Q1 2017 construction materials update

A year ago, at the onset of 2016, the construction materials sector was in the midst of enormous change.

The merger of LafargeHolcim had concluded in October 2015. Summit Materials had gone public seven months prior. Oldcastle Materials entered the cement business. Heidelberg was in the process of acquiring Essroc. Summit Materials had bolstered its cement presence through the acquisition of the Davenport cement terminal. And the 2.5 million-metric ton McInnis cement plant was under construction in Canada.

With so much change occurring in the cement market, there was ample strategic rationale for downstream transactions.

In the end, what happened surprised us: The market for downstream materials (aggregate, asphalt, concrete and paving) was quiet.

Aside from the acquisition of Boxley Materials/AMC by Summit Materials in the first quarter of the year, there were no other major platform acquisitions by strategic buyers in the United States. The M&A market was characterized by defensive “bolt-on” acquisitions by domestic buyers and a continuance of the cement acquisition trend that began in earnest with the LafargeHolcim merger in mid-2015.

On the downstream side, Summit Materials, Martin Marietta and U.S. Concrete were the most active buyers, but nearly all of their deals involved adding on to existing operations (the so-called “bolt-on” transactions). Larger international firms remained on the sidelines.

In cement markets, activity remained robust, with four major transactions resulting in an additional $1.5 billion trading hands in 2016.

Divestitures from the Heidelberg/Italcementi transaction continued with the sale of Essroc’s Martinsburg, West Virginia, cement plant announced in August. Cemex was also active in the market, divesting its Lyons, Colorado, and Odessa, Texas, plants to GCC (Grupo Cementos de Chihuahua), and its Fairborn, Ohio, plant to Eagle Materials in an effort to pay down debt.

Finally, Mexican billionaire Carlos Slim’s Grupo Elementia purchased a 55 percent stake of Giant Cement in December, providing the company with a strong presence on the East Coast of the United States.

Cement plants are the most expensive assets in a materials company’s portfolio, with the highest barriers to entry and typically the greatest profitability (when running near full capacity). Cement producers defend these investments through terminal networks, supply agreements and vertical integration into ready-mix concrete businesses.

Our thesis continues to be that as the dust settles on this competitive reshuffling in upstream markets, downstream markets in aggregate, asphalt and concrete will all be affected through additional deal activity in 2017.

A November surprise

Donald Trump’s ascendancy to the presidency is one of the most dramatic political stories of our lifetimes.

According to Fortune magazine, the odds of Donald Trump winning the presidency hovered around 25-to-1 in August 2015. On the eve of the election, Trump’s odds had improved to 5-to-1 but he was still a long shot by any measure.

The Trump presidency is a wild card for the construction materials industry. Trump’s plans, though short on details, suggest he maintains a strong commitment to infrastructure development and job growth in the United States.

If Trump is successful in navigating political waters in Washington, a meaningful infrastructure package could be the growth catalyst the industry has needed since the onset of the Great Recession. This, along with tax and regulatory reform could create a strong boost for the industry.

At least the market thought so.

By Nov. 10, two days after Election Day, domestic construction materials saw double-digit percentage growth in their stock prices.

U.S. Concrete received a 19 percent price jump in the two days following the election, and Vulcan Materials, Granite Construction, Martin Marietta and Summit Materials all saw a bounce of more than 13 percent.

The market clearly failed to anticipate the election of Donald Trump and believes the prospects for infrastructure development are substantially higher than they were prior to the election.

This growth trend has continued since election week with shares of domestic construction materials firms continuing to perform well. FMI’s Construction Materials Index (CMI) has outpaced the S&P 500 by more than 12 percentage points over the past three months and 14 percentage points over the past year.

However, on a 10-year basis, the CMI has yet to return to its January 2007 levels and remains well behind the S&P 500 and Dow Jones Industrial Average. In sum, the market’s reaction to Trump’s election has been a positive to construction materials stocks, and if Congress is able to pass a meaningful infrastructure funding package, there remains plenty of room for growth. We’d place the odds at somewhat better than 25-to-1.

Will foreign buyers return to the United states?

While changing competitive dynamics in North American cement markets and a Trump infrastructure plan are both strong catalysts for foreign construction materials investment in the U.S., a third factor has emerged that may also spur a resurgence in foreign interest in U.S. materials firms: the strengthening U.S. dollar.

Since July 2014, the value of the U.S. dollar versus other major world currencies has increased by well over 25 percent. The strength of the U.S. dollar has several implications for foreign investment in U.S. construction materials firms. Most notably, foreign investment in the U.S. becomes more expensive.

However, if foreign investors believe the dollar will continue to strengthen, future profits will grow concurrently and improve overall return on investment.

 

Secondly, imports become cheaper for U.S. consumers. Barring any changes in tariff structures, construction materials firms could benefit from cheaper equipment costs from overseas.

With weakening world economies and a strengthening U.S. dollar, the United States becomes an increasingly attractive investment for foreign firms.
When combined with the potential of a meaningful infrastructure investment package from Congress, 2017 may be the year foreign buyers return to the U.S. in earnest.

As the dust continues to settle on the megamerger and the U.S. dollar strengthens, large international firms are likely to refocus on their positions in U.S. markets.

If a Trump administration is successful in passing a more robust infrastructure package, we would expect 2017 to be a strong year for valuations and ultimately, downstream deals.

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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.