VMC - Summit Materials: A Good Buy At Current Levels

2023-11-26 02:16:02 ET

Summary

• Summit Materials has good growth prospects with revenue growth expected from price increases and positive demand trends in non-residential and infrastructure markets.
• The company's revenue increased by 8.2% YoY in Q3 2023, supported by price increases and strong demand in non-residential and infrastructure sectors.
• The upcoming acquisition of Argos USA is expected to diversify and expand the company's operations, contributing to revenue and margin growth.

Investment Thesis

Summit Materials ( SUM ) has good growth prospects ahead. The company’s revenue growth should benefit from the carryover impact of recent price increases and incremental price increases moving forward. Additionally, positive demand trends in heavy non-residential and public infrastructure markets are expected to contribute to growth and should help offset the softness in the residential sector. In the medium to long term, once the interest cycle starts reversing over the next couple of years, the residential end-market should also start recovering and add to opportunities from secular growth trends and government infrastructure funding in other end-markets supporting revenue growth. Furthermore, the company also recently announced combination with Argos North America Corp. (“Argos USA”), which is expected to diversify and expand the company’s operations across the country. This should help the company’s revenue growth moving forward.

On the margin front, the company should be able to offset inflationary pressure and expand margins with the help of price increases, improving portfolio mix and cost synergies from the Argo USA acquisition. So the growth prospects ahead look good. Moreover, the company is also trading below its historical averages, which when combined with revenue and margin growth prospects ahead make it a good buy.

Revenue Analysis and Outlook

In my previous article on Summit Materials Inc., I discussed the company’s good growth prospects ahead benefiting from price increases and healthy demand in heavy non-residential and public infrastructure sectors. The company reported earnings for its third quarter of 2023 earlier this month and similar dynamics were seen there as well.

In the third quarter of 2023, the company’s revenue growth benefitted from price increases in the previous quarters. This helped the company offset declining volume in its cement business. In addition to price increases, the company experienced good demand in heavy non-residential and public infrastructure, due to various government stimulus like CHIPS and Science Act and IIJA respectively. As a result, the company’s revenue increased by 8.2% YoY growth to $742 million.

Looking forward, I believe the company should be able to deliver revenue growth in the coming year. It should benefit from price increases, secular demand trends in heavy non-residential and infrastructure sectors, and acquisition synergies.

Just like the rest of the industry, SUM has been relying on price increases to offset inflationary pressure. This is benefiting the company’s revenue growth. The company took price increases in July and plans to take further price increases entering 2024. So, I expect the company’s revenue growth should keep benefiting from the impact of carryover price increases and further price increases.

In addition, the company is also experiencing good demand in the infrastructure sector. This demand is backed by secular trends to upgrade and modernize aging infrastructure in the U.S. This is also supported by the Infrastructure Investment and Job Act (IIJA) by the federal government. In Q3 2023 earnings call , management stated that they expect funding from IIJA to accelerate in fiscal 2024, implying that demand should remain elevated in the coming years as well. Moreover, end market demand is also good in the heavy non-residential sector. The secular trends backing the non-residential sector are reshoring and onshoring manufacturing in the U.S. and increasing demand for semiconductor and EV battery factories. These trends are also supported by the federal government’s Inflation Reduction Act and the CHIPS and Science Act. I believe these trends should continue to benefit the company’s revenue growth for next few years.

The residential sector has been under pressure due to high interest rates. However, management expects the residential sector to begin stabilizing in fiscal 2024 due to some sequential improvement in permits and starts for single-family houses. I also believe the recent data around inflation is a positive development and indicate we are near the peak of the interest rate cycle. Once the interest rate cycle starts reversing in the medium term, the residential segment's should see a swift recovery as demand supply conditions are tight thanks to over a decade of underbuilding of the new homes in the US post the great housing recession of 2008.

In addition to good organic growth, the company's revenue growth should also benefit from the recently announced combination with Argos. In September, the company entered into an agreement to acquire Argos North America Corp. (“Argos USA”). The transaction is expected to complete in the first half of 2024. Argo USA is among the largest cement producers by total installed capacity in its areas of operations, which include the Southeast, Mid-Atlantic, and Texas. This purchase is anticipated to form the fourth-largest cement platform in the United States by merging Summit and Argos USA. This should strengthen the company's materials-focused approach and position it for increased success with a nationwide presence and substantially enhanced scale. This should help the company better meet the growing demand for construction across the country. Management expects leverage at closing and before synergies to be at or below 3x pro-forma EBITDA, which looks manageable.

Overall, I remain optimistic about the company’s growth prospects ahead.

Margin Analysis and Outlook

In the third quarter of 2023, the company’s margin growth benefited from price increases, and good operational execution. This helped the company offset inflationary pressure. As a result, the company witnessed a 210 basis point YoY increase in its adjusted cash gross profit margin to 33.9%, while the adjusted EBITDA margin experienced a 110 basis point YoY increase to 28.1%.

One should note that the company's profit margins exhibit a seasonal trend, with the first quarter typically being the least profitable. This is attributed to weather-related factors, such as prolonged periods of rain and cold weather at the start of the year, leading to operational difficulties and reduced revenue.

Looking forward, I believe the company should be able to expand its margins moving forward. As mentioned in the revenue analysis, the company is planning to continue increasing prices in the coming year to offset inflationary pressure. Further price increases and carryover impact of recent pricing increase should keep benefiting the company’s margin growth in fiscal 2024 as well.

In addition to price increases, the company is also expected to benefit from cost synergies through the acquisition of Argo USA. Management expects annual cost synergy of at least $100 million from the transaction within 2 years of closing. Moreover, I expect the margin to also benefit from improving the portfolio mix. In the recent years, the company has been divesting lower-performing businesses and acquiring margin-accretive businesses, which should improve the overall margin profile for the company. Hence I remain optimistic about the company’s margin growth prospects.

Valuation and Conclusion

The company is currently trading at a 19.63x FY24 consensus EPS estimate of $1.78. This is at a discount to its 5-year historical average forward P/E of 25.94x as well as a discount from its peers.

The company has good growth prospects in the near term with support from price increases and secular demand trends in public infrastructure and heavy non-residential sectors. The recovery of the residential market once the interest rate cycle start reversing in the medium term should add to the muti-year secular demand in the infrastructure and heavy construction market, making the medium-to-long term outlook favorable as well. Furthermore, the upcoming acquisition of Argo USA is also looking good for the company’s revenue and margin growth as it should help the company diversify and expand across the country and benefit from nationwide scale. So, good growth prospects and attractive valuation make SUM stock a buy.

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