SUM - Summit Materials Enjoys Significant Government Expenditures And Appears Undervalued

2023-03-10 15:05:08 ET

Summary

• Summit Materials Inc. is a company dedicated to the production and sale of various elements for construction and is a leader in the US market.
• As a result of the strategy, I would be expecting product improvement, lower costs, and a larger social impact, which will most likely draw the attention of more investors.
• In my view, when investors start to see an increase in free cash flow, the demand for the stock could increase, which may lead to stock price increases.

Summit Materials, Inc. (SUM) reported beneficial guidance for 2023, including EBITDA margin expansion and reduction in costs thanks to strong and consistent investment in residential construction and government spending. I do believe that there are risks for equity holders from the current levels of debt, and goodwill impairments. With that said, SUM appears to be cheap at the current market price, however.

Summit Materials Offers Many Products Internationally, And Reports Many Production Plants

Summit Materials Inc. is a company dedicated to the production and sale of various elements for construction, and is a leader in the US market.

The objective of this company in the short term is to be able to provide integral services to its clients, offering them a great variety of products that complete all the demand required in construction. As of today, Summit Materials' operations span the United States, British Columbia, and Canada.

Its two main product branches are cement and aggregates. This includes ready-made mixes of the cement itself or asphalt, ready for immediate application. In the last annual report, Summit Materials reported its total revenue by product as follows.

The operations are divided into three business segments by geography: Eastern segment, Western segment, and the cement segment. Each of these segments has its own management team, and is independent to make decisions in relation to the other teams in terms of prices in the region and particularities of the market in question.

The West segment operates in Colorado, Texas, Idaho, and Oklahoma among other states, providing ready-mix concrete, aggregates, asphalt mixes, and related services to its customers. This segment represented 58% of net annual revenue in 2022.

The East segment provides similar services in the states of Kansas, Missouri, North and South Carolina, and Virginia. Lastly, the cement segment has four production plants as well as nine distribution facilities along the Mississippi River. These plants have the particularity of recycling solid and liquid waste that serves to feed the establishment with energy, reducing costs by 50% in this regard. 15% of total 2022 revenue came from this segment.

With that about the different business segments, I believe that it is a great time to review the expectations from management. In the last quarterly report, Summit Materials noted that it expects EBITDA margin expansion and EBITDA expansion thanks to several strategies to control costs and investments from governments.

Assets Include $520 Million In Cash, And Property, Plant And Equipment Of $1.8 Billion

As of December 31, 2022, the company reported cash of $520.451 million together with accounts receivable of $256.669 million, inventories worth $212.491 million, and other current assets of $20.787 million. In total, current assets stand at $1.018 billion.

Property, plant and equipment is equal to $1.813 billion with goodwill worth $1.132 billion, intangible assets close to $71.38 million, deferred tax assets of $136.986 million, and total assets of $4.255 billion. The asset/liability ratio stands at more than 2x, and the total amount of cash is significant, so I believe that the balance sheet stands in good shape.

Liabilities

The liabilities include a current portion of debt of $5.096 million, the current portion of acquisition related liabilities of $13.718 million, accounts payable worth $104.031 million, and accrued expenses of $119.967 million. Besides, with current operating lease liabilities of $7.296 million and billing in excess of cost and estimated earnings of $5.739 million, total current liabilities stand at $255.847 million.

Long term liabilities include long term debt worth $1.488 billion together with acquisition related liabilities of $29.051 million, a tax receivable agreement liability of $327.812 million, and other noncurrent liabilities of $106.686 million. Finally, total liabilities stand at $2.243 billion.

It is worth noting that the net debt/EBITDA stands at close to 2x-3x, which does not look small. With that, the company has made a significant amount of efforts to reduce its long term debts, and has a significant amount of properties. In my view, investors may not be afraid of the total amount of debt outstanding.

Expectations From Other Market Analysts Include FCF Growth In 2024 And 2025

Market estimates include 2025 net sales of $2.156 billion, EBITDA of $580 million, operating margin of 17.20%, and pre tax profit of $360 million. Besides, 2025 net income would stand at $271 million with a net margin of 12.60% and 2025 EPS of $2.28. Finally, 2025 free cash flow is expected to be close to $315 million with a FCF margin of 14.60%.

It is worth noting that the FCF margin is expected to grow from 8% in 2023 to 14.6% in 2025. In my view, when investors start to see the increase in free cash flow, the demand for the stock could increase, which may lead to stock price increases.

My Assumptions Include A Beneficial US Construction Market And Public Investments

The forecasts for the current decade are promising as there is an expectation of growth in the US construction market, in private and public spheres. It is estimated that the investment and amount of money allocated to works managed by government entities will increase by 16% between 2023 and 2027, according to projects by the Portland Cement Association. I assumed that Summit Materials will likely benefit from this beneficial trend in the construction market.

In addition, by the year 2026, according to the Infrastructure Investment and Jobs Act, $52.3 billion dollars will likely be allocated to the construction of public works in the states of Kansas, Utah, Texas, and Missouri. A useful fact to accompany this forecast is that 35% of Summit Materials' profits in 2022 came exclusively from its business with the public sector.

Currently, the company is executing a growth plan based on four key factors, market leadership, social responsibility, innovation in its products, and its asset-light approach. As a result of the strategy, I would be expecting product improvement, lower costs, and larger social impact, which will most likely draw the attention of more investors.

I also assumed that Summit Materials will likely acquire other competitors, which will likely bring not only synergies, but also new technologies and margin enhancement. Management was very specific about its intentions in the last annual report.

We seek to enhance margins through proven profit optimization plans, managed working capital and achieved scale?driven purchasing synergies and fixed overhead control and reduction. Our management team, supported by our operations, development, risk management, information technology and finance teams, drive the implementation of detailed and thorough profit optimization plans for each acquisition post close. Source: 10-k

My Cash Flow Model Implied A Valuation Of $37 Per Share

My cash flow statement model includes 2033 net income of $927.5 million, a depreciation, depletion, amortization and accretion of $713.5 million, and share based compensation expense close to $61.5 million.

I expect the net gain on asset and business disposals close to -$612.5 million, changes in deferred tax assets of $233.5 million, changes in accounts receivable of $51.5 billion, and cost and estimated earnings in excess of billings close to -$16.55 million.

Additionally, I assumed other current assets close to -$24.5 million, changes in accounts payable of -$68.5 million, and changes in accrued expenses of -$84.5 million. Finally, net cash provided by operating activities would be close to $1.25 billion. With purchases of property, plant and equipment of -$86.85 billion, 2033 FCF would be close to $383.5 billion.

If we assume an exit multiple of EV/FCF of 29.5x and a WACC close to 8.55%, the NPV of FCF would be $5.35 billion. If we add cash worth $520 million, and subtract the debt, the equity would stand at close to $4.3865 billion, and the fair price would be $37 per share.

Competitors And Risks

Competition for Summit varies depending on the company's product or service. In terms of aggregates, Summit competes with large integrated vertical service companies, some of which have captured 30% of the market, as well as smaller-scale local producers. In relation to the sale of cement, there seem to exist only 90 production plants that exist in the country, which are mostly owned by large foreign companies with international operating levels. In this sense, access to the cement market presents a large number of barriers for new entrants due to the level of capital to be invested in a first step and the numerous regulations that exist to operate within the market.

In the first place, Summit depends on the cyclical movements of the construction markets, in which its products and services have agreed prices as well as fixed or semi-fixed costs that in the long run reduce the possibility of increasing profits. Besides, in terms of national operations, Summit is in a highly competitive environment. In the short term, there is a risk that it will not be able to carry out its growth strategy, which includes strategic acquisitions. Goodwill impairments could bring the expected FCF down.

To these factors we can add some minor risk factors that also affect the behavior of the company, such as the possibility that infrastructure plans run by governments diminish, which would lead to a direct reduction in revenue.

There is also dependence on the supply of oil and derivatives to power the production plants. Besides, regulations coming from the operation within the construction materials market and the possible limitations on the use of certain fuels in the future may be detrimental for Summit Materials.

My Takeaway

Summit Materials expects to benefit from significant growth in construction in the United States from now until 2027, and management is implementing strategies that will likely offer product improvement, lower costs, and better social impact. I dislike the total amount of debt, but I appreciate that management intends to lower its net debt/EBITDA ratio. Yes, there are risks from oil price increases or goodwill impairment, however I believe that Summit Materials could be worth more than what the market shows.

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