Will the ‘Trump bump’ endure for the aggregate industry?

By , and |  June 9, 2017

The first quarter of 2017 has been a remarkable one for the construction materials industry. Economic conditions continue to improve, while stock prices of publicly traded companies continue to ride a seesaw of expectations related to infrastructure spending. The good news is that materials firms have largely recovered from the recession, and with positive economic drivers, the market is poised for a strong 2017.

The bad news is that the recent run up in construction materials firms’ stock may not last without agreement between Republicans, Democrats and President Trump on an infrastructure-spending package. In total, these dynamics will combine to have a substantial effect on the construction materials mergers and acquisitions (M&A) market.

Public companies reported full-year 2016 results in the first quarter, and the news continues to be positive. Revenues for FMI’s Construction Materials Index constituent companies increased on average by 6.6 percent while EBITDA margins averaged 19.0 percent for 2016, reaching their strongest levels since 2009. More importantly, stock prices grew dramatically in 2016: Eagle Materials and Martin Marietta increased share value by more than 60 percent in 2016, and the broader Construction Materials Index (CMI) improved by nearly 42 percent.

The ‘Trump bump’

CMI firms have continued to benefit from President Trump’s repeated statements supportive of increased spending on U.S. infrastructure. From Election Day to Inauguration Day, FMI’s CMI grew by more than 12.0 percent on expectations that an infrastructure bill would be a top priority of President Trump.

This “Trump Bump” has driven CMI companies’ median enterprise value to EBITDA (EV/EBITDA) back up above 10.0x, a high multiple by historical standards. The market is effectively betting that the earnings of CMI companies will grow substantially in the event an infrastructure package is passed by Congress, and investors are willing to pay for that now to be ahead of the curve.

Since Inauguration Day, however, the CMI has remained stagnant, lacking the clear growth catalyst that drove it prior to mid-January. Barring recessionary forces, public construction materials firms will likely continue to be range bound until the administration and Congress provide more clarity on the plans for infrastructure spending legislation.

The failure in late March by both President Trump and Rep. Paul Ryan (R-Wisconsin) to approve healthcare legislation has added to the skeptics’ case that both parties won’t be able to come together on an infrastructure package. Continued missteps by President Trump would continue to fuel this line of thinking and likely hurt the valuations of CMI companies.

As we have discussed in prior columns, one way public companies can grow their stock price in this type of environment is through acquisitions. If a public company is trading at 10 times EBITDA, every additional dollar of EBITDA the company generates should theoretically increase the company’s enterprise value by $10. As a result, public companies work to make acquisitions at a multiple of earnings that lies beneath their own and, as a result, increase their valuation through financial alchemy.

This is exactly what we have witnessed in the first quarter of 2017. With CMI companies trading at strong multiples of earnings, strong catalysts for growth in a potential infrastructure package and a conclusion to the megamerger era, CMI firms are returning their focus to small and mid-sized transactions in the United States.

The first quarter of 2017 was one of the busiest for construction M&A in recent years, with several key strategic buyers returning to the market. Oldcastle, Vulcan and Lehigh Hanson returned to the market with deals in the first quarter, acquiring Mulzer Crushed Stone, Lojac Holdings and Cemex’s Pacific Northwest assets, respectively.

Summit Materials also continued its activity, acquiring Razorback Concrete and Everist Materials. Most public company CEOs have been enthusiastic about their M&A plans in 2017 and, barring any signs of recession, we expect 2017 to be a banner year for M&A activity.

The outlook for 2017

A review of industry fundamentals suggests that 2017 will be another year of continued growth for the construction materials industry. The industry’s primary economic drivers of residential and highway / infrastructure spending continue to demonstrate strong growth catalysts.

On the residential side, while prices alone might indicate the potential for another bubble, housing inventories remain well below the 10-year average. The data suggests that there remains ample room for continued growth in the market. FMI is projecting 5 percent growth in residential markets in 2017, down from 7 percent in 2016.

While Congress and the president wrestle with infrastructure reform, prospects for additional spending in the states remains strong. California’s recently passed SB1 will provide upwards of $5.2 billion annually for infrastructure spending over the next 10 years, while Texas’ Prop 7 passed in 2015 will provide $2.2 billion in funding in 2017/2018 and $2.5 billion in 2018/2019. Similar efforts are under way across the country with 26 states having approved increases to transportation revenues since 2012, and if coupled with a larger infrastructure package from Congress, the construction materials market could be in for a highly profitable few years.

CMI stocks are likely to continue their streak of volatility in the coming months, and the Trump Bump may not endure without congressional action on infrastructure. However, with strong economic growth prospects, strong stock market valuations and the recent return of several key strategic buyers to the market, we expect 2017 to continue to be a busy year for construction materials M&A.

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.

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