Market Insights: Is now the right time to sell?

As the nation moves beyond the distress of 2020, the economy and government have turned their attention back toward growth and development. 

With a renewed focus on infrastructure, all eyes are on the construction materials sector in early 2021. There are a number of significant factors that are setting up the construction materials space to have a robust year operationally along with an extremely active mergers and acquisitions (M&A) market.

First, the pandemic induced a white-hot residential market, as homebuyers demand more space for work-from-home lifestyles. Homebuyers also have access to record-low mortgage rates.

Second, the market has renewed optimism in state and federal funding sources. The continuing resolution of the FAST Act passed in December 2020, the potential reauthorization of the federal highway bill due by the end of September, and President Biden’s American Jobs Plan brought a one-time infrastructure investment to the forefront of political discussion. With all the positive activity surrounding construction materials, the public markets have given a favorable view to the stock prices of the publicly traded construction materials companies.

Since the November elections, FMI’s Construction Materials Index (CMI), a proprietary composite of 17 publicly traded construction materials companies, has outperformed the broader indexes. As sentiment and stock price are the “currencies” in which public companies trade, this recent increase positions the large public companies to be highly acquisitive.

Armed with strong balance sheets and a “war chest” of cash accumulated during the pandemic, construction materials buyers are hungry for acquisitions that align with their strategic plans.

In conjunction, sellers are watching for potential increases in capital gains tax rates, adding new motivation to sell. In the last six months, FMI has seen more construction materials acquisitions announced than any other similar timeframe since 2018. The stars are aligned for the construction materials sector to have a banner year for M&A.

Public company performance

Public markets have viewed the construction materials sector favorably ever since the president emphasized infrastructure as being vital to jump-start the economy.

The CMI has outperformed both the Dow Jones Industrial Average and the S&P 500 by about 11 percent, and the individual companies making up the CMI have all had positive performance in their stock price.

This is important for M&A activity for two reasons. First, it gives C-suite executives the confidence to undertake more ambitious projects. Second, it signifies that investors have expectations of positive financial performance in the future, lowering the risk on investing in growth initiatives. Both of these factors present the ideal situation for driving up buyer interest.

In addition to increased demand for acquisitions, buyers are well-positioned to pay for their top targets. The pandemic forced companies to bolster their balance sheets to weather the unprecedented period of uncertainty. Construction materials companies tapped into low-cost financing to strengthen their cash position, whether it be through debt markets, equity markets or federal programs such as the PPP program.

Also, many companies focused on core operations and paused all ambitious capital projects. Now, many buyers find themselves with abnormally large cash balances and manageable debt positions.

M&A activity

Strong buyer positions led to a surge of M&A coming out of 2020. This can be seen globally and in the construction materials space.

There were nearly three times as many construction materials acquisitions announced in the second half of 2020 than in the first half of the year – and the total acquisition activity in the U.S. has picked up 61 percent in the six months spanning October 2020 to March 2021.

The dearth of acquisitions in the first half of 2020 led to pent-up demand in the latter half of the year. The construction materials sector announced 37 deals from October to March. This level of activity had not been seen since 2018.

“In 2020, nothing happened, and you would expect it to come roaring back in 2021 – and it’s busy,” says Tom Hill, chairman, president and CEO at Vulcan Materials.

Buyers are eager to pursue deals that align with their strategic goals, which often focus on increased vertical integration. A strong trend FMI is seeing in the market is the disciplined strategies of buyers. Buyers are not pursuing every opportunity, but when a deal makes sense for their strategy and position, they are pursuing vigorously with aggressive pricing.

Infrastructure funding

The construction materials sector gained a boost with the announcement of President Biden’s American Jobs Plan.

In it, the president called for $2.25 trillion in infrastructure funding to be spent over the next decade. For transportation infrastructure, there is an allotment of $621 billion, and of that value, $115 billion is to be spent on “[modernizing] bridges, roads and main streets that are in most critical need of repair.”

The proposal comes as a double-edged sword for construction materials producers, as Biden is calling for an increase in corporate taxes from 21 percent to 28 percent to finance the bill.

Additionally, although not mentioned in this version of the bill, the Wall Street Journal reports that “taxes on high-income individuals’ income, capital gains, estates and noncorporate businesses are expected in a future segment of the president’s agenda.” This increase in tax rate could be a strong motivator for potential sellers who want to capitalize on proceeds from a transaction before an increase in capital gains tax becomes a reality.

Conclusion

The fundamental difference between the 2020 construction materials market and 2021 is certainty.

There is an undeniably robust residential market, an increasing likelihood of an infrastructure bill and strong momentum toward a reauthorization of the FAST Act. The statistics show there is pent-up demand in the M&A market, with buyers visibly signaling the desire to pursue growth through acquisition.

With the possibility of tax changes and the frothiness of the market, privately owned construction materials producers might want to consider their next steps.

George Reddin is a managing director with FMI Capital Advisors Inc., FMI Corp.’s investment banking subsidiary.