Construction Materials Demand Could Surprise
This article is from the archive of The New York Sun before the launch of its new website in 2022. The Sun has neither altered nor updated such articles but will seek to correct any errors, mis-categorizations or other problems introduced during transfer.
It’s official. Notwithstanding yesterday’s good news on housing starts, construction is indeed slowing down. After posting growth of around 10% in 2004 and 2005, the rate of gain has moderated to low to mid-single digits. That is according to Jack Kasprzak with BB&T Capital Markets, who spoke at a conference on the construction materials industry earlier this week.
Notwithstanding the cooling, the New York Society of Security Analysts gathering attracted a sell-out crowd eager to hear from the managements of such zippy sounding companies as Granite Construction (GVA $54), U.S. Concrete (RMIX $6) and Florida Rock (FRK $39).
Why all the attention? Think umbrellas on a sunny day, or straw hats in winter. That is, the group is out of favor, and investors are wondering if there might be bargains about.
There is also considerable interest from the private equity folks. The investment case for some segments of the materials industry is appealing. The companies are selling at low multiples of cash flow (at least based on recent healthy earnings rates), the industry is fragmented so there are opportunities for consolidation, and some of the basic materials are in short supply. Voila. We’ve given away the story.
Pervading the presentations was the implication that investors are overreacting to a fall-off in residential construction. This segment accounts for 52% of construction spending but a much lesser amount of aggregates demand.
A case in point is Vulcan Materials (VMC $78). The stock is down 17% from its 52-week high. Don James, the head of the company said, “Everywhere we go people are concluding that because housing is declining our industry is going to fall off the table.”
He points out that Vulcan, the largest aggregates company in America, has consistently outperformed the S&P 500 over the past one-, two-, five-, and 10-year periods, and indeed since first going public in 1956. That covers a lot of cycles.
Buoying the outlook is that activity in other end markets such as non-residential and public works appears to be in better shape, and for many of the presenters, a turnaround in these markets could prove more significant than the slowing in home building. Non-residential construction was especially weak though 2002, enduring the worst slump since World War II, according to Mr. Kasprzak, but is turning higher.
A strong economy should support strength in office and commercial development. Office vacancy rates have been dropping for eight straight quarters. The Architectural Billings Index published by the American Institute of Architects has been in positive territory for 19 months, and suggests a good pace of building well into 2007.
The public works sector, meanwhile, is being buoyed by healthier state and local budgets, and by the passage of the six-year highway construction bill last summer. New highway contract awards hit record levels in 2005, and have continued to improve. Awards are up 16% year-to-date and hit a monthly rate of $4 billion for the first time ever earlier this year. Projects on the ballot in California should further buttress the sector. Public works spending is typically not very volatile, but constrained state and municipal budgets did have some impact in recent years.
Mr. Kasprzak expects that housing will continue to weaken, and that the downturn will have some impact on the materials companies. The inventory of new and used homes is up sharply; speculators hoping to cash in on the good times are now beginning to flood the market. This week saw a dip in home prices for the first time in 13 years.
However, even in this segment, he reminds us that the underpinnings of population growth and the rising rate of home ownership might limit the downside.
One of the strongest messages being delivered by the conference speakers is that location is key. Not all the markets are going to move together. California and Florida, where residential construction and prices have been red-hot, may be in for a drubbing. Meanwhile, Texas, the Carolinas and some other areas which have enjoyed a less hectic growth rate, may hold up better.
This is the likely explanation for the fall-off in the price of Florida Rock shares, currently selling 43% below their 52-week high. About 65% of revenues come from Florida for this aggregates and concrete supplier.
Location is especially significant for the aggregates producers since transportation costs are high for such bulk commodities, placing a premium on local supplies and well-placed reserves. This is especially true these days, as costs of opening new quarries have soared. It is also difficult to get permission to open new facilities, and hard to find new sources. Consequently, in some products there are no large capacity additions coming on stream, which should help maintain prices.
This appears to be especially the case in cement. Though some expansion is underway, the industry currently faces about a 25% shortage, with some companies sold out of the product for the next 20 years. These factors may keep cement and aggregates prices high, despite the slump in housing. Mr. Kasprzak says that there has only been one price decline in aggregates in the past 30 years.
“Even in a slower economy you don’t see companies cutting prices to gain market share. That differentiates this group from other cyclical industries.”
It is also the case that spending for non-residential construction and public works generates much greater demand for aggregates than does housing. For instance, public works account for about 23% to 25% of total construction dollars, but 40% to 50% of aggregates demand. The only product especially vulnerable to housing, according to various speakers, is gypsum wallboard, for which home construction accounts for 50% of demand.
Another problem for this segment is that there is considerable new capacity coming on stream through 2009. If demand is flat, capacity utilization could fall below 90%.
These factors are also encouraging consolidation within the buildings materials industries. In a number of products, large publicly-owned companies only account for about 20% of industry revenues, with small, local “mom and pop” operators making up the balance. The bigger companies such as Vulcan may increasingly turn to acquisitions as they strive to line up strategically positioned reserves.
Overall, though homebuilding is undoubtedly slowing, some materials companies may prosper. None of these projections, though, is cast in stone.