Construction materials developments to expect in 2018

By , and |  April 11, 2018

Expect at least one billion-dollar-plus transaction to go down in the industry in 2018. (Photo:

The construction market had an exceptional year in 2017, with construction put in place (CPIP) likely to exceed $1.2 trillion for the first time.

Strong growth in residential, office and commercial construction markets led to strong financial performances for construction materials firms overall. Most of FMI’s Construction Materials Index (CMI) constituent firms posted strong gains in 2017, and many analysts are projecting further growth in 2018.

For U.S. construction markets, the post-recession period of 2011 to 2017 represents the strongest six years of growth since the U.S. Census Bureau began tracking construction spending in 1993. During this period, CPIP grew at a compound annual growth rate of 7.8 percent, with 2014 and 2015 CPIP growing at 11 percent and 10.5 percent annually – exceptional growth rates by any measure. In 2016 and 2017, growth rates fell somewhat but remained positive.

There is ample evidence to suggest that 2018 could be another strong year for construction markets. The Tax Cuts & Jobs Act signed by President Donald Trump will provide companies with a substantial tax break, which will improve cash flows and incentivize capital investment. However, there are meaningful concerns across the market about labor, increasing interest rates and a potential slowdown in the broader U.S. economy.

Public companies face high growth expectations

In 2018, FMI’s CMI firms with activities primarily focused in the United States (Eagle Materials, Granite Construction, Martin Marietta Materials, U.S. Concrete and Vulcan Materials) are expected to grow revenues by 12 percent and earnings before interest, taxes, depreciation and amortization (EBITDA) by 24.5 percent on a consolidated annual basis, according to consensus estimates.

These are historically strong growth rates. Consider that the compound average annual revenue and EBITDA growth rates for U.S. CMI firms between 2011 and 2017 was about 11 percent and 25 percent, respectively, during the strongest six-year period for construction in the past 24 years.

In other words, U.S.-focused public construction materials firms will need another very strong year of revenue improvements to meet analyst expectations.

FMI’s U.S. CMI firms’ revenues are tightly correlated to U.S. CPIP. Since 2011, the revenues of these firms have been remarkably intertwined. Given that each of these firms is national in scale, this is logical.

However, a closer look at analyst forecasts for 2018 is telling: For these companies to meet expectations, CPIP will need to grow organically at more than an 8 percent annualized rate, an infrastructure bill will have to pass and drive meaningful additions to CPIP, or companies will have to improve revenues through alternative means (i.e., mergers and acquisitions).

We are skeptical that Congress will pass an infrastructure bill that will have a meaningful impact on the revenues of construction materials firms in 2018. Furthermore, an 8 percent growth rate in CPIP is highly optimistic.

As a result, analysts may be required to revise estimates downward, firms will need to fund additional M&A, or both. This is a trend worth paying close attention to as 2018 takes shape.

Resource depletion will drive valuation in select markets

The time difference between permitting a quarry in California and coordinating a moon landing are not altogether different, particularly near larger urban centers.

In California in particular, the permitting of reserves can be a decades-long process. Increasing levels of regulatory oversight and bureaucratic process has the effect of increasing barriers to entry and ultimately improving valuations of firms with existing aggregate reserve positions.

In the San Francisco Bay Area, this dynamic is driving strong premiums for acquisitions. The most notable is U.S. Concrete’s acquisition of Polaris Materials, a provider of Canadian-mined aggregate that’s shipped to ports along the West Coast via barge.

Polaris has the capability to deliver rock to aggregate-starved San Francisco. With reserves rapidly depleting in that market, the acquisition of Polaris presented a prospective buyer with a long-term aggregate supply in a market where aggregate is increasingly difficult to find.

U.S. Concrete won the auction with a $245 million acquisition price, which represents a price of more than $80 per production ton and a 254 percent premium to Polaris’ share price in late August. While a rich purchase price by any measure, the transaction is a great example of where valuations will head in markets where reserves are depleting rapidly and new permits are a substantial challenge.

Public valuations are unlikely to increase

Overall, CMI firms continue to trade at strong multiples of earnings. Since 2013, FMI’s CMI companies have traded above 10 times trailing EBITDA on average, with several periods of multiples exceeding 12 times on average.

Consider that prior to 2010, the average enterprise value (EV) to EBITDA multiple for these firms was 7.2 times. The rationale for much of this multiple expansion was expected growth: total CPIP fell more than 30 percent (peak to trough) in the Great Recession, and investors anticipated strong gains as the economy recovered. This growth has materialized and valuation multiples have declined since their peaks in mid- to late 2014.

Notably, we saw a similar valuation run up during the mid-2000s expansion period. EV/EBITDA multiples improved from their lows of five to six times in 2002 and 2003 to a peak in May 2006 of about 9.5 times. As investors began to foresee a lack of long-term growth catalysts, valuations began to decline and ultimately fell dramatically as the recession took hold in 2008.

While FMI remains bullish on the 2018 construction market, we believe investors will increasingly weigh the probability of a recession over the course of the next five years. The recently passed tax bill may extend the business cycle and provide investors with greater confidence, but it is unlikely to spur the same growth rates in CPIP we saw coming out of the Great Recession.

Accordingly, we do not expect public company valuation multiples to expand meaningfully in 2018. These stable or declining valuation multiples will likely influence the thought process of strategic buyers as they evaluate transactions and may, ultimately, lead to lower valuations for some privately held firms as well.

Permitting a new quarry can be a years-long, if not decade-long, process. But regulation and bureaucracy also serve to improve valuations of firms with existing aggregate reserves. Photo courtesy of Bluegrass Materials

The mega merger is not dead

Historically, M&A activity has been robust late into the business cycle. Despite a decline in CPIP in both 2007 and 2008, large transactions continued to close.

Rinker’s sale to Cemex and Florida Rock’s sale to Vulcan, among others, are but a handful of larger transactions that closed in 2007 and 2008. Even if construction markets begin to slow, we believe 2018 will be a strong year for M&A for two primary reasons.

First, as we have discussed previously, M&A activity in construction materials markets remains robust largely due to strategic realignments coming out of the cement mega mergers. Lafarge’s merger with Holcim, Heidelberg’s acquisition of Italcementi, CRH’s acquisition of Ash Grove Cement, and Summit Materials’ entry into U.S. cement markets all altered competitive dynamics across the country. These new competitive dynamics will continue to drive strategic need for further acquisitions of cement, ready-mix, aggregate and asphalt assets.

Second, the macro factors for construction remain positive for now. Interest rates are low, market multiples are strong, and there are catalysts for continued growth into 2019 and beyond through a potential infrastructure bill and growing state initiatives to fund infrastructure.

As a result of these factors, we expect at least one, if not several billion-dollar-plus transactions, to take place in construction materials markets in 2018.

George Reddin, managing director, and Scott Duncan, director, are with FMI Capital Advisors Inc., FMI Corp.’s investment banking subsidiary. They specialize in mergers and acquisitions and financial advisory services.

Comments are closed