Summary
- Single-family housing will be a major headwind, but multifamily housing and private non-residential starts should increase.
- Highway and infrastructure funding should be a strong growth catalyst, although timing in release of funds could make near-term effects uneven.
- Performance of the next year will be determined by the depth of the decline in single-family residential construction.
- The offsetting factor will be the timing and growth of infrastructure and private non-residential construction.
Vulcan Materials ( VMC ) reported solid earnings in the third quarter, but looking ahead, there are tailwinds and headwinds pushing against one another that will determine the performance of the company over the next year and further out.
Essentially, the tailwinds will include almost everything outside of single-family residential construction, which is appearing to be a strong headwind over the next year or two. The only question there will be the depth of the slowdown.
On the other hand, private non-residential construction looks like it should maintain momentum, and increased funding for highway and infrastructure projects is in place, but the main issue there is the timing of the release of funds allowing the launching of those projects.
Any significant delay on large projects in particular could put downward pressure on Vulcan in at least the first half of 2023, and possibly longer, depending on the length of any delay in funding and starting construction and/or repairs.
In this article, we'll look at the latest earnings number and the conflicting catalysts that will determine the performance of Vulcan over the next year or two.
Latest numbers
Third quarter revenue was $2.09 billion, beating estimates by $80 million. Non-GAAP EPS in the reporting period came in at $1.78, beating by $0.07. Adjusted EBITDA was $507 million, up 21 percent year-over-year. VMC upwardly revised full year adjusted EBITDA to be in a range of $1.64 billion to $1.68 billion.
An increase in shipments and "accelerating pricing growth" in comparison to last year in the third quarter were the reasons given for improvement in earnings. According to CEO Thomas Hill, each product line had better earnings in the quarter.
As a percentage of revenue, SAG expenses were 6.5 percent of revenue, an improvement of 30 basis points over last year in the same quarter.
VMC strengthened its balance sheet further by issuing $550 million of commercial paper, using the capital to pay down 50 percent of its $1.1 billion term loan. It also had its credit facility increased to $1.6 billion while extending its maturity to August 2027.
At the end of the third quarter, the company had net leverage of 2.5x adjusted EBITDA, in alignment with the company's targeted range of 2x to 2.5x
Its strong balance sheet allows the company the flexibility to take steps to grow organically and inorganically. In the first three quarters of 2022 VMC deployed $378 million in operating and growth capital to grow organically, while deploying another $528 million in M&A. Another $159 million was used to pay its dividend. Full-year 2022 spend is guided to be in a range of $600 million to $650 million. Accelerating expenditures in the fourth quarter are from deliveries of equipment ordered.
Outlook
Looking ahead, there is no doubt the biggest headwind VMC faces is in the single-family residential segment. This has been expected for some time because of the rapid increase in inflation associated with the construction industry, the rising price of homes, and the response to soaring interest rates resulting in more expensive mortgages.
Other data confirms this with a drop in permits and housing starts. In some markets, the decline is slower than in others.
On the other hand, starts in multifamily housing and private non-residential are still in growth mode. Over the last year, private non-residential demand grew at a healthy 21 percent pace. It may not continue at that pace, but momentum remains in that segment of the market.
Concerning public projects, the funding available for infrastructure is enormous, and those projects will be a strong tailwind for VMC, with the caveat the release of the funds and timing of starts can be uneven and delayed, meaning the impact on any specific quarter could be minimal or disproportionate, depending on the process.
Based upon TTM, highway starts were up 14 percent and various other infrastructure starts were up 18 percent. Management said July and August 2022 received the highest highway awards over the last decade.
As mentioned above, the demand for aggregates will be determined by the timing of infrastructure starts in 2023. The unpredictable nature of government funding for projects needs to be taken into consideration in modeling VMC over the next year or two.
A major strength of the company is it has the pricing power to help offset the inflation affecting things like diesel fuel and other cost inputs. Throwing off as much cash as it does provide options for the company that many business sectors don't have.
For example, its aggregates pricing was up 12 percent, asphalt was up 26 percent and concrete was up 13 percent. With infrastructure and non-residential demand, along with pricing strength, the company is carrying momentum for the remainder of 2022 and into 2023.
Conclusion
When taking a lot of pieces related to the performance of VCM into consideration, it really comes down to two things: how much will the single-family residential market contract, and how much will infrastructure and non-residential projects offset it.
Because of the uncertainty in regard to CPI and the Federal Reserve's response to it, there's uncertainty concerning how high interest rates will be, and by extension, mortgage rates. If there is a positive surprise with inflation and the CPI, that would change the narrative and result in the next year or two being very profitable for VCM.
And in the case of public projects, the lack of consistency in timely release of funds and starting projects exposes VCM to risk if there are significant delays or extremely staggered funding that results in a number of boom or bust quarters.
Over the long term, VCM should be okay, but over the next year or two its performance could be choppy and unpredictable, depending on inflation and the Federal Reserve, and if single-family housing performs better than expected. The next couple of inflation readings will bring more clarity to that situation.
I would model for single-family housing, but consider the possibility of what happens if things don't go too far south there.
The good news is it has a solid balance sheet and access to capital to endure the difficult times while taking advantage of the opportunities it definitely has in infrastructure and non-residential markets.
For further details see:
Vulcan Materials: Performance Looks Mixed Going Forward