10 construction materials market drivers

By |  April 9, 2019
The likelihood of the next U.S. recession mirroring the last one is highly unlikely, says FMI’s George Reddin. Photo: iStock.com/zoom-zoom

The likelihood of the next U.S. recession mirroring the last one is highly unlikely, says FMI’s George Reddin. Photo: iStock.com/zoom-zoom

Several factors weighed on the construction materials market in 2018. George Reddin, managing director of FMI Capital Advisors, detailed 10 that most affected the market at the 2019 Pit & Quarry Roundtable & Conference.

1. Tax reform. The U.S. economy entered 2018 with strong momentum from the Tax Cuts & Jobs Act, which provides a temporary stimulus to U.S. companies.

“It’s a complicated bill, but the two takeaways are companies will make more profit via less tax, and companies are able to immediately deduct the tangible asset values in deals, further reducing their taxes,” Reddin says.

2. An “active” buyer pool. The first half of 2018 was the first time since pre-2008 that all large companies in the construction materials sector actively pursued acquisitions.

3. (Lack of) an infrastructure stimulus bill. Failed infrastructure legislation impacted merger and acquisition activity, especially for larger deals.

4. Tariffs. Most construction materials firms are indirectly exposed to the new Chinese tariffs. Rising steel prices, for example, may mean fewer construction projects and less money for construction materials.

“Tariffs bring in a lot of uncertainty,” Reddin says. “What will the impact be? Steel price increases may potentially impact future construction projects.”

5. Inclement weather. Historic precipitation levels impacted performance in a number of regions.

“That was the big story,” Reddin says of the weather. “Tom Hill, (CEO) of Summit Materials, said it cost them $35 million to 40 million of EBITDA (earnings before interest, tax, depreciation and amortization). Vulcan Materials and Martin Marietta made similar comments.”

6. Input cost increases. Rising input costs, especially costs related to energy, materials and labor, hurt construction materials firms’ earnings.

“If you are in the asphalt business, liquid asphalt – your most costly ingredient – went up throughout the year,” Reddin says. “Diesel fuel was increasing at its highest rates right in the middle of the busy season. You had cost inflation, without enough time in the peak paving season to pass on your price increases.”

7. High demands for labor. The “war on talent” continues as labor constraints are restricting organic growth and fueling acquisitions.

“We have fewer people looking for work, and this supply/demand labor dynamic results in increased costs,” Reddin says. “Labor costs at the production and field level went up significantly.”

Talent acquisition is becoming an increasingly important driver in M&A transactions, he adds.

“Sometimes, it’s easier to acquire an organization than to build one,” Reddin says.

8. Rate increases. The increases of the federal funds rate throughout 2018 added to stock market volatility. The market experienced four rate hikes in 2018 alone, following five increases between 2008 and 2017.

“Interest rate increase made the cost of capital more expensive, thus impacting buyers in their ability to finance deals,” Reddin says.

9. Trends in housing development. Weakening residential forecasts signaled a slowdown of growth, albeit not a steep decline.

In 2018, FMI economists continuously moderated their total residential construction growth forecasts. The beginning-of-2018 growth forecast was 8.8 percent, but that shrunk to 4.1 percent by the end of 2018. FMI economists also revised forecasts downward for 2019 and 2020 based on 2018 data.

“Residential construction is a big driver for ready-mix concrete and cement,” Reddin says. “A softening in residential construction will have a material impact on their producers.”

10. Missed earnings. As public and private companies revised their operating budgets downward throughout the year, the market increased its focus on trailing-12-months (TTM) performance.

Third-quarter earnings reports in particular represented a watershed moment for public players who were impacted by continued bad weather, according to FMI.

“The first half of the year left many producers behind their budget performance, but with a feeling that they could make up ground in the second half of the year,” Reddin says. “Earnings misses, however, continued into the third and fourth quarters.”

Source: FMI Capital Advisors

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