AGB 2023.1 - Vulcan Materials (VMC)
Benefiting from Infrastructure Tailwinds
Subscribe to AGB - One analysis of a good business every five weeks.
Vulcan Materials is the leading producer of aggregates in the U.S. with ~10% market share in 2021. The company has the #1 or #2 position in ~90% of its markets and its facilities are strategically located in 35 of the top 50 MSAs in the U.S. across 22 states. Vulcan also provides asphalt and ready-mix concrete in certain states, which are vertically integrated with its aggregates production facilities. The company has over 22k customers.
Aggregates are primarily crushed stone, sand and gravel, usually sourced from a local quarry. Once mined, the stones are crushed and separated into various sizes for different use cases. Aggregates are a key material used for the construction of highways, parking lots, bridges, schools, commercial and residential buildings and other key infrastructure. As an example, a typical interstate highway requires 21 inches of aggregates laid on compacted soil and another 11 inches of concrete on top.
Priced between $10-$15/ton, aggregates have one of the lowest ratios of value to weight among construction materials, making proximity to the end customer very important from a cost perspective. Over 60% of the U.S. population lives 60 miles from a Vulcan owned aggregates facility. The end products are delivered to customers by trucks, trains and ships, with over 80% of the transportation being done by truck. Trucks have carrying capacity of 20-25 tons. Train cars can hold 4-5 truckloads and ships can hold 65 truckloads.
Customers of aggregates can be broken down into publicly and privately funded construction. In 2021, 42% Vulcan’s aggregate revenues were for publicly funded construction, of which 22% were for highway construction. The remaining 58% were for privately funded construction. Non-residential construction makes up the most of aggregates volume accounting for ~40%. Residential constructions makes up ~22%, highways ~23% and other non-building infrastructure ~15%.
As a general rule, non-residential construction and public infrastructure are more aggregates intensive than residential construction. According to Morgan Stanley, ~38k tons of aggregates are required for the construction of one mile of a four lane interstate highway. By comparison, the average home requires ~400 tons of aggregates and the average school or hospital requires ~15k tons, mainly for the support and foundation of these buildings.
Publicly funded construction is typically less cyclical than privately funded construction because public sector spending on infrastructure is supported by Federal funding bills. From 1998-2005, it was the Transportation Equity Act for the 21st Century (TEA-21); from 2005-2012 it was the Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users’ (SAFETEA-LU); from 2012-2015 it was the Moving Ahead for Progress in the 21st Century (MAP 21); and from 2015-2021 it was the Fixing America’s Surface Transportation (FAST) Act. The states in which Vulcan has a presence benefited from these funding bills more than other states, except during SAFETEA-LU era.
In 2021, the Infrastructure Investment and Jobs Act (IIJA) was signed into law. The bill was for $1.2T, of which the Federal Highway Program funding was the largest part. This program starts at $66.9B in 2022 and increases to $72.1B in 2026 for a total of $347.5B over the 5 year time period. This is the largest increase in federal highway, road and bridge funding in many decades.
Privately funded construction is more cyclical as many projects are correlated with job growth and demographic trends. Growth in the workforce creates demand for housing as well as offices, shopping centers, warehouses, restaurants, etc. A slowdown in the economy does have an impact on aggregates demand. From a profitability stand point, there isn’t much difference for Vulcan to sell aggregates to publicly funded or privately funded construction customers.
The company’s aggregates segment contributed 72% of revenues and 94% of gross margin in 2021. Vulcan also has an asphalt segment, which makes up 14% of revenues and 2% of gross margin. Asphalt is considered a downstream business from aggregates because aggregates is a key input to make asphalt and makes up 95% the weight. Aggregates are mixed with liquid asphalt cement, which the company purchases from third parties, to make asphalt. Vulcan sells asphalt in a few states like Alabama, Arizona, California, New Mexico, Tennessee and Texas. Margins are much lower in asphalt (3% vs. 30% for aggregates) because the extra cost of liquid asphalt cement and the fact that asphalt is very temperature sensitive. Asphalt has a higher mix of privately vs. publicly funded construction demand.
Vulcan’s concrete segment makes up 14% of revenues and 4% of gross margin. This was lower in the past but the company acquired U.S. Cement in 2021, increasing its contribution mix from concrete. The company sells ready-mix concrete in a few states like California, Maryland, New Jersey, New York, Oklahoma, Pennsylvania, Texas, Virginia, the U.S. Virgin Islands, and Washington D.C. Aggregates make up 80% of the weight of concrete. Because ready-mix concrete hardens quickly, usually the end customer has to be in close proximity to the production facility. This segment also has lower margins at 7% because of the extra input costs required and the lower barriers to entry in producing this product.
The aggregates industry is very fragmented with over 5.5k companies and 11k operations. The company estimates that 2/3 of the industry is owned by small regional players, implying that consolidation is still an ongoing trend. The top ten producers commanded 15% of the market in 1983, reached 21% by 1992 and now command 33%. Vulcan is the leader at ~10% and Martin Marietta Materials is a close second.
Prices of aggregates, unlike other construction materials, tends to trend upwards even during periods of slowing to negative demand. Reasons for this dynamic are (1) aggregates are essential for construction but have almost no substitutes, (2) aggregates have low value/weight, meaning they can only be economically sourced by the end customer from local facilities, (3) aggregates are a small portion of the total cost of a project (2%-10% range), and (4) quarries can start and stop operations with ease (15 minutes to shut the operation down). This results in annual price increases that are almost always positive. Even during drop in demand during and after the Great Recession, prices remained flat or positive. Industry average prices have increased at a CAGR of +4.3% from 2003-2020 and Vulcan did better at a +5% CAGR during the same period.
Financial metrics that are important to the company are gross profit/ton and incremental margins. At Vulcan’s 2019 Analyst Day, the company provided a target of $9 in cash gross profit/ton on 230M-240M tons of volume, which implies $2B in EBITDA. The company reached $7.43 in cash gross profit/ton in 2022 and volumes of 223M tons. At the 2022 Analyst Day, the company provided a new long-term target of $11-$12 in cash gross profit/ton on volumes of 260M-270M tons, resulting in an EBITDA target of $2.7B-$3B. As for incremental margins, the company aims for 60% flow through on a gross profit/ton basis.
Why is it a good business?
As the largest producer of aggregates, Vulcan benefits from its intangible assets and scale advantages. Permitting for quarries are the limiting factor when trying to secure a new aggregates facility. According to Merrill Lynch, the permitting process can take up to 10 years and usually involves convincing the local community and regulators. Community members will likely complain about the excess noise and traffic created during the construction of the site. Furthermore, there may be environmental impact studies required.
And usually when there is already an established local aggregates quarry, it’s very difficult to get approval for another. The company’s 15.6B tons of proven and probable reserves become even more valuable as permitting becomes more difficult and zoning/environmental laws become more stringent. According the USGS, the number of aggregates quarries in the U.S. peaked in 1976 at 12.6k and have steadily moved lower to just 9.2k in 2018.
As the largest aggregates producer, Vulcan already has rights to many key quarry locations in the states that the company services. Being closer to the end customer gives Vulcan a pricing advantage relative to other individual quarries that are farther way from the customers’ sites, because transportation is such a large part of the total cost of aggregates. Aside from areas along the U.S. gulf coast and the eastern seaboard, most of the transportation of aggregates is done by truckloads (82% for Vulcan). Transportation by truck can cost anywhere in the range of $0.15-$0.30/ton mile, economically limiting the range of deliveries by trucks to ~50 miles. According to USGS, 90% of aggregates are used within a 50 mile radius from the extraction site.
And when diesel prices move higher, Vulcan states that the company is a long-term beneficiary since more customers will look to purchase aggregates from better located facilities. Given the closer proximity of Vulcan’s facilities to its customers, the company has been able to raise prices more than the peer group recently. Since 2017, Vulcan has increased prices cumulatively by +20%, while the peer group has only been able to raise it by +15%.
Given that the aggregates business is a local one, Vulcan’s scale advantages aren’t that pronounced at the individual facilities. Having said that, higher utilization rates usually result in higher margins due to more volume being spread across the fixed cost of the facilities. In 2015, Vulcan stated that the company had capacity to produce 300M tons, implying a 60% capacity utilization. The company has acquired new plants and added additional greenfield ones since then and is still operating below capacity. Scale also benefits the company in the sourcing of equipment, parts and supplies in a cost efficient manner. Parts and supplies are 20% of the cost structure of the company.
The aggregates industry also benefits from a lack of real substitutes for the material. While recycled materials are used in certain instances because it’s viewed as a lower-cost alternative, many construction projects will not allow the use of recycled materials due to technical specifications and meeting of performance criteria. Recycled materials usually mean lower fidelity in terms of durability and strength. According to USGS, recycled materials make up less than a couple percent of the aggregates market.
The company’s concrete and asphalt businesses do not benefit from these advantages. There are no barriers to starting a concrete or asphalt facility since anyone can purchase the required inputs to create these materials. Because of this, most producers compete heavily on price, which results in much lower gross margins than the aggregates business. Concrete and asphalt facilities also require heat as part of the production process, which means that the cost of turn off and restart a plant is much higher than with aggregates. This means facilities are kept running, even if demand slows down, resulting in much more volatile margin profiles for these businesses.
Returns on incremental capital?
Over the past ten years, Vulcan has spent almost half of its capital on capex and the remainder on M&A, offset by 6% of capital gained on the sale of PP&E and 16% in divestitures. Capex can be broken down into maintenance at ~45% and growth capital at ~55%. Maintenance capex is spent on keeping existing facilities running smoothly. Vulcan gives an example of a seven-foot cone crusher. Maintenance costs are ~$50k but waiting until it’s failed costs $150k to repair, without considering the loss of production due to an unplanned breakage in equipment.
Growth capex is mainly spent on maintaining or improving the number of aggregate tons in reserve. This is done by either expanding an existing facility to increase capacity or establishing greenfield facilities. This is difficult to do and takes a lot of time. The process involves procuring the land, surveying the geology, getting permitting, and building the facility. And to do this economically, the company has to be able to predict where there will be increased demand for aggregates in the future. Vulcan states that greenfield projects are some of the company’s highest returns on capital but the trade off is that it takes years to get them up and running.
The company also spends capex on innovations for operations and logistics. In 2017, Vulcan introduced the Vulcan Way, which involves leveraging data and technology to improve their selling and operating strategies. On the selling side, the company has been able to leverage data to quantify booking pace, price momentum and win percentages. This has resulted in sales reps being able to focus on higher quality leads and is part of the reason that Vulcan has been able to raise prices ahead of its peers. On the operating side, the company has improved its plant performance by improving sourcing capabilities, track asset level performance in real time, and help its customers with logistics.
M&A is Vulcan’s other method of increasing its reserves and is the primary way of expanding into new geographies. The large acquisitions of the past two+ decades include CalMat in 1999 (expansion into California and Arizona), Florida Rock Industries in 2007 (expansion into Florida and Mid-Atlantic regions), Aggregates USA in 2017 (expansion into Florida, Georgia and South Carolina), and U.S. Concrete in 2021 (further expansion into California + Texas and metropolitan areas like New York and New Jersey).
U.S. Concrete was acquired for $2B including debt. The company was estimated to do $190M in EBITDA, implying a transaction multiple of 10.6x. Vulcan has estimated ~$50M in synergies, implying a multiple of 8.3x EBITDA, or a 12% return. U.S. Concrete’s main business is ready-mix concrete at 85% of revenues and 65% of EBITDA. The company also has an aggregates business that does 12.5 tons of volume annually. That’s a little more than 5% of Vulcan’s aggregate volumes in 2021. The acquisition was completed in August of 2021. Going forward, aggregates should represent 64% of revenues (and still most of gross margins and EBITDA), asphalt 12% and ready-mix concrete 24%.
Vulcan prunes its portfolio of assets from time to time. Most important is how assets perform relative to the company’s long-term view of profitability and return on investment. Sometimes the company will do an asset swap and other times underperforming assets will be divested. In 2014, the company divested its Florida cement and concrete business for $721M, making it the biggest divestiture over the past decade.
We estimate that Vulcan generated returns on incremental capital between 15%-25% over the past 5 years. While the company doesn’t explicitly state what the internal hurdle rates are for capex and M&A, Vulcan did mention at the 2015 Analyst Day that a 10% pre-tax return on capital is too low. The company also believes that their cost of capital is too high, given the quality of the assets and positioning in the industry.
Vulcan estimates that the U.S. aggregates market has a TAM of $30B with volumes of 3B tons annually, implying an average price of $10/ton. This estimate for price is lower than what the company gets (~$14.87/ton in 2021) but is in-line with what prices were for Vulcan back in 2012-2013. We also have to remember that the company leads the industry in price with its key locations and customer relationships. Furthermore, price is influenced by transportation costs and proximity to the customers’ sites.
Vulcan estimates that its addressable market for aggregates is $20B because its aggregate facilities are located in 35 of top 50 growth MSAs. Remember that 60% of the U.S. population lives within 60 miles of a company owned facility. Assuming a price/ton of $14.87, $20B would imply annual volumes of 1.34B tons, which implies a 17% penetration rate of the company’s TAM in 2021.
Demand for aggregates should continue to move higher on the publicly funded side from the $1.2T IIJA infrastructure bill signed in 2021. The largest part of that is funding for the Federal Highway Program, which got an annual increase from $43.4B in 2021 to $66.9B in 2022. This will move higher to $72.1B by 2026. Highway starts have increased y/y in every month in 2022, going from a +2% y/y increase in January to +14% by August/September. Vulcan estimates that the increase in demand for aggregates will also come from investments in the energy grid, waterworks, ports, airports, rails and other forms transit.
On the privately funded side, while there may be weakness in residential construction, non-residential construction continues to show strong demand, especially in Vulcan’s markets. Also, we have to remember that publicly funded infrastructure is much more aggregates intensive. Highways are 7x and non-highway construction is 4x more aggregates intensive than residential construction.
For the asphalt segment, the company estimates that the TAM is $24B on 410M tons. At $778M in revenues in 2021, Vulcan has roughly 3.2% market share. For the concrete segment, the company estimates that the TAM is $49B on 390M cubic yards of volume. Accounting for the acquisition of U.S. Concrete, the company would have done $1.5B in concrete revenues for 2021, implying a market share of 3%.
With a reinvestment rate between 60%-80% and a return on incremental capital between 15%-25%, we estimate that Vulcan has increased its intrinsic value between 12%-15% annually over the past 5 years. Going forward, the U.S. Concrete acquisition will suppress returns on capital but the elevated reinvestment rates will offset that somewhat. Furthermore, as the Federal Highway Spending dollars flow through, the company should see higher returns on capital, assuming that utilization increases.
What else is important?
Inflation has impacted Vulcan on the cost side but because the price increases of aggregate have been consistent, the company’s cash gross profits have improved throughout 2022. Gross margins saw a slight negative impact in March of 2022 but flipped positive by May. This is because while costs rise due to inflation, price increases don’t flow through right away. The benefit from price increases usually lags as older jobs get completed and facilities shift to more recently quoted work. The company’s aggregate prices increased by +6.9% y/y in 1Q, +9.6% in 2Q and +12.4% in 3Q. Vulcan expects aggregates price increases to be in the double digits in the 2nd half of 2022, implying a +12%-13% increase by 4Q.
On the cost side, the company has seen a surge in key inputs like labor, energy and transportation. Labor is roughly 1/3 of Vulcan’s cost structure, parts and supplies 20%, diesel 8%-10%, and electricity another 8%. For the asphalt segment, the increase in liquid asphalt has put pressure on the segment’s margins.
What Happened to Vulcan during the Great Recession?
Aggregate industry volumes peaked in 2005/2006 at 3.5B tons and after the great recession, troughed close to 2.2B tons of volume in 2011. Vulcan saw an even larger drawdown in volumes, dropping by more than 50% from 2006 at 305M tons to 143M tons by 2011. The company has admitted that during downturns, Vulcan loses share as it remains disciplined on price and margins vs. competitors who will take lower prices to survive. On the subsequent upswing, Vulcan tends to recapture the lost share and then some.
During that time, the company was also in a precarious financial position as Vulcan took on debt to acquire Florida Rock Industries in 2007 for $4.6B in cash and stock. The debt/EBITDA ratio was above 6x in 2011. The company was also undergoing an ERP implementation at the same time.
Vulcan’s aggregate volumes have recovered since then, reaching 233M tons in 2021. Price has also improved from $10.25/ton in 2011 to $14.87/ton in 2021. Prices were steady even after the great recession, remaining very close to $10/ton. So even though the company’s volumes haven’t come back to the levels from 2005/2006 (the company has mentioned that its facilities are still underutilized), gross profit/ton and thus profitability have increased substantially.
M&A will be Vulcan’s main source of optionality. Even as the largest producer of aggregates in the U.S., the company only has operations in 22 states. Vulcan has expanded geographically mainly through M&A in the past with the acquisitions of CalMat, Florida Rock Industries, Aggregates USA, and most recently U.S. Concrete. After the company expands into new geographies, Vulcan can expand by establishing new greenfield facilities and/or investing in downstream assets like asphalt or concrete.
The company may be reluctant to expand internationally given the recent shut down of its operation in Quintana Roo by the Mexican government in May 2022. The government first prevented Vulcan from shipping out of the quarry for 6 weeks and then subsequently shut down any new extraction. This operation accounted for 3% of Vulcan’s aggregate shipments to the U.S., which mostly served customers along the gulf coast.
If you made it this far, I hope you received some value from reading our analysis. Please subscribe to the newsletter and share with anyone that would find it valuable. Thank you for your support!