportation funding
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. As such, VMC noted at its Aggregates Day last month that the next five years could result in the highest growth rate in highway demand across VMC’s footprint in the last 30 years. Currently 85% of VMC’s revenue base is derived from eleven states. Those eleven states combined are expected to increase highway spend by 60% on average. VMC’s two largest footprint states, California and Texas, are expected to increase highway spend by 140% and 130%, respectively. These two states alone account for 31% of VMC’s top line.
Exhibit 3. VMC’s revenue footprint by state
Source: VMC Aggregates Day presentation; Amherst Pierpont Securities
Leverage now within target range
Prior to being upgraded to investment grade, VMC’s leverage was 6.5x. At that time in 2Q13, VMC was rated Ba3/BB. Over the past six years, VMC has reduced leverage to 2.4x, within their 2.0x-2.5x target range; reduced overall debt outstanding and improved the structure and cost of debt to be appropriate for the company’s asset base through the cycle. The reduced leverage gives the company flexibility to fund growth as well as invest in the business. Over the aforementioned time period, VMC has improved ROIC by 770 bp, with adjusted EBITDA up 20% on CAGR basis.
Management has noted that given the cyclicality of the business, they will look to be at the lower end of their leverage target range should they begin to see the cycle turn. Leverage could decline lower than 2.4x when the company posts 3Q results due to strong EBITDA growth. Last quarter, EBITDA grew roughly 17% year-over-year and 3Q street estimates have EBITDA growth at roughly 18%. VMC’s leverage is roughly in line with MLM’s, which posted 2.3x debt/EBITDA for 3Q.
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