MLM - Eagle Materials Holding Up Ahead Of A More Challenging Year

Summary

• Eagle Materials had a modestly weaker fiscal third quarter, as weather issues offset healthy pricing in cement and wallboard.
• Calendar 2023 is going to see notable weakness in the residential market, impacting both cement and wallboard demand, but housing should rebound in 2024/2025.
• As infrastructure projects ramp and industry players maintain discipline on capacity, cement demand and prices should be strong for several years beyond 2023.
• Eagle offers attractive efficiency (EBITDA/ton) and good enough leverage to the U.S. cement cycle, and the valuation is attractive even with some near-term risks.

Weaker residential and non-residential construction is going to pause some of the momentum in the cement industry for 2023, and certainly more than just pause the market for residential building materials, but the outlook for 2024 and beyond remains robust. The residential housing correction is likely to be brief (in part due to inadequate supply) and strong federal stimulus for infrastructure projects and little capacity growth is likely to be a powerful combination for cement for several years.

Eagle Materials ( EXP ) shares have done alright over the last year, outperforming CEMEX ( CX ), CRH ( CRH ), and Martin Marietta Materials ( MLM ) while underperforming Holcim ( HCMLY ) and GCC (GCC.MX). While the shares aren't the cheapest play on cement out there, I don't believe they should be given that Eagle earns solid EBITDA per ton and its geographical footprint offers less exposure to import competition. Below the $150s, I think this is a name to consider, even with some downside volume risks in 2023.

Weather Offsets Price In Fiscal Q3

Eagle is continuing to see strong realized prices across its businesses, but bad weather and limited surplus inventory compromised the company's ability to fully leverage that price momentum in the fiscal third quarter.

Revenue rose 10% in the quarter, missing by about 4%. Heavy Materials revenue rose 3%, with Cement down 2% and Concrete & Aggregates up 30%. Within the Cement operations (80% of the Heavy Materials segment), strong pricing (up 13%) was offset by a 13% decline in volume due to inventory and weather issues. Light Materials revenue rose 23%, with wallboard revenue up 30% on 5% volume growth.

Gross margin improved 110bp from the prior year and declined 110bp from the prior quarter to 31%. Adjusted EBITDA rose 14% yoy and fell 12% qoq to $199M, while adjusted operating income rose 17% yoy and declined 16% to $158M (including JV equity earnings), with margin up 180bp yoy to 30.8%.

By segment, Heavy Materials profits declined 11% (margin down 380bp to 27.2%), with Cement earnings down 9% (margin down 220bp to 29%). Light Materials earnings rose 51% (margin up 750bp to 40.4%), with wallboard up 44% (margin up 390bp to 41.1%).

That 13% price leverage in cement was pretty much spot on with the overall U.S. cement market in the fourth quarter. Looking at some comps that have reported, CEMEX posted 16% revenue growth in its U.S. operations, with a 7% volume decline in cement in the quarter and pricing up 21%, while Martin Marietta posted 8% growth on an 11% volume decline and a 21% increase in pricing.

Calendar 2023 Will Be Challenging, But Better Days Lie Ahead

Between cement and wallboard, Eagle has significant exposure to the U.S. residential market. Residential use accounts for about 30% of U.S. cement volumes and about 80% of Eagle's wallboard volume, and I expect this to be a pretty ugly year for new starts. The Portland Cement Association feels similarly, with this industry group forecasting a 13% decline in residential cement demand for 2023. While remodel/repair is meaningful to the wallboard business, I expect a meaningful decline here as well, given how the pandemic pulled forward remodeling demand and consumer confidence has softened.

Non-residential, too, will not be much of a help. I've been bearish on non-residential in '23 for some time now, and the numbers are starting to back that up in terms of project activity and spending, and the PCA is looking for a 2% decline in this segment (which accounts for around 15% to 20% of U.S. cement demand).

Infrastructure should be positive in 2023, but federally-subsidized projects are only just getting started. Growth is likely to be in the low single-digits in 2023, but I expect meaningful acceleration in 2024 and beyond as road, highway, and bridge projects (as well as other public works projects like water infrastructure) move forward. I believe infrastructure spending could sustain high-single-digit cement demand growth for multiple years, and there is no meaningful new capacity coming online, as the industry has been very rational about adding capacity so far.

Cement is a regional business, though, and Eagle's geographic footprint is important to consider.

Eagle has meaningful operations in Texas but is otherwise primarily a Midwestern operator, with plants in Ohio, Kentucky, Illinois, Missouri, Oklahoma, Wyoming, and Nevada, and terminals in California, Utah, Colorado, Nebraska, Kansas, Oklahoma, Iowa, Missouri, Wisconsin, Indiana, Ohio, Kentucky, Pennsylvania, and West Virginia. That means that faster-growing markets like Florida, the U.S. Southeast (the Carolinas, Georgia), Arizona, and Southern California are much less significant in the business mix. With that, I see relatively less leverage to residential and infrastructure growth compared to players like Cemex.

On the other hand, that footprint is also generally well away from the coasts. With strong pricing across the U.S., operators are seeing more imports coming from countries like Turkey, Mexico, and Vietnam, but it's impractical to transport large volumes of imported cement to most of Eagle's core operating footprint.

The Outlook

One of the issues I've had with CEMEX is that despite the company's attractive U.S. footprint, its earnings in the U.S. cement business are substandard. That's not a problem for Eagle, as the company's U.S. operations are quite profitable on an EBITDA per ton basis. They're not the leader (that would appear to be GCC), but they're above average, and I think that's a strong positive in the company's favor as demand reaccelerates in 2024.

As Eagle's fiscal 2023 includes two quarters of 2023 and fiscal 2024 will as well, the financial reports will look a little different than peers. I expect Eagle to close this fiscal year with strong double-digit revenue growth (+15%), while next year sees a small drop in weaker volumes. I expect a double-digit rebound in FY'25, though, and a few strong years after that with healthy housing and infrastructure markets. Long term, I'm looking for around 6% annualized revenue growth.

Higher input costs are an issue now, and I'm not confident that these pressures are going to abate soon. Nevertheless, as demand reaccelerates in CY'24, I expect good pricing and good operating leverage opportunities that will drive mid-30%s EBITDA margins. Eagle has historically generated strong double-digit FCF margins across its business cycles and I expect that to continue, with a few years of "over-earning" keeping FCF margins in the 20%s.

Eagle does seem priced to generate high-single-digit long-term annualized returns on a discounted cash flow basis, but DCF is a tough approach to use for cyclical businesses. Using my preferred blended EV/EBITDA approach, I get a fair value in the low-$160s based on FY'24 EBITDA and a mid-$150s based on a longer-term approach that factors in full-cycle EBITDA (to mitigate periods of over/under-earning).

The Bottom Line

I kinda wish that Eagle had sold off into this expected CY'23 downturn. Even so, I think the price is still reasonable and offers upside from here, though I do see some downside risk in the next few quarters given weaker fundamentals for the U.S. cement end-markets. I'm willing to take/look past that risk to participate in longer-term upside in the U.S. cement market, and I think this is a name strongly worth considering, and especially if there were to be some pullbacks on weaker near-term quarters.

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