Build firm foundations with US basic materials stocks

At the core of this particular investment case is the structural demand for basic materials, as the US goes through a programme of updating its crumbling infrastructure over the next decade. According to official surveys, at least $2.6trn (£2trn) needs to be spent to replace unsafe bridges, old dams and mediocre roads if the country’s infrastructure is to be brought up to scratch. While that structural (infrastructural?) point lurks in the background, the interaction between the price of their products and the cost of their inputs is aligning to boost the profitability of cement companies in the US at just the right time.

Prices rise, input costs fall

The average cost for US-made cement hovered around $130 (£104) per metric tonne in 2022, its highest average level for many years, and has barely fallen despite forecasts of lower demand in the spring from construction projects linked to the residential housing market. This is combined with falling inputs costs like natural gas, which concrete firms use in large quantities in their production process. The Henry Hub spot price for natural gas has fallen to levels last seen in August 2020, which will benefit the concrete producers once they have finished working through their forward contracts. The combination of falling input costs (apart from labour) and high prices should ensure good underlying profitability for the sector this year.   

While there are signs that lenders are rowing back from parts of the mortgage market, which might have an impact on construction of new homes and may hurt companies such as Eagle Materials (US:EXP) – which specialises in products aimed at the residential building market – demand even in this segment has stayed relatively resilient. It is also relevant to a company like James Hardie Industries (US:JHX) which has a global footprint and supplies materials to “tough build” projects that are expected to stand the test of time.  

However, if the emphasis is on large build infrastructure projects, investors will need to look to larger companies that can supply materials in huge quantities. In this context, Vulcan Materials (US:VMC) could offer a better entry point for investors. Based in Birmingham, Alabama, the company is a leading supplier of crushed aggregates but also produces downstream basic materials like asphalt and concrete. It has 400 active aggregates facilities, 70 asphalt facilities and 240 concrete facilities across 22 states in the US, and also in British Columbia, Canada. The company dominates the southern markets of the US but aspires to grow into a national player. It realised part of that strategy in 2021 with the acquisition of US Concrete for $1.29bn, which gave it a greater foothold in metropolitan Texas and complemented its existing facilities in the state, as well as in the prize markets of New York, New Jersey and the aggregates segment in California.

The company’s strategy seems to be to maximise its aggregates business by buying up downstream assets, while disposing of those that do not generate enough margin. For instance, Vulcan recently got rid of ready-mix cement assets in New York that did not tie into its strategy. The ongoing efforts to improve the margin has worked to a measurable degree: average cash profit per ton has grown by an aggregate of 5 per cent per year since 2017, to $7.45.

The improvement in margin reflects operational efficiencies and a growing volume of projects within the important highways sector. The first of the projects funded by the US government’s infrastructure plans started to come through in the summer. For instance, according to official statistics, the number of highway projects starting in August 2022 was 14 per cent higher year-on-year, reflecting in part the return to pre-pandemic normality, but also the higher levels of funding that is creating demand for Vulcan and other companies. About 41 per cent of Vulcan’s business is generated by highways and bridge renewal (large-scale infrastructure projects) and gearing up to serve those markets is neither easy nor cheap for potential competitors.

This is why the company often talks about the wide moats around the business – it isn’t just opening a concrete plant and hoping for the best. Companies in this sector need to be sitting on vast reserves of aggregates and need to position their assets to be close to the fastest growing markets, which takes considerable logistical savvy. This is why Vulcan concentrates its operations in the lower 30 states in the US: not only are these sun belt areas growing markets, but also benefit from the main depository points for aggregates washed down by the US’s mighty rivers. In other words, benign geographic conditions and accidents of geological time have created a natural barrier to entry for Vulcan’s competitors. In addition, the capital needed to build cement plants that have comply with stringent environmental regulations puts further obstacles in the way of competition.

In valuation terms, Vulcan’s forward PE for 2024 of 24.4 is slightly ahead of the underlying index and reflects the price moves that are underpinning its profitability over the next two years, with a price to book value of 2.8 times. In part, that reflects the impact on inflation on the value of Vulcan’s inventory – aggregate in the ground still counts as inventory. However, there is a way of averaging off the investment by splitting capital with the much lower rated Eagle Materials, which comes with a forward rating of 11.9. As mentioned, Eagles’ lowlier value is due to its greater exposure to the uncertain US housing market. However, in portfolio terms, it has the advantage of boosting returns from a lower base if housing construction and renovation activity pick up over the next two years. Fundamentally, both are cyclical companies that simply find themselves at radically different points in their respective business cycles.

But whichever way you choose to play it, an increasingly government-driven US economy is driving demand for construction materials, so that companies can make things. According to Census Bureau data, spending on factory construction hit an all-time high of $108bn in 2022. While a good majority is going into battery factories and other high technology industries such as semiconductors that are backed by billions in government grants, the pursuit of efficiency and reliability of supply chains means that many lower technology companies are reshoring their production after decades of shipping this abroad. It is also a phenomenon that is happening across the nation, from rust belt to sun belt to surf belt, as firms look for suitable building land near to established or growing markets. While the new factories will employ far fewer workers than in Turkey, Thailand or China because of automation and efficiency gains, the mere fact of their building is a boon for materials companies of all types. This suggests that investors should concentrate on an extended business cycle for materials suppliers, more so than the ailing though not tumbling housing market would otherwise imply for the sector.