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Summary

  • U.S. Concrete emerged from bankruptcy in 2010 and finally achieved positive free cash flow for 2 consecutive years.
  • Though exposed to high-growth markets, the concrete industry is very competitive, with low barriers to entry.
  • It's hard to imagine paying a high single digit EV/EBITDA multiple for a company in such a poor industry.

Operating leverage can be an investor's best friend or his worst enemy. When a company is recovering from a cyclical downturn, and analysts continually set beatable estimates, shares soar. On the other hand, when analysts underestimate the magnitude of change caused by operating leverage, companies miss estimates, shares plunge and the market remembers the downside of operating leverage.

U.S. Concrete (NASDAQ:USCR) is a prime example of a company with a tremendous amount of operating, and in this case, financial leverage. Let's take a look at the company and see if it still has room to the upside, or if shares are appropriately valued, given the nature of the industry.

Overview and Background

U.S. Concrete is the classic example of a roll-out strategy rather than a platform. The firm held its initial public offering in the late 1990s and subsequently went on an acquisition spree. The firm went bankrupt in 2010, after getting pummeled by the financial crisis, only to re-emerge as a public company with a different ticker in 2011. The previous company had too much debt and too little success in extracting synergies from additional acquisitions.

Like much of the construction space, concrete is a very cyclical business, dependent entirely on residential and commercial construction, as well as infrastructure projects. This formula works extremely well when the economy is growing quickly, credit is loose, and government budgets are in good shape. Of course, the above factors tend to be highly-correlated, with good credit availability driving strong growth, and robust government budgets. When the economy is poor, or even lackluster, credit is tight, and government budgets are being slashed, the concrete business is pretty lousy.

The concrete market in particular is highly fragmented with no players holding dominant positions. U.S. Concrete competes with other public companies, like Cemex (NYSE:CX) and Vulcan Materials (NYSE:VMC), as well as tiny owner-operators and regional players. With so much competition, concrete companies earn commodity margins, so it's up to companies to differentiate themselves with superior balance sheet management, operating efficiency, and environmental differentiation. U.S. Concrete is able to invest some money into R&D and can create some modest product differentiation, thus the firm has created concrete that can help a building become LEED Certified-improving the attractiveness of the building for the landlord.

Geographic Markets

For a business as vast as concrete, not all geographies are created equal. U.S. Concrete has several geographic regions in which it operates, with 40% of revenue coming from Texas, 35% from California, and 18% from New Jersey/New York. I can hardly come up with better locations.

State GDP ($mm)

2008

2009

2010

2011

2012

California GDP

1,900,463

1,818,627

1,845,249

1,908,985

2,003,479

% change y/y

-4.3%

1.5%

3.5%

4.9%

New Jersey GDP

482,099

471,957

483,007

493,175

508,003

% change y/y

-2.1%

2.3%

2.1%

3.0%

New York GDP

1,079,719

1,080,441

1,136,417

1,169,436

1,205,930

% change y/y

0.1%

5.2%

2.9%

3.1%

Texas GDP

1,209,267

1,140,218

1,226,714

1,321,005

1,397,369

% change y/y

-5.7%

7.6%

7.7%

5.8%

Source: BEA, Detroit Bear

California, Texas, and New York all have $1.2 trillion + economies, with Texas and California both growing at robust rates. The New York and New Jersey area is also growing at a solid pace, and when combined, account for a higher percentage of any state not named California. The domestic oil-drilling renaissance should keep Texas chugging along for years, and California remains one of the most desirable places to live in the United States.

Though these markets are enormous, they are also extremely competitive, so firms are unable to earn robust margins. Companies slash prices to take the lowest margin possible, and barriers to entry are extremely low due to the reasonable cost of purchasing a cement mixer. All things considered, I would much rather own a cement business in a growing market than a struggling place like Detroit or Milwaukee.

Profitability

Since re-emerging from bankruptcy in 2010, U.S. Concrete has made positive EBIT in only 2012 and 2013, with pre-tax operating margins of 0.23% and 3.46%, respectively. Gross margins have ranged from 11%-16%, so generating any decent amount of profitability is entirely dependent on achieving operating leverage from higher revenues.

Free cash flow hasn't been much better. In the past four years, the company's strongest annual free cash flow generation was a paltry $4 million. This equates to a 0.9% free cash flow yield on an enterprise value of $434 million. Shareholders aren't making a lot of money, nor does it seem likely, given the high capital reinvestment needed to maintain the business.

Valuation

It does not seem likely that the company will earn a GAAP profit in FY14, though the company should post a positive operating margin. There isn't any analyst coverage, and management does not give guidance. We do have some insight with regards to revenue, thanks to the backlog, but margins are a trickier story. Costs can fluctuate during the year pretty substantially, and certain events (think weather) can impact revenue timing.

At 10.66x last year's EV/EBITDA, I cannot imagine that the company is trading at any better than 9x next year's EBITDA. I generally dislike using EBITDA as an earnings metric, since it obscures real costs, but the firm's equally unimpressive free cash flow generation capabilities do not provide much support for any valuation. Ultimately, I could hardly imagine paying 4x mid-cycle earnings on an EV/EBITDA valuation, let alone a high single-digits multiple. U.S. Concrete is the sort of company best bought when its earnings are most depressed, assuming its balance sheet can stomach a downturn.

Overall, I think traders can make money in this name if they are able to make accurate macro calls. However, the concrete industry is too fragile for long-term investment as a public owner, and every downturn is accompanied by the risk of bankruptcy. At this time, I do not see much upside.

Source: A Levered Bet On Construction: U.S. Concrete