Considering Vulcan Materials’ (VMC) revenue remain mostly tied to public infrastructure, I see a challenging outlook ahead for the company and its peers, with a new administration set to take office in 2021. My base case now calls for limited funds allocated to infrastructure, with any uplift from a highway bill unlikely to flow through until late 2022 (assuming a 12-24 months lag). With VMC shares also pricey at the current c. 15x EV/EBITDA multiple, I am neutral on the shares.

Cost Discipline Offsets Weakness in Aggregate Sales

Vulcan’s FQ3 earnings report saw aggregate sales declining by c. 7% Y/Y on the back of weakness in freight & delivery revenues (-13% Y/Y). The top line declines look concerning at first glance, but I think the shipment-led decline in freight revenue was somewhat unsurprising considering the ongoing uncertainty due to COVID-19, along with weather-related headwinds and the wildfires in California for the quarter.

3Q19

4Q19

1Q20

2Q20

3Q20

Aggregates

1,133

960

868

1,071

1,049

Aggregates Growth (Y/Y)

9.9%

4.0%

0.8%

(7.4%)

(Source: Company Data)

Nonetheless, aggregates gross margins improved to 32.2% (up c. 70bps Y/Y), benefiting partly from higher prices but mainly from lower diesel fuel costs (c. $9 million benefit) and operating efficiencies, offsetting headwinds from lower sales volumes.

3Q19

4Q19

1Q20

2Q20

3Q20

Aggregates Gross Margin %

31.5%

28.6%

22.4%

32.8%

32.2%

(Source: Company Data)

Building on the impressive cost control this quarter, VMC also posted resilient FQ3 EBITDA of $403 million on an adjusted basis (-0.8% Y/Y) as lower unit costs and lower SG&A again offset the weaker top line. However, the company disappointed on the EPS front at $1.56 (-7% Y/Y), as a result of higher interest expenses and an elevated tax rate.

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(Source: Vulcan Materials FQ3 ’20 Presentation Slides)

Near-Term Guidance Rests on a Volume Recovery

Notably, VMC re-established its full-year EBITDA guidance at $1.285-1.315 billion, with similarly positive commentary to peer Martin Marietta Materials (MLM), pointing to a gradual recovery in volumes through fiscal 2021 amid a favorable pricing environment. While the near-term volume outlook seems strong, I would point out that the full-year EBITDA guidance implies a below-consensus FQ4 EBITDA of c. $290 million at the mid-point. In turn, this likely means a Y/Y decline in aggregates gross margin embedded in the guidance – a rather negative surprise.

(Source: Vulcan Materials FQ3 ’20 Presentation Slides)

Also notable was management’s take on the favorable leading non-residential indicators across warehouses and distribution centers in VMC states. Interestingly, management is now calling for private non-residential construction activity to stabilize throughout fiscal 2021, with the pricing outlook also broadly favorable. However, with a new administration at the helm (Note: VMC held its earnings call just before election results were called), I think there is a material risk that the fiscal 2021 guidance numbers (due early next year) could disappoint.

Favor Residential Resilience over Non-Residential Cyclicality

In contrast with management’s bullish near-term outlook, the Dodge Momentum Index (a monthly measure of initial reports of non-residential building projects in planning) has seen a c. 1.8% sequential decline in October (commercial buildings -4.4%), reflecting lower contract award activity. While the institutional component did see a sequential gain, I would note that the institutional building index is still well below pre-COVID-19 levels as budget concerns linger. Using the index as a leading indicator, I see a slow recovery ahead for VMC, which remains heavily exposed to non-residential demand.

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(Source: ForConstructionPros.com)

On the other hand, residential tends to be more resilient, with higher visibility. Heading into fiscal 2021, fundamentals look far better on the residential side considering the strong household formation trends, low inventories, and an increasing preference for single-family residences (which are more aggregate-intensive) as people shift to the suburbs. As the chart below illustrates, median single-family home prices remain robust despite the COVID-19 headwinds in 2020.

(Source: Wolf Street)

Multiple Compression Risk as Post-Election Headwinds Loom

The continuation of a divided government is not all bad, but considering the enthusiasm around an (unlikely) major infrastructure plan under a “Blue Wave” scenario, I am concerned about the potential for a downside surprise. Furthermore, both sides still need to agree on fiscal stimulus measures such as the highway bill, and therefore, I see a material risk of a delay to 2022. Even in management’s scenario (excerpt from the FQ3 call below), where the highway bill is passed in late-2021, the 12-24-month lag to aggregates volumes implies any uplift will not hit VMC’s financials until late-2022 or so.

And then two, and really importantly, congress passes a new better highway funded – a new better funded highway bill in late 2021.

Relative to my base case for a smaller stimulus package and limited funds allocated to infrastructure and state & local governments, the valuations seem rich. With consensus 2021 estimates holding up on hopes of a recovery next year, VMC trades at a premium c. 15x EV/EBITDA multiple despite the limited near-term upside catalysts. Going forward, I see a risk of fund outflows compressing the multiple, with continued volume headwinds and a delayed highway bill likely to drive a downside surprise to upcoming 2021 guidance numbers.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.



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