Eagle Materials: Top Line Is Driving Value For The Firm

| About: Eagle Materials (EXP)

Summary

Top-line is providing the future value to the firm.

Margins would remain flat.

EXP is conserving its cash flows.

Eagle Materials (NYSE:EXP), operating since the 1960s, is growing on the back of increasing construction activity in both the private and public sector, following an upturn in the economy, coupled with the pass of FAST Act. Through FAST, the company would benefit largely from the sale of "Aggregate and Concrete" product as the construction of roads requires large volumes of concrete. Further, the boom in residential on the backdrop of shrinking inventories of existing houses would bode well for its "Wallboard" and "Cement" product. Additionally, increase in 1QCY16's corporate profitability means that the commercial construction activity would boost further growth in the demand for basic construction material's products.

In order to further study the fundamentals of the firm, I have used various ratios to gauge the financial strength of the firm.

EXP crossed a billion-dollar mark in FY15 when it posted a sales revenue of $1.06 billion. After that, now in FY16, the revenue jumped to $1.143 billion, increasing by ~7.23% YoY. Further, if we take past ten years into account, the revenue growth went negative during the financial crisis. However, after FY11, the revenue has been on the steady rise owing to expansion in capacity together with burgeoning demand due to an upswing in economic activity. Further, going forward, I expect the company to post an average growth of ~10% for the next five years.

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Continuous margin accretion has occurred after the firm recovered from the America's financial crisis of CY08-09. The below chart shows an interesting picture, where even though the margins have recovered to some extent, they have not yet reached the level of the pre-recession period of FY06-07. Moreover, it is worth noting that the dip in the margins of FY16 is primarily due to the dismal performance of oil and gas proppants following suppressed international oil prices. Going forward, I expect the margins to normalize at current levels as the company has no material plans to improve its internal efficiency.

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I have used SG&A sales ratio to identify the administrative efficiency of Eagle Materials. As the graph below depicts, the company has mildly improved its administrative efficiency as a minute dip can be observed after FY13. On the other hand, net margin has also expanded since the financial crisis; however, the recent plunge was largely because the company has taken a charge of $37 million, which is due to amortization of an intangible asset. Going forward, I opine the net margin to normalize at FY15 levels.

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EXP has a consistent policy in managing its working capital as its cash conversion cycle hovers at 103 days against the average cash conversion cycle of ~45 days in the pre-recession era of FY05-07. However, it appears that in order to improve its liquidity ratios, the company has almost doubled its investment in working capital in the post financial crisis era. Further, the WCI (working capital investment) to sales ratio and the components of cash conversion cycle also depicts the same trend in the graphs below. Going forward, I believe cash conversion cycle to hover around ~103 day-level and WCI to sales ratio to remain at 23%.

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Eagle material's normalized debt to equity ratio is ~0.5 with an increasing ability to pay off the charge on both its short and long-term debts as illustrated in the graph below. Going forward, I foresee expected debt to equity ratio to converge at 0.5.

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Valuation

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Apart from the recent descent (the reason of which is mentioned above), the company enjoys a healthy return on equity against the cost of equity, which means that the company is creating future value for its investors. Additionally, it is worth noting that the entity is driving its value primarily on the basis of the expected surge in top-line. However, I believe that no significant margin accretion at any level is expected to occur.

Furthermore, the below graph shows an interesting historical relationship. The DPS (dividend per share) is stabilized at $0.4 per share despite an increase in free cash flow per share, which is greater than pre-financial crisis period. This means that the company is now following a very conservative approach in determining dividend payout ratios for the investors as its primary aim is to consolidate reserves, strengthening the financial position of the entity.

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Using discounted cash flow model, the stock has a "Buy" call with a target price of $85 per share till March '17, giving a limited upside of 9.5%. On a relative basis, the company is trading at P/E ratio of 25.44x against the construction materials' P/E of 37.5x.

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.