Vulcan Materials

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Business Description

Company: Vulcan Materials Company (NYSE: VMC) is the nation’s largest producer of construction aggregates – primarily crushed stone, sand and gravel – and a major producer of asphalt mix and ready-mixed concrete. Their materials are used in the construction and maintenance of infrastructure and other public projects. They are also used in the private sector in the construction of housing, commercial buildings, and industrial facilities. The company currently operates 344 aggregates facilities in over 20 states.

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Recent Performance

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News:

News A: On September 26, 2016 The first presidential debate between Hillary Clinton and trump, part of the debated outlined each of their individual plans for revitalizing the united states infrastructure. Clinton called for a plan costing between $275 billion and $400 billion. Trump called for a plan costing $1 trillion. Clinton had previously talked about her plans but this was the first time anyone had any idea what Trump was planning.

News B: On November 4, 2016 Vulcan Materials Company missed its earnings per share by 10.98% but caused little to no change in the stock’s price. On November 8, 2016 trump was elected president of the United States and in the following days the materials and construction industries increased in value. As VMC is positioned in the south and being the largest materials company is set to rake in a large quantity of this government spending but companies like Martin Marietta Materials that are much more concentrated in Texas had a higher reaction to Trump winning the election.

News C: On November 22, 2016 the Roland George program bought 548 shares at $128.00 per share based on the belief that the market hasn’t truly priced in the full effects of trumps plans, the ability of the industry leader to capitalize on this, and the long term stability of the industry growth rate.

News D: On January 25, 2017 trump signed an executive order to build a wall on the U.S. Mexico Border. This action solidified trumps statements of building a wall that will cost $10 billion but the industry estimates it will cost $25 billion. Congress has a reserve of $25 billion and is looking to acquirer $15 billion of that for this project. The market originally reacted strongly but during the following weeks it has become apparent that no planning has been done and no timelines are set up, the market is increasingly weary of what actions trump will take, which he will follow through with, and which are empty promises.

Business Breakdown:

Vulcan provides the basic materials used to build the roads, tunnels, bridges, railroads and airports that connect us, and to build the hospitals, churches, schools, shopping centers, and factories that are essential to our lives and the economy. Vulcan Materials breaks its business operations into three primary divisions.

1) Aggregates: Construction aggregates are used as a base material underneath highways, walkways, airport runways, parking lots and railroads. Also used to aid in water filtration, purification and erosion control. Aggregates have a high weight-to-value ratio and, in most cases, are produced near where they are used; if not, transportation can cost more than the materials, rendering them uncompetitive compared to locally produced materials.

2) Asphalt mix: Asphalt mix relies on reserves of aggregates, functioning essentially as a customer to the aggregates operations. Aggregates are a major component in asphalt mix, comprising approximately 95% by weight. Vulcan meets the aggregates requirements for Asphalt Mix segment primarily through the Aggregates segment. Asphalt mix is produced and sold in 4 states: Arizona, California, New Mexico and Texas.

3) Concrete: Concrete also relies the reserves of aggregates, functions as a customer to aggregates operations. Aggregates are a major component in ready-mixed concrete, comprising approximately 80% by weight. Ready-mixed concrete is produced and sold in Arizona, Georgia, Maryland, New Mexico, Texas, Virginia, Washington D.C. and the Bahamas.

Revenue Breakdown: As of 2015, 83% of the company’s revenue came from its aggregates segment, 12% came from its asphalt mix segment, and the remaining 5% came from the concrete segment. By states, VMC’s top ten revenue-producing states accounted for 83% of the company’s 2015 revenues, while the top five accounted for 59%.

Growth Strategies

Take advantage of being the largest producer: Vulcan is the largest aggregates company in the U.S., measured by shipments. The company’s 344 active aggregates facilities provide opportunities to standardize operating practices and procure equipment, parts, supplies and services in an efficient and cost-effective manner, both regionally and nationally. Every operation uses a similar group of assets to produce saleable aggregates and provide customer service.  Moreover, VMC is able to share best practices across the organization and leverage size for administrative support, customer service, accounting, procurement, technical support and engineering.

Coast-to-Coast Footprint: Demand for construction aggregates correlates positively with changes in population growth, household formation and employment. VMC pursues to increase their presence in metropolitan areas that are expected to grow the most rapidly. VMC currently serves nineteen of the top 25 highest-growth metropolitan areas. Over the next decade, Vulcan-served states are predicted to have 77% of the total population growth, 72% of household formation, and 64% of new jobs. VMC is positioned to capitalize in high growth areas.

VMC focuses on three major profit drivers:

1) Price for Service: Vulcan seeks to receive full and fair value for the quality of products and service provided. Vulcan’s price for service will continue to grow due to the fact that expanding margins have just begun to benefit from the mid-to-high single digit price gains associated with cyclical recoveries.

2) Operating Efficiency and Leverage: Vulcan focuses on rigorous cost management, small savings per ton add up to significant cost reductions. The company is operating a capital-intensive business at 55-60% capacity and are extremely well positioned to further leverage fixed costs to sales.

3) Sales and Production Mix: Vulcan actively manages inventories, which results in improved cost performance and an improved return on capital. As the recovery continues, Vulcan’s goal is to sell the entire production mix much more efficiently and at fuller value, as construction activity grows for years to come. 

Competitive Positioning

Growth in Vulcan-Served States: Long-term growth in demand for aggregates is largely driven by growth in population, jobs and households. While short- and medium-term demand for aggregates fluctuates with economic cycles. Vulcan aggregates reserves are strategically located throughout the United States in areas that are projected to grow faster than the national average and that require large amounts of aggregates to meet construction demand. Vulcan-served states are estimated to generate 77% of the total growth in U.S. population with 45% of that growth in California, Florida and Texas. Vulcan states also account for 72% of the total growth in U.S. household formations between 2015 and 2025 with 38% of that growth in CA, FL, and TX. Vulcan states will also account for 64% of employment growth with 32% of that growth in CA, FL, and TX. 2017 aggregates demand growth in top revenue producing states are as follows: Texas -2.60%, California 9.60%, Virginia 1.12%, Georgia 21.60%, Florida 34.00%, Tennessee 4%, Arizona 10.30%, Illinois -11.70%, North Carolina 7%, and Alabama 8.20%.

Profitable Growth: VMC has quality top-line growth that converts to higher-margin earnings and cash flow generation. Vulcan Materials Company has increased its TTM gross profit per ton by $2.22/ton or 87.06% since 2013. The company went from having gross profit per ton of $2.55 in 2013 to $4.77 in 2016. VMC has also increased its aggregates cash gross profit per ton from $4.19 in 2013 to $6.02 in 2016, representing an increase of 43.68%. The company is currently operating at 50-60% capacity and is extremely well positioned to capitalize on demand recovery, the company would net an aggregates cash gross profit per ton of $8.02 at normal demand. This signifies a 37.04% increase from current levels and a 96.90% increase from 2013. VMC’s profitable growth also comes from tightly managing its operational and overhead costs. The company increased its freight price per ton by $1.70 or 15.98% since 2013, having a freight price per ton of $10.64 in 2013 to $12.34 in 2016. VMC is actively seeking new opportunities to expand their existing portfolio of locations and operating margins in order to further enhance long-term earnings growth.

Strategically Located Assets: VMC is the largest aggregates company in the U.S, as measured by shipments. Being the largest, allows the company to benefit from sales in operations, procurement, and administrative support, along with its extensive and advantaged logistics network. VMC is also able to complement its business model with their complementary asphalt mix and concrete business in select markets. The company’s effective land management allows it to take prudent decisions regarding the life cycle management of the 120,000 acres of land they currently own. The company currently has 15.7 billion tons of permitted and proven or probable aggregates reserves. The bulk of these reserves are located in areas where with greater than average rates of growth in population, jobs and households, which require new infrastructure, housing, offices, schools and other development. Zoning and permitting regulations in some markets have made it increasingly difficult for the aggregates industry to expand existing quarries or to develop new quarries. These restrictions curtail expansion in certain areas, but they also increase the value of Vulcan’s reserves at existing locations.

Industry Overview

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Future Outlook: The U.S. has been averaging close to 2% growth per year for the past four years. The FAST act extends this growth for another 5 years and keeps the ratio of construction/GDP steady. According to the National Stone, Sand & Gravel Association (NSSGA), the FAST Act is expected to increase aggregates demand by 31 million of metric tons in 2017, 41 in 2018, 14 in 2019 and 2 in 2020. This increases total aggregates demand to 2400 M of Mtons in 2017, 2460 in 2018, 2480 in 2019, and finally to 2520 by 2020, thereby resulting in a 2%/year growth in aggregates consumption above normalized levels. The forecasted demand arising from the FAST Act is highly concentrated in the Non-Building segment in which highway spending is the major component. In 2016 there was an increase of 30 M of Mtons in 2017, but then the incremental impact reaches a maximum in 2018 with an increase of 50 M of Mtons, and normalizing at 1160 M of Mtons through 2020. This represents a 2.75% and 4.50% growth for 2017 and 2018, respectively. By 2020, the impact is very minor as expected inflationary price increases reduce the purchasing power of the additional funds allocated to highway spending. As of right now, the out years of 2019-2020 are not fully funded in the FAST Act.

Private Sector Construction: The private sector construction markets include both nonresidential building construction and residential construction and are considerably more cyclical than public construction. In 2015, privately funded construction accounted for approximately 51% of VMC’s total aggregates shipments.  The value of new private construction projects entering the pipeline were $90 billion in 2014, $152 billion in 2015, and $177 billion in 2016. The value of private projects increased by 16.45% in 2016. Overall demand in private construction is driven by job growth, vacancy rates, private infrastructure needs and demographic trends. Vulcan is strategically positioned to capitalize in high growths areas.

Federal Highway Funding: On December 4, 2015, the President signed a new, long-term federal highway bill into law titled Fixing America’s Surface Transportation Infrastructure Act (FAST Act). The Federal-Aid Highway Program is the largest component of the law and has provided, on average, 52% of all state capital investment in roads and bridges over the last 10 years. The FAST Act increases Federal-Aid Highway Program funding from $41 billion in the federal fiscal year (FFY) 2015 and growing about 2 percent a year to $47 billion in FFY 2020. The funding levels and five years of stability will help to rebuild America’s aging infrastructure and protect millions of jobs.

Risk Factors

Trump Infrastructure Spending: Donald Trump’s infrastructure plan is to spend $1 trillion over the next decade rebuilding the nation’s infrastructure. With VMC being the largest materials company the VMC is situated to capture the largest share of this. According to Trump, “Our roads and bridges are falling apart and our airports are in third-word condition”. Donald Trump has been characteristically vague on the amount of money annually spent, but has promised a $1 trillion investment. The Market has already priced in Hillary Clintons $400 billion spending plan and trumps wall so the all future growth is dependent on how much of trumps incredible vague plan is executed and how quickly it is executed. The market has priced in a 30% revenue growth rate and analyst estimate 40% but a full $1 trillion investment could push growth rates into the 50% rage over the next 2 years. The five year growth rate is estimated at 17.56% but growth is expected to hit close to 0% in 4 years because the difficulty of sustaining growth after this massive spending starts.

Highly competitive industry: Within VMC’s local markets, this may negatively impact prices, volumes and costs. The construction aggregates industry is highly fragmented with a large number of independent local producers in a number of markets. Additionally, in most markets, Vulcan competes against large private and public companies, some of which are significantly vertically integrated. Therefore, there is intense competition in a number of markets in which Vulcan operates. This significant competition could lead to lower prices and lower sales volumes in some markets, negatively affecting Vulcan’s earnings and cash flows.

Commodity Risk: VMC uses large amounts of electricity, diesel fuel, liquid asphalt and other petroleum-based resources that are subject to potential supply constraints and significant price fluctuation. This could affect operating results and profitability. In the production and distribution processes, VMC consumes significant amounts of electricity, diesel fuel, liquid asphalt and other petroleum-based resources. The availability and pricing of these resources are subject to market forces that are beyond the company’s control. Variability in the supply and prices of these resources could materially affect VMC’s operating results from period to period and rising costs could erode profitability.

Industry is capital intensive: This results in significant fixed and semi-fixed costs. Therefore, earnings are highly sensitive to changes in volume. Due to the high levels of fixed capital required for extracting and producing construction aggregates, profits and profit margins are negatively affected by significant decreases in volume.

Financial Analysis

Revenue growth: Vulcan Materials Company has grown its revenue by about 37.43% over the last 5 years, indicating an average growth of 6.7% year over year since 2011. One of its main competitors CEMEX (CX) grew revenues by 25.08% in the same time period. VMC revenue grew by 12.38% more than that of its competitor. VMC had revenues of (in billions) $2,406.90 in 2011, $2411.20 in 2012, $2628.70 in 2013, $2944.20 in 2014 and $3422.20 in 2015.

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Margins: VMC has increased gross profits by 14% in the last 5 years, compared to its competitor CX which only grew gross profits by 5.11% (Exhibit 5). CX has better margins due to it being a bigger company and leveraging their size to the industry’s high fixed costs. Vulcan had 11.07% gross profit in 2011, in comparison to 25.06% in 2015. The industry median is currently 32.1%. Vulcan has also increased operating income by 14% in the same time period; the company had 2.47% in 2011 in comparison to 16.07% last year.

Return on Equity: Since 2011, VMC increased their ROE by 7.3% in the last 5 years. The company had ROE of -1.9% in 2011 in comparison to 5.4% last year (Exhibit 6). Its competitor CX increased their ROE by 7.3% in the same time period, however, CX had ROE of -15.7% in 2011. Higher ROE on VMC’s part is a result of better financial leverage, higher return on invested capital, and higher asset turnover. This pattern of better fundaments seem to hold over time, demonstrating the company’s ability to remain profitable in the long- term.

Earnings: Vulcan Materials Company earnings history exhibits a trend of beating consensus estimates expectations. Although the company missed earnings the last two quarters, missing the second quarter by 10% with an estimated EPS of $1 and actual EPS $0.90, and the third quarter by 10.60% with estimated EPS of 1.12 and actual EPS of 1.13Missed earnings was due to below-trend shipment growth due to extremely wet weather and slower than expected large project starts. VMC beat earnings the 6 prior quarters, and had a 9.5% EPS surprise in 2015.

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Operating Cash flow: Net cash provided by operating activities was $503.4 million in 2015, a $243.1 million increase or 93.39% from $260.30 in 2014. Cash outflows from investing activities were $-309.70 million for 2015 compared to $238.3 in 2014, this is primarily attributed to strategic acquisitions. VMC purchased $289.3 worth of property, plant and equipment in 2015 with $.2 million of inflows originated from the sales proceeds of divested locations. In 2015, VMC purchased $485.1 million principal amount of outstanding debt and incurred charges of $67.1 million

Free Cash Flow: A more relevant measure of cash flow is free cash flow, which represents the deduction of property, plant & equipment purchases from net cash provided by operating activities. Since 2013, the company increased its free cash flow by 164%. VMC had free cash flow of $81.1 million, in comparison to $214.1 million last year. This demonstrates the company’s ability to take on future acquisitions. VMC has placed itself in a position in which it does not require to incur any additional debt for repaying its current liabilities and/or engaging in new expansion projects.

SAG to Sales: Vulcan Materials Company has positively leveraged selling, general, and administrative expenses to total revenues since the recovery (Exhibit 9). Since 2011, VMC has decreased its SAG expenses by 2.93%. The company had SAG expenses of 11.31% in 2011 compared to 8.38% in 2016. One of its main competitor CX has more than twice SAG expenses at 20.75% of total revenues. The company profitability improvement is consistent with longer range goals and SAG expenses of 6% at normal demand.

Total Debt: VMC total debt is primarily comprised of long-term notes with interest rate ranging from 1.75% to 10%. In addition, the company possesses bank credit accounts. VMC’s consolidated debt had a weighted average interest rate of 5.18% and 5.21%. The company decreased it total debt from 50.1% in 2008 to 30.8% last year, consisting of a 9% reduction in 2015 and 2016. In regards to debt to equity, VMC holds $2 billion in total debt outstanding, including $235 million of floating-rate borrowings, as of Q2 of 2016. The company’s debt-to-equity ratio of .44 is lower than some of its primary competitor and the industry at 1.14.

Pro Forma

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The Pro Forma Income Statement exhibited above was constructed to estimate Vulcan Materials Company revenues and earnings per share growth for the last two quarters of Fiscal 2016 and the four quarters of Fiscal 2017. All figures were calculated using a weighted average of personal projections derived from the information in the Financial Analysis section as well as historical growth records, management predictions, and analyst forecasts.

Revenue Growth: Revenue growth estimates for 2016 and 2017 were obtained from historical growth records on a seasonal basis and personal estimates based on the anticipated effects of the presidents plans to build a wall and infrastructure. Revenue growth was expected to continue its stable trend of 8-10% since the materials recovery in 2013, with slower growth than expected in 2016 due to below level aggregates shipments the industry faced during the year. The annual growth rate and all other projections were weighted in order to arrive to an estimated revenue growth of 5. 19.68% for 2016 and 2017.

Cost of Revenue: The cost of revenue as a percentage of revenue was calculated by averaging the proportions of each quarter year over year from the last two years. VMC’s cost of revenue has been fairly stable over time, ranging from 70% to 80%. Therefore, it is likely that this trend will continue throughout the remainder of 2016 and 2017, considering that the company has not stated any plans to alter its historical gross margin but if the materials industry ramps up production under the increased demand under trump.

Earnings per Share Growth: EPS growth projections were derived through the same methodology employed in the revenue growth computations. Personal estimates were obtained through careful observations of historical movements, the forecasted revenue growth figures, and by assuming a constant in shares outstanding. The estimated EPS and the actual EPS could widely defer based on the fact that estimates include trumps plans and highly depend on when actual execution of the projects start.

Analysis: VMC value is highly dependent on theorized projections on the value added to the industry from trumps prosed actions. Some analysts estimate 40% revenue growth for the 2 years following the start of his projects. Currently the stock has priced in a 25% growth rate but without any added government spending the industries growth rate was expected to be less than 10%. Even though the wall is enough to cover the difference in growth rates for VMC if the president’s actions are delayed or fall through the potential downside for VMC is massive On the other hand if the president fully acts on his promises there is still some upside to be gained. The wall is expected to cost $25billion and take 5-8 years and trump also promised a $1 trillion-dollar infrastructure spending over the next 10 years, this exceeded Clintons promise of $400 billion that is factored into the price of the stock already.  

Valuation

In this section, we estimate the fair values of VMC stock.  It should be noted that all input data were derived from historical company data and pro forma estimates. When referencing other company’s estimates however, a consensus estimate was utilized.

Multi-stage Residual income Model: The Multi Stage Residual Income Model uses a company’s current book value per share of and the present value of expected future residual income plus a terminal value at the end of the forecast horizon. The extra return adds value to the stockholders of the company. Sysco fits this model as it has high income growth ra This model provides a Fair value of $129.86 and an undervaluation of 1.2%.

Franchise Value Model: This valuation determines whether a company can repeat its business model at a lower cost. Franchise value is created when the company uses its competitive advantage to reinvest its earnings at a rate higher than the required rate of return. Given that Vulcan Materials Company is projected to continue its expansion efforts and growth opportunities in the foreseeable future, the franchise value model is appropriate for identifying the company’s valuation. This model provides a Fair value of $128.06 and an overvaluation of 0.2%.

Fair value: My valuation models have assigned Vulcan Materials Company a fair value of $128.96, and an undervaluation by 0.5%.

Recommendation: I recommend that we sell all 548 shares of VMC.

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