Economics Pulse: Construction materials update

The first quarter of 2015 brought four areas of interest to the construction materials sector: year-end earnings reports; the first initial public offering in the sector in more than a decade; continued anticipation of the industry’s merger of its two largest players; and the continued ineptitude of Congress to act on federal funding for highways.

Public company performance

The Construction Materials Index (CMI) in Figure 1 for a 10-year period, Figure 2 for the 12 months ended March 31, 2015, and Figure 3 for 2015 year-to-date shows the performance of CMI versus the market as a whole for the relative period. The CMI underperformed the market as a whole over the 10-year and 12-month periods, but significantly outperformed the overall market in the first quarter of 2015. The sector is coming off modest improvements in 2014 and a sense of improved optimism for 2015.

Figure 4 presents select operating metrics for the CMI companies for the 12 months ended Dec. 31, 2014, while Figure 5 presents the composite EBIT and EBITDA for the CMI. While volumes stabilized in recent years and showed improvement in 2014, there is still pressure on pricing and throughput costs as many operators continue to operate at inefficient plant volumes. We anticipate improved margins as volumes continue to increase.

Figure 6 shows the stock performance of the CMI companies for 2014 and the 12 months ended March 31, 2015. It is difficult to look at the stock gains/losses in 2014 and draw conclusions as seven of the 12 had losses or single-digit gains and five had double-digit gains with U.S. Concrete leading the way (27.3 percent gain). Earnings per share improved for all but three of the companies with Lafarge showing the biggest decrease.

Construction materials volumes

The sector had its largest volume gains in recent years as shown in Figure 7; however, the year was relatively uneventful and did not match the optimism demonstrated as the year began. Bad weather in the first quarter, the inability of Congress to deal with long term transportation funding, midterm elections and a higher than expected degre of uncertainty in the overall economy resulted in less than expected results for the year. Figures 8-11 present a historic view on volumes of crushed stone, sand and gravel, cement, ready-mixed concrete and hot-mix asphalt.

As shown in Figure 3, the CMI has outperformed the market in the first quarter of 2015, and the message from executives and presenters at the annual conventions for NSSGA, NAPA, NRMCA and PCA was that 2015 should experience stronger gains in volumes and pricing. While the outlook for residential and commercial construction is strong, optimism for any significant changes in transportation funding has stalled. A wildcard is the impact of the low price of oil, which could have a dampening effect on certain markets.

Highway funding

Historically, the Highway Trust Fund was a significant priority of Congress. The bills were long in duration and ensured that a reasonable funding level would be maintained and visible. This was highly beneficial for companies in their capital-spending strategies. The “pork” attached to the highway bills, together with the success of the Tax Protection Pledge movement in the Republican party, began to cause increasing political pressure among representatives to Congress.

It took two years and 12 short-term extensions to authorize SAFETEA-LU and then it was for only four years. It took three years and nine short-term extensions to authorize MAP-21 and then it was only for two years at relatively flat funding. As we speak, Congress finds itself with another expiring transportation bill that surely will face another series of short-term extensions. This absence of long-term visibility for funding has a negative impact on project planning and capital spending.

Although the Tax Protection Pledge movement has held Congress hostage, they have not been bashful about transferring funds from the General Fund to the Highway Trust Fund. Since 2008, Congress transferred $53 billion to the Highway Trust Fund to ensure it remained solvent (see Figure 12).

In spite of the challenges of the past five years, the industry was optimistic that Congress would be able to pass a transportation bill in 2015. In January, there were reports that a bipartisan group of lawmakers would be able to address highway funding through a repatriation tax break. Legislators acknowledged that it would not be a long-term fix to the trust fund’s problems but with the lack of alternatives, it would be a reasonable solution to shore up the fund’s solvency.

A potential opportunity emerged when the White House recently proposed a six-year transportation bill similar to the “TEA” period that would provide stability that has not been present this decade. However, both Senate and House Republicans would need to buy into the proposition and, with presidential candidacies beginning, Republican approval will be a tough sell. Looks like more of the same from this Congress.

Summit Materials IPO

Summit Materials Inc. launched a successful IPO in March, the first in the construction materials sector in more than 15 years. The company raised about $400 million, valuing the Blackstone Group controlled company at $1.67 billion. Blackstone will remain the majority owner and will most likely look to reduce its investment as the stock performs and presents an attractive exit.

Summit Materials, a collection of construction materials assets, was founded in 2009. The company grew through 34 acquisitions achieving a critical mass that made it a candidate for an IPO. It now has 11 companies in its portfolio. Summit produces and supplies aggregates, ready-mixed concrete, cement and asphalt paving, among other things.

This company also engages in asphalt paving and road-related construction activities. Summit Materials reported revenue of $1.2 billion in 2014 and net income of $2.5 million on a pro forma basis. At year-end, the company had total debt of approximately $1.1 billion.

Holcim/Lafarge merger

In April of 2014, Holcim and Lafarge announced the merger plans of Europe’s two largest cement companies, resulting in a $44-billion market value company. At the time, the market cap of both firms was similar and the two companies agreed on an equal share swap. Nearly a year after the deal was announced, Holcim’s market cap was approximately 25 percent larger than that of Lafarge, creating issues for Holcim’s largest shareholders.

The two primary drivers of the change in market caps are the dramatic appreciation of the Swiss franc against the euro after the Swiss National Bank abandoned a cap on the country’s exchange rate, helping make Holcim’s shares more valuable. Lafarge reported a net loss of €145 million in the fourth quarter of 2014 after writing down the value of assets, mainly in Syria and Iraq, while Holcim reported fourth-quarter net profit of €335 million.

Holcim’s major shareholders were looking for changes to the terms and a change in the proposed leadership as they objected to Bruno Lafont being named CEO. The companies revised the exchange ratio so that Holcim will give 0.90 of a share in return for one share of Lafarge, instead of the original one-to-one ratio.

Initially they agreed to Bruno Lafont becoming co-chairman of the new entity alongside Holcim Chairman Wolfgang Reitzle. Objection continued and the two companies finally agreed to name Eric Olsen, Lafarge’s executive vice president of operations, as head of the merged entity. Both companies hold shareholder meetings in May to approve the merger.

Recent transactions

In addition to the Summit IPO and the Holcim/Lafarge merger, merger and acquisition activity continued at a modest pace. Similar to 2014, we expect corporate divestitures and strategic bolt-on acquisitions to dominate the activity. Cemex just announced that it had earmarked approximately $100 million of assets of a global plan to divest approximately $1.0 to 1.5 billion globally.

George Reddin is a managing director with FMI Capital Advisors Inc., FMI Corp.’s investment banking subsidiary. He specializes in mergers and acquisitions and financial advisory services.