By now, we’ve all read about the extreme over-building during the housing bubble. A much less familiar story, however, is the extraordinary under-building that has occurred subsequent to the bubble deflating. Over the last 52 years, a period during which the US population has nearly doubled, the three lowest years for new housing starts were 2008, 2009 and 2010, with 2011 headed for a similar low. In fact, trailing ten-year new housing starts from 2000-2010 per 100k people are at a 60-year low, despite this period of time including much of the recent housing bubble.
Summing up the last 10 years of new housing starts, divided by the average trailing decade population for each year starting in 1968, demonstrates that 2010 holds the record for the lowest population adjusted new housing construction figure. 2011 is currently set to break that record. Finally, residential construction is at historic lows in dollar terms as well. Private residential fixed-investments are 2.2% of GDP, a 60-year low, and half the 1947-2010 average. I believe current levels of normalized new housing starts will need to at least double in order to keep up with population growth and obsolescence. This bodes well for companies connected to residential construction that have survived the crash.
A very well written summary of this and other contrarian reasons to be bullish was posted recently on the Value Investors Club and on SCRIBD. I cannot claim credit for this excellent write-up, but I believe it makes a compelling case for a housing turn-around, whereas housing related equities are pricing in a permanent continuation of today’s depressed housing starts.
One such equity I would like to discuss is US Concrete (Nasdaq:USCR). US Concrete is a producer of ready-mixed concrete and pre-cast concrete products primarily in Texas, California and New Jersey/New York. US Concrete exited bankruptcy on 8/31/2011, converting $272.6 million of their Senior Subordinated Notes into new equity.
The effect of the dramatic decline in residential construction can be seen in the company’s revenue mix over the last few years [click to enlarge images]:
As of 11/11/2011, USCR had 12,867,239 shares outstanding (according to the most recent 10Q), for a total market cap of $40 million at a price of $3.11 a share. At 9/30/2011, the company had $4.797 million in cash, $55 million in convertible secured 9.5% notes due 2015 (carried at $47.9 million on the balance sheet), $475k in capital leases, $1.817 million in notes payable and other financing, and $24.614 million outstanding on the company’s senior secured credit facility due 2014 for total gross debt of $81.906 million and net debt of $77.109 million. This yields a current enterprise value of $117.1 million. The company also has two classes of warrants outstanding exercisable at $22.69 and $26.68 per share, which I have ignored in this analysis (it would be a good problem to have as equity owners if these somehow became dilutive).
The company entered into a $75 million senior secured credit facility due August 2014 on 8/31/2010. As of 9/30/2011 USCR had $24.6 million outstanding under the facility with $20.7 million of standby letters of credit. At 9/30/2011 there was an availability block of $15 million due to a fixed charge coverage test, which if not met would increase the block by $1 million monthly to $20 million. The First Amendment to the facility entered into in November, decreased the block to $10 million permanently and modified the fixed-charge coverage ratio covenant, so that beginning 4/1/2012, any time availability is less than $15 million, a fixed-coverage charge ratio must be at least 1:1 until availability is greater than or equal to $15 million. Pro forma for the amendment and updated $10 million block, availability under the facility would have been $19.7 million as of 9/30/2010. In practice, however, this borrowing capacity is closer to $14.7 million going forward in order to keep availability of at least $15 million to eliminate the requirement of a fixed coverage test (the $10 million block does not count towards this amount).
The 9.5% convertible notes require the company to meet a debt ratio of 7.5 to 1 for the year beginning on 4/1/2012. This is calculated as total debt to cash flow. In the most recent 10Q the company noted that “We believe that it is reasonable possible that we will not meet the consolidated secured debt ratio in April 2012. Given this uncertainty, we may seek an amendment to the Indenture to provide relief from this covenant.” I believe it is likely that USCR will obtain this waiver based on their ability to obtain the recent amendment to their credit facility as well as the make-up of the note holders (to be discussed in further detail later).
Trailing twelve month EBITDA as of 9/30/2011 was $10.6 million which should increase going forward given recent improvements in backlog, volume, pricing, and the overall construction environment stabilizing/improving. Current financing available ($14.7 million) appears adequate with the absence of trucks coming off leases through 2012 (for the first nine months of 2011 cap ex was $5.9 million of which $3.9 million was for the purchase of trucks coming off lease), and $11.3 million of interest expense (annualizing Q3 expense).
Below are some historic financial numbers:
[Note that the company went public in 1999 and bankrupt in 2010.]
As of 12/31/2010 USCR’s primary plants and equipment were as follows:
- 16 wet batch plants (estimated replacement cost of $1.5 million per plant or $24 million total)
- 97 dry batch plants (estimated replacement cost of $0.7 million per plant or $67.9 million total)
- 11 portable ready-mixed concrete plants used for larger projects
- 7 aggregates production facilities (two of which are leased to 3rd parties for retained royalties on production) which produced 3.1 million tons in 2010
- 7 precast concrete plants
- 800 owned and leased mixer trucks (estimated useful life of 12 years) with new truck cost of $160-190k for total replacement cost of $180 million (though average fleet age was 9 years as of 12/31/2010)
Before assigning a value to the company’s portable plants and aggregates facilities, we’re already at a total cost of $231.9 million to replicate USCR’s present physical capacity, which might make the current enterprise value of $117.109 million attractive to a strategic acquirer.
The following is a quick valuation exercise to show the enormous leverage USCR has to a return of normalized housing demand. Under normalized housing demand I assume that volume shipped increases 50% from 2010 levels (3.805 million cubic yards) to 5.7075 million cubic yards. I assume $120 of total revenues per cubic yard shipped (a bit below current levels), for total annual revenues of $685 million (approximately what 2008 revenues were). If EBITDA margins return to 7% (below historic average over 8%) the company would produce EBITDA of $48 million. At a multiple of 6x EBITDA (also below historic average trading levels over 8x EBITDA), USCR would have a total EV of $288 million in a normalized housing environment. Backing out current net debt of $77 million leaves a $211 million market cap. However at this implied market cap, the 9.5% notes would likely convert to equity, increasing the share-count by 5.239 million shares to 18.106 million, and reducing net debt to $22 million. This changes the target market cap to $266 million or $14.70 per share. There’s obviously substantial upside to this in a housing recovery if the company gets to average or above average margins/multiples, but this just shows it doesn’t take much in the way of construction recovery for things to get interesting.
The bankruptcy filings, especially the disclosure statement, include some interesting checks on this valuation exercise. The effective date of the bankruptcy was 7/31/2010 (this valuation was definitely not completed during a normalized housing demand environment). The disclosure statement estimated a fair value of $180-208 million with midpoint of $194 million. Since net debt is $77 million this would imply equity value of $117 million or about $9 a share. As part of the disclosure statement valuation, a DCF was performed using a 14.5%-15.5% discount rate and terminal EBITDA multiple of 6.5-7.5x. In addition Lazard (who performed the valuation analysis for the disclosure statement) looked at precedent transactions over 12 years, finding, low, high and median EBITDA multiples of 7x, 8x, and 8x.
Also, as part of the chapter 11 plan, USCR had to calculate a likely liquidation value (to justify the alternative of reorganizing as an ongoing operation). The estimated proceeds in a liquidation including operational wind down costs and chapter 7 fees, came to $101.037 million on the low end and $148.966 million on the high end for a mid-point of $125 million, above the current EV for USCR.
The convertible notes do trade, with cusip of 90333LAE2. Despite the recent sell-off in USCR shares, the notes have actually traded up since bottoming in October in the low 80s to their current level of 95.
[USCR Convertible Notes in Blue down 15% last 3 months, Shares in Red down 52% in last 3 months]
Longer term view of the two securities (source: CapitalIQ)
This combined with the fact that many of the owners of the convertible notes are the largest owners of equity leads me to believe that USCR will be successful in obtaining waivers from the convertible note-holders, buying enough time for the company to benefit from a recovery in residential construction.
From the initial bankruptcy reorganization plan it should be obvious that the same parties that control the convertible notes have a significant interest in the equity, in addition to their conversion rights, since originally USCR entered into a purchase agreement to sell $55 million in convertible notes to Monarch Capital, Whitebox Advisors, and York Capital who also received significant amounts of shares in the reorganization. Below is a summary of the most recent ownership statements available.
- Whippoorwill Associates originally owned 1,490,688 shares, or 11.1% consisting of 742,783 common shares and 747,905 shares convertible through ownership of $7,853,000 in principal according to an SC 13G filed on 1/11/2011. They have actually increased their ownership stake according to an SC 13 G/A filed on 9/9/2011, now owning 2,155,508 shares through ownership in 1,350,460 common shares (an 81.8% increase in ownership) and 805,048 shares held as convertible debt in the form of $8,453,000 principal (an increase of 7.6%). They own about 10.5% of the common and 15.4% of the convertible notes.
- York Capital originally owned 2,092,550 shares, consisting of 1,195,789 shares of common stock, and 896,761 shares convertible through ownership of $9,416,000 in principal amount. The company reduced their ownership in the convertible notes to $4,853,000 principal while keeping their ownership in common shares the same according to an SC 13 G/A filed on 2/4/2011. This leaves them with 9.3% ownership of the stock and 8.8% ownership in the notes.
- JPMorgan filed an initial SC 13G on 2/3/2011 declaring ownership of 1,701,860 shares but does not break out what form the ownership takes (common stock vs. convertible bonds)
- Most recently filed SC 13G on 5/9/2011 for Citigroup shows ownership of 452,712 shares
- Helios Advisors LLC filed an SC 13G on 1/21/2011 declaring ownership of 656,429 shares
- Monarch Capital filed an SC 13G on 9/10/2010 declaring ownership of 1,248,533 shares consisting of 537,087 shares and 711,446 shares from $7,470,000 principal convertible notes. This would show an ownership of 13.6% of the notes.
- Whitebox Advisors filed an SC 13G on 2/15/2011 disclosing ownership of 1,247,008 shares consisting of both convertible bonds and common stock, but the two are not broken out.
- From this, it’s clear that a significant amount of the note-holders / lenders have material equity exposure, which should mean they would have an economic interest in granting a waiver.
Finally, USCR recently hired a new CEO, William Sandbrook, who had been CEO of Oldcastle Products and Distribution, a well-run building materials company several times larger than USCR. Sandbrook’s compensation is heavily weighted towards USCR equity, where 50% of his “performance shares” vest if USCR’s stock price per share is above $16. The other 50% vest only above $20 a share. He also purchased some stock in the market in August and September.
In sum USCR appears to be an attractive investment based on the following:
- Fundamental factors favoring an upturn in demand in the near to medium term
- A significant cost-cutting program currently under way combined with minimal cap ex requirements over the course of 2012 and creditors with economic exposure to the equity
- An absolute valuation at historic lows (the company’s assets have never had an EV this low, even in bankruptcy), with enormous upside leveraged to a residential construction recovery
Disclosure: Long USCR