Vulcan Materials Company Recommendation
BUY Key Information NYSE:
VMC
Current Price
$81.37
Fair Value
$97.00
2018 Target Price
$133.00
Annual Return
17%
Market Cap.
10.78B
2014 EPS
$1.54
2018 EPS
$5.21
2014 Gross Margin
20%
2018 Gross Margin
31%
Industry Average Gross Margin
43%
2014 Debt/EBITDA
3.4
2018 Debt/EBITDA
0.6
USF
MUMA
COLLEGE OF BUSINESS UNIVERSITY OF SOUTH FLORIDA
Company Overview Vulcan Materials Company is the nation’s largest producer of construction aggregates and a major producer of aggregates-based construction materials including asphalt and ready-mixed concrete. VMC’s products are used in nearly all forms of construction and are particularly important in the building and repair of infrastructure. Its business segments are Aggregates, Asphalt Mix, Concrete, and Calcium.
One Year Performance
Investment Thesis
Catalysts
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Materials Demand Inelasticity VMC’s products are integral to the construction and repair of infrastructure. However, there is resistance to opening new quarries. This leads to a supply-demand imbalance and price appreciation.
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Increased Infrastructure Spending The United States government has announced plans to significantly increase infrastructure spending.
Infrastructure Deterioration Infrastructure throughout the United States is in need of serious repair. The American Society of Civil Engineers rated the health of U.S. infrastructure as a D+. The society estimates $3.6 trillion must be invested by 2020 to complete vitally important repairs. VMC’s products are necessary in the repair of everything from bridges and roads to waterworks and ports. As a manufacturer of these required products, VMC will capitalize on ongoing and future infrastructure repairs.
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Pricing Power VMC is the largest supplier of aggregates in the nation, enabling significant pricing power. VMC’s materials have a long history of price appreciation.
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Strategic Geographic Positioning VMC operates from coast to coast, serving approximately 40% of U.S. states, including 7 of the 10 fastest growing states.
Risks •
Revenue Sensitivity Revenues are sensitive to government and private construction spending conditions.
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Seasonal Conditions Construction activity is impacted by weather conditions at both the local and national level.
Muma College of Business | Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
April 23, 2015
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Investment Thesis Infrastructure Deterioration Infrastructure throughout the U.S. is desperately in need of repairs. As alluded to on the first page, the American Society of Civil Engineers performed a detailed analysis of U.S. infrastructure in 2013. Overall, the country received a D+ rating. Of particular note to VMC are the D ratings of the country’s dams, drinking water facilities, wastewater facilities, and roads. Ports received a C and the country’s bridges and rail system received a slightly better, but still troubling, C+. All this deficient infrastructure will require immense amount of aggregates as part of their repair. Concrete and asphalt will also be key to the required repairs. These extensive projects will drive demand for VMC’s products. These repairs must be made, the only real question is when. State and local governments have been funding projects and certainly boosting demand, but federal funding would be a huge boon for VMC. Though nothing has been officially agreed upon, we see reason for increased federal funding during our investment horizon. The first and likely the strongest support for federal funding is jobs. We were unable to find a truly concrete or unbiased projection of the jobs this funding would create, but it is quite clear that an impressive number of workers would be needed to complete all necessary repairs. Second, improved infrastructure would add efficiency throughout the country, reducing time spent in traffic, time and money spent making repairs to structures truly in need of replacement, potentially leading to improvements throughout the economy. Despite the uncertainly surrounding federal funding, we are confident that statewide and municipal projects will continue to have a positive effect on demand for VMC’s products.
Construction Recovery Based on economic analysis, which is discussed in greater depth later on in the report, we foresee continued improvement in construction. In addition to continuing improvement, we expect this construction cycle to be of significant length. This opinion was developed after examining previous construction cycles. We noticed a couple commonalities to the end of these previous cycles. The first is inflation and the second is the responding interest rate increases that are meant to keep inflation in check. Given these two variables, the current inflation numbers and the seemingly perpetual promise of rate hikes, runaway inflation and the corresponding construction dampening rate hikes seem quite unlikely in the near term. As a significant portion of VMC’s revenue comes from construction, this long-winded cycle will drive a substantial up-tick in demand for VMCs products.
Pricing Power There is resistance to opening new quarries. The “not in my backyard” mentality is keeping new quarries from popping up in stone rich areas. With no new quarries opening, demand rising, and no substitute, prices will increase significantly. During the last construction cycle, VMC saw aggregate prices increase around 7% annually. These price increases, combined with growing sales and margin expansion ramp up VMC’s profits dramatically. The combination of these factors will almost double VMC’s profit per ton of aggregates over our investment horizon.
Strategic Geographic Positioning The final piece of our thesis is the location of VMC’s operations. VMC’s operates in 7 of the 10 most rapidly growing states in the country. Their presence in these markets will allow VMC to get the most out of the increasing demand for their products.
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17% Business Overview
Vulcan Materials Company
Construction Aggregates The Vulcan Materials Company is the largest producer of aggregates in the United States. The aggregates business segment accounts for 78% of total revenue. Aggregates are a collection of granular materials used in construction. Aggregates include sand, stone, and gravel, and although they are natural resources, production of these materials involves the use of explosives, hydrocarbon fuels and electric power. Aggregates are produced from natural deposits such as granite, limestone, and trap rock. These materials are mined from quarries on land that Vulcan owns or operates.
The quarrying process entails drilling and blasting the rock into smaller pieces. Next, the materials go through a crushing and screening process to produce the various sizes and specifications needed by customers. The transportation of aggregates is very costly, thus Vulcan has quarries located in strategic locations where they can be transported by rail, barge, or ship. Vulcan has operating facilities across the U.S., Mexico and the Bahamas. A key business strategy of Vulcan is to have quarries located in the U.S. where the population is expected to grow at an above average rate, thereby increasing the demand for construction. Aggregates are used in virtually all types of construction and in the production of asphalt mix, and ready-mixed concrete. Vulcan serves both the public and private sectors. In 2014, publicly funded construction products accounted for 50% of sales volume in the aggregates segment. Vulcan currently serves 20 states, Washington D.C. and other local markets in Mexico and the Bahamas. Construction aggregates are used in a variety of ways, which include use as a base material underneath highways, railroads, airport runways, parking lots and walkways. Aggregates are also used in the water filtration and purification process, and aid in erosion control. Additionally, construction aggregates mixed together with other raw materials also form the foundation of houses, apartments, schools, hospitals, roads, bridges, commercial buildings and retail space, sewer systems and airports. Vulcan has the largest proven reserves of aggregates in the U.S., currently totaling an estimated 15.8 billion tons. The only quarry that contributed more than 5% of total revenues in 2014 was the facility located in Playa del Carmen, Mexico. Moreover, Vulcan’s customer base is large and not one customer accounts for more than 2% of Vulcan’s total revenue.
Asphalt Paving Materials Vulcan produces and sells asphalt mix in Arizona, California, New Mexico and Texas. It is a leading producer of hot mix asphalt paving mixtures, which are used in paving surfaces such as roads, highways, parking lots, driveways, walking trails and bike trails. Vulcan produces the asphalt mix in 38 facilities it owns and operates in the Southern and Western regions of the U.S. The asphalt segment accounted for 15% of Vulcan’s total revenues in 2014. The production of asphalt mix is heavily dependent on aggregates, as it is a major component of the mixture. Approximately 95% of asphalt mix is comprised of aggregates. The asphalt segment is essentially a customer of the aggregates business segment. Delivery of the asphalt mix is typically done in close proximity to the facility, as asphalt mix hardens rapidly. Vulcan serves its customers through the local production facilities.
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Business Overview, continued Ready-Mixed Concrete Vulcan is a significant producer of ready-mixed concrete, which is also known as Portland cement concrete. The concrete business segment accounted for approximately 13% of revenues in 2014. Ready-mixed concrete is comprised of fine and coarse aggregates, cementitious binders, and water. Ready-mixed concrete is used to construct highways, bridges, dams, buildings, airports, tunnels, sewer systems, the foundation of homes and driveways and sidewalks. The ready-mixed concrete business segment is also reliant on the aggregates business segment, as approximately 78% of ready-mixed concrete consists of aggregates. This business segment also serves as a customer of the construction aggregates segment. Vulcan serves its concrete customers in local markets, as ready-mixed concrete hardens quickly. Vulcan owns and operates 65 ready-mixed concrete facilities located in California, Georgia, Maryland, New Mexico, Texas, Virginia, the District of Columbia and the Bahamas. The ready-mixed concrete is usually transported from local production facilities via truck.
Calcium To a lesser extent of operations, Vulcan produces calcium products from a limestone quarry located in Brooksville, Florida. The calcium segment of business operations accounted for 0.54% of total revenues in 2014. High quality calcium carbonate (CaCO3) material is mined from the limestone quarry and is intended for use in end-use products such as animal feed, paint, plastics, and water treatment. Vulcan also produces agricultural limestone, also known as aglime. Aglime is typically used in areas that experience moderate to heavy rainfall, as it helps neutralize soil that may be highly acidic due to rainfall. Aglime is also proven to increase the efficiency of fertilizer nutrients and the effectiveness of herbicides. Calcium is considered an inexpensive alternative to other components that may be used in the aforementioned end-use products.
2014 Revenue breakdown
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17% Macro Analysis Total private nonresidential construction spending increased 3.0% from 2006 to 2014. We backtested VMC revenue results to total nonresidential construction spending and found a 0.80 correlation using 10 years of data. We expect total nonresidential construction to grow at its fouryear average growth rate of 8.2% to 2018. Even if this expectation is not met, VMC still benefits from any growth as its addressable market grows.
Vulcan Materials Company
Total Construction Spending
New, private housing building permits authorized have trended upward since 2008. Assuming permits authorization continues to grow 5% annually, we expect the amount to return to its historical trend by 2018. VMC revenues have historically yielded a 0.63 correlation to new private housing building permits authorized. Since the housing crash, new single-family homes sold in the United States has modestly recovered. U.S. Census observations exhibit a slight positive change in the trend of new home sales. The correlation coefficient between VMC revenues and new single-family homes sold in the United States is 0.71. We anticipate that permits authorized will continue to revert to its 50-year historical trend.
Nonresidential Construction Spending
VMC’s revenue also shows a strong correlation to total construction spending (0.90), total private construction spending: nonresidential (0.89), and total private construction spending: residential (0.72). All three indicators are recovering well since bottoming out. Total construction spending is in the process of regressing to its 20-year average, as Residential Construction Spending is total private construction spending: residential. The United States population is growing at a 3-year annual average of 0.73%. Much of the growth has been realized in the Southern region of the United States, which has grown at a 3-year annual average of 1.01%. Florida and Texas are the two largest growing states in the South with 3- year average growth rates of 1.23% and 1.56%, respectively. By 2020, Florida is projected to grow at an annualized rate of 9.8%, reaching an estimated population of 22.4 million. Texas is projected to grow at an annualized rate of 4.7% in the same time period, reaching a total population of 27.2 million.
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Market Overview
Source: United States Geological Survey and Analyst Estimates
To estimate VMC’s total addressable market, we examined cement production, consumption, and price in the United States and correlated them to VMC revenue results. Cement is a key ingredient in concrete. Using eight years of data, we found the correlation coefficients to be 0.85 (Cement Production to Revenue), 0.81 (Cement Consumption to Revenue), and 0.89 (Cement Price to Revenue). Our analysis and projections indicate that VMC currently owns approximately 38% of the total addressable market. We expect that by 2018 VMC’s market share will increase to approximately 47%.
Source: United States Geological Survey, Data is in thousands of metric tons
Upon inspecting the supply and demand characteristics of the industry, U.S. Cement Production has historically not met U.S. Cement Consumption. We see no changes in the industry that indicate this favorable imbalance will reverse. It is, however, quite possible that the production shortfall will increase as infrastructure projects are funded and commercial and residential construction continue their recovery.
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17%
Vulcan Materials Company
Company Analysis Vulcan Materials Company operates in 7 of the 10 states that are growing most rapidly. We expect Vulcan’s largest served states (TX, CA, FL) to increase from a combined population of 85.6 million in 2014 to 90.9 million by 2018. This implies a compound annual growth rate of approximately 1.52%. This growing population will place more stress on current infrastructure, necessitating repairs and new construction. These projects will fuel demand for the company’s products and drive substantial revenue growth in 2015 and 2016.
States Served By Vulcan Top 10 Highest Pop Growth States
Gross Margin Over the past four years, VMC experienced an increase in gross income as a percent of sales from 11% in 2011 to 20% in 2014. This increase resulted from strong sales growth relative to the growth of costs from 2011 to 2014. This trend is expected to continue as the company focuses on properties that have the most cost effective production. In addition to focusing on the most efficient properties, the company will receive a substantial tailwind from pricing increases. As a result of these factors, the company’s gross margin will grow to just under 31% by 2018.
Operating Margin Discipline throughout the product chain and cost saving initiatives will greatly reduce sales, general, and administrative costs. The company has a history of strong execution in terms of SG&A costs, reducing SG&A as a percent of sales from about 13% in 2010 to 9% in 2014. Continued execution will shrink the SG&A margin to just over 6% in 2018.
Competitive Moat & Price Appreciation VMC owns approximately 15.8 billion tons of aggregate reserves. Current zoning and permit regulations make it difficult for enterprises to expand or develop new quarries, thereby increasing the value of VMC’s existing reserves. This increase in value is recognized in increased product prices. Product prices have significantly outpaced PPI growth, growing 5.1% annually, compared to the PPI’s 4.4%.
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Competitive Analysis Our analysis of the industry unearthed the firms that operate with similar business models to VMC. These firms are Martin Marietta [MLM], Eagle Materials, Inc. [EXP], and CRH PLC [CRH]. Martin Marietta is the second largest aggregates producer in the United States, making it VMC’s closest competitor. Martin Marietta has approximately 300 operations and competes in similar markets as VMC. Eagle Materials, Inc. is a provider of building materials in the United States. The operations of EXP are segmented into Cement, Gypsum Wallboard, Recycled Paperboard, Concrete and Aggregates, and Oil and Gas Proppants. Eagle Materials is regarded as a low cost producer in the industry. CRH PLC manufactures and distributes building materials. CRH has a global footprint, 46% of revenues are derived from Europe and the remainder is from the Americas. CRH generates revenues from five segments, Distribution, Materials, Heavyside, Products, and Lightside. In 2010, VMC reported the lowest operating margin against its peers, at -0.57%, and executed in recording the second highest margin in 2014 at 11%. Relative to its peers, VMC reported the most impressive operating margin growth from 2006 to 2014. The company’s 5-year average for margin growth is -89% while the 3-year average is 66%. The only company with more rapid margin growth over this 3-year period was CRH.
Operating Margin
VMC also reported the largest growth in net margin. Its 3-year average net margin growth is 169.5% and its 5-year average is 9.6%, accounting for a 159.9% increase. This is more impressive when we note that the 9-year net margin growth average is -131.0%. No other identified competitor came close to reporting similar results.
Net Margin
VMC’s existing operations are located in an ideal geographic areas throughout the United States. We expect the population growth in VMC’s served markets to support increased demand and price appreciation. VMC’s prices are greatly influenced by demand, not costs. Along with the location of VMC’s operations, our investment will benefit from the industry’s high barriers to entry. Quarry permits are difficult to obtain and even if a new competitor obtains a permit, it will be difficult for the new entrant to establish a competitive distribution network.
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17%
Vulcan Materials Company
Management J. Thomas Hill Tom Hill, 55, joined Vulcan Materials in 1979 and over the span of his 25-year career at the firm he has held many management positions. Hill has served as President and Chief Executive Officer since July 14, 2014. Prior to his current role, Hill formerly served as the Chief Operating Officer and Executive Vice President at Vulcan. Mr. Hill is a graduate of the University of Pittsburgh and the Wharton School of Business, Executive Management Program.
John R. McPherson John McPherson, 46, has served as the Executive Vice President, Chief Financial and Strategy Officer since July 2014. Prior to his current role, he served as the Senior Vice President of Vulcan’s East Region. He joined Vulcan in 2011 as the Senior Vice President of Strategy and Business Development. Prior to joining Vulcan, Mr. McPherson was a Managing Partner at McKinsey & Company and previously an Investment Banker at Goldman Sachs in New York and Hong Kong. McPherson earned a Bachelor of Science and a Master of Business Administration from Stanford University.
C. Wes Burton, Jr. Wes Burton, 48, currently holds the position of Vice President and Treasurer at Vulcan Materials Company. Prior to joining Vulcan in May 2011, Burton was a Management Consultant with the Enterprise Performance Management Strategy practice group of Accenture, LLP. Mr. Burton brings with him more than 20 years of corporate finance experience having covered the building products, building services, and retail industry sectors at 2 different banks. Mr. Burton earned a Bachelor of Science in Management with a concentration in Business and Finance from Georgia Tech.
Scott L. McCaleb Scott McCaleb, 62, currently serves as President of Vulcan Lands. He previously served as Vice President of Vulcan’s South Region. Prior to joining Vulcan, Mr. McCaleb served as the Vice President of Corporate Development for Florida Rock Industries since 2002. McCaleb obtained a Bachelor of Science in Finance and Real Estate from Florida State University.
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Valuation After analysis of the many factors affecting VMC’s revenues, most importantly demand and price appreciation, and margins, which costs could be controlled and to what ability, we forecasted VMC’s income through 2018. Following the forecast of revenues, we employed multiple models to determine both intrinsic value and a 2018 target price. The first model employed was a free cash flow to equity model:
In calculating the intrinsic value, a terminal value, based off our EV/EBITDA model, of $133.00 was used. Although we feel the discount rate derived by CAPM to be appropriate and accurate, the table below shows intrinsic values based on a variety of discount rates. As the table shows, even with a discount rate as high as 15%, the stock is undervalued.
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17%
Vulcan Materials Company
Valuation The second model employed was an EV/EBITDA model. Historically the company’s multiple has shrunk as construction cycles accelerate. To account for this trend, we shrunk the terminal multiple to VMC’s 10 year average forward EV/EBITDA multiple of 12.9.
This model was also used to calculate a bull and bear scenario based on increased/decreased revenues, cost of sales and SG&A. The full model can be found in the appendix. VMC has a true value of $97.00. Our 2018 target price is $133.00, which represents a 17% annual return.
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Appendix - Analysts Jonnathan De Jesus Jonnathan De Jesus, a native of Bayamon, Puerto Rico, is fluent in English and Spanish. Through the Applied Securities Analysis program, De Jesus has learned much about how to properly interact with others, how to present himself in a professional manner, and how to handle uncertainty. He aspires to work as a portfolio manager and plans to start his own fund.
Daniel Dorman A native of Denver, Colo., Daniel Dorman spent most of his childhood in Bradenton, Fla. Dorman is a senior at USF majoring in finance and management. Dorman is passionate about equity investment and has maintained a paper portfolio for more than two years. Dorman currently interns at National Investment Services' Sarasota office. Prior to entering the Applied Securities Analysis program, Dorman spent a year as a department manager for Barnes & Noble College, the book retailer's collegiate division.
Bianca Rodriguez Bianca Rodriguez is passionate about the global financial markets. This passion led her to pursue a degree in finance. As a full-time student with a full-time job, Rodriguez has maintained a 3.85 GPA in her major while managing a dental practice that generates more than $1 million in revenue annually. When Rodriguez isn't analyzing the markets, she enjoys watching sports and traveling. Upon graduation in May 2015, she aspires to earn the CFA designation.
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17%
Vulcan Materials Company
Appendix
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
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Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Appendix
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Muma College of Business | Student Managed Investment Fund
Recommendation: BUY | Target Price: $133 |Expected Return 17%
Vulcan Materials Company
Appendix
Analysts: Jonnathan De Jesus, Daniel Dorman, Bianca Rodriguez
15
Vulcan Materials Company
NYSE: VMC | April 23, 2015 | Price: $82 | Fair Value: $97
Appendix
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Muma College of Business | Student Managed Investment Fund