Assessing the construction materials market right now
Demand for construction aggregates remains high according to the U.S. Geological Survey. Photo: P&Q Staff
The results came in July 28: The U.S. economy contracted for the second consecutive quarter.
Although not yet official as of that date, the general consensus is that the U.S. is in a recession. The economic downturn was brought on by historic levels of inflation, subsequent interest rate hikes and supply chain constraints.
The construction materials sector is not immune to these plights. But there are two caveats for the sector that should mitigate the pain from a recession. These are the committed federal funds from the Infrastructure Investment & Jobs Act (IIJA) and the individual and unique markets where certain producers operate.
For construction materials merger and acquisition activity, buyers who see beyond the current economic environment could find themselves in a more fortified position. Large, publicly traded buyers are still looking to grow while navigating this period of economic uncertainty. As such, buyers will deploy capital to strategic targets in favorable markets where they have existing operations.
As Warren Buffet famously professed: “Be fearful when others are greedy and greedy when others are fearful.” But those who are “greedy” at this time could see themselves in a much stronger position when the economy recovers.
Inflation
U.S. economist Thomas Sowell once characterized inflation as “the most universal tax of all.”
Inflation has run wild in the global economy to a point of historic proportions. In June, the consumer price index, a measurement of average costs (and one of the main barometers for inflation) increased to 9.1 percent year over year. That is a 40-year high.
Additionally, the producer price index (PPI), a measurement of average change in selling prices, reached 11.3 percent in June. The dedicated construction segment of the PPI logged an eye-popping 19.2 percent.
All of these metrics indicate that the cost of goods is up dramatically, hurting consumer purchasing power and resulting in margin erosion for companies. Some specific components of inflation have impacted construction materials in a greater way.
Facets of the PPI, including energy and steel, increased significantly over the past year. These cost increases hurt construction materials producers’ profits. As such, the producers who pass on increased costs to customers will fare much better than those who cannot.
Interest rates
Opposite the inflation dilemma is the monetary response.
The Federal Reserve embarked on an aggressive campaign to tame inflation by raising interest rates four times this year alone. According to The Wall Street Journal, that’s the most aggressive pace since the 1980s.
Raising interest rates increases borrowing costs and reduces demand for goods. This concludes with prices declining, thus bringing down inflation.
At the July meeting, the Fed raised the federal-funds rate by 75 basis points to a range between 2.25 percent and 2.5 percent. Additionally, the Fed signaled that there will be more rate hikes throughout the year. While monetary policy is important, the focus should be on how this specifically relates to construction materials.
First, this directly impacts the residential sector, as home borrowing costs have increased significantly over the course of the year. Second, with the cost of debt increasing, financing equipment through loans will continue to become more expensive.
Although uncomfortable, increasing interest rates is necessary to set prices back to sustainable levels.
Supply chain
The interconnectivity of all these issues compounded the ongoing problem of the supply chain.
The initial problems brought on by the pandemic and tariffs were only exacerbated by war and global economic turmoil, resulting in major bottlenecks to supply chains. The strained supply chain directly impacts the construction materials sector as it pertains to equipment purchases.
Long lead times for equipment pushed planned investments to 2023 and beyond. Additionally, equipment costs are up significantly to compensate for high demand.
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