U.S. Concrete Is Still Attractive Even After More Than Doubling This Year

| About: US Concrete (USCR)
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Investment thesis

U.S. Concrete (NASDAQ:USCR) trades at the peer average multiple despite an exclusive focus on the strong U.S. market, a strong moat and one of the healthiest balance sheets in the industry.

Company overview

USCR is a domestic producer of ready-mixed concrete and aggregates (including crushed stone, sand and gravel).

In 2012, USCR sold its Arizona and California precast operations in order to focus on the ready-mixed concrete market while asset acquisitions strengthened its presence in the Dallas and San Francisco Bay area.

Improving macro outlook is primary catalyst

Domestic construction demand for ready-mixed concrete continues to be strong as evidenced by the fact that last year was the first time residential construction demand improved since the peak in 2006.

As a result, USCR continues to deliver impressive top and bottom line growth. In the most recent quarter, revenue rose 18% to $173.6 million (the 12th consecutive quarter of revenue increases), driven by broad-based volume growth and price increases. The 5.9% price increase in the ready-mixed segment was the tenth consecutive quarter of higher average selling prices. Moreover, the average selling price per cubic yard of $104 exceeded the peak price of $91-92.

U.S. Concrete's high operating leverage drove a 108.7% EBITDA increase to $18.6 million while the EBITDA margin rose 460 basis points to 10.7%.

Moreover, there are three overlooked catalysts that can support even further stock appreciation.

First, management said on the most recent conference call that its vertically integrated peers are showing pricing discipline as memories of the recession remain. This should enable continued margin expansion (or at the very least stable margins) and should not be taken for granted as other industries (such as property and casualty insurance) consistently forget the lows at the peak, which sows the seeds for the next period of weak pricing power.

Second, continued increases in operating efficiencies and raw material spread expansion are additional margin drivers. For example, the ready-mixed spread rose 110 basis points to 46.8% while SG&A expenses as a percentage of revenue (excluding costs related to its headquarters relocation and non-cash expenses) declined 160 basis points to 7.6%.

Third, USCR has federal NOLs of ~$64.7 million that don't begin to expire until 2028, which should result in a low cash tax rate for at least the next several years.

Market share gains represent another catalyst

The strong moat and superior products can be used to steal market share from small independent producers and even large vertically integrated ones. This is driven primarily by five factors.

First, USCR has a core base of repeat customers, which can lead to significantly lower customer acquisition costs and higher visibility. Furthermore, its long operating history provides a competitive advantage in the bidding process given that the purchasing decision for many jobs is relationship-based.

Second, USCR is not merely another commodity supplier. For example, it can lower overall construction costs (of which concrete is only a small part) by providing customized formulations (e.g. fibers to control shrinkage cracking and replace rebar) and delivery as well as on-site quality control. Moreover, these value-added products and services produce higher margins.

Third, its aggregates segment provides a secure source of raw materials (for instance, 40% of aggregates sales in the mrq were to the ready-mixed segment) and an additional revenue stream in the form of external sales and royalty agreements.

Fourth, increased concern regarding the effects of concrete plants (e.g. dust, process water runoff, noise, truck traffic) has resulted in greater difficulty in obtaining new plant permits and licenses. Along with regulatory delays and significant upfront capex requirements, these challenges have resulted in higher barriers to entry, which results in less competition and margin pressure.

Fifth and arguably most important, its environmentally friendly products provide a competitive advantage. This is significant as the industry has not been traditionally considered "green". For example, USCR is positioned to take advantage of the secular trend towards environmentally friendly construction with its EF Technology, which allows customers to receive LEED credits. Every key constituency benefits by using this technology. The environment is saved due to lower carbon dioxide emissions and reduced landfill space consumption. Contractors benefit due to lower costs compared to cement and no compromises on durability*. USCR benefits in the form of higher margins. This technology is being used at the new World Trade Center complex, the new Hudson Yards project and in rebuilding areas affected by Superstorm Sandy.

*This point should not be overlooked as the environmental consequences of a bridge collapsing are obviously greater than forgetting to recycle a soda can. The reason the green movement has gained so much ground recently is because it offers tangible benefits to consumers (e.g. Sodastream (NASDAQ:SODA) prevents the need to carry/store hundreds of soda cans each year) compared to the past when it required significant sacrifices (e.g. don't take long showers).

Strong and core ownership profile

Part of the reason for the strong price performance YTD may be the low float. As more investors continue to "buy in" to the USCR story, they are forced to accumulate a rapidly shrinking number of available shares.

For example, in addition to the insider ownership, USCR is majority owned by three distressed debt investors, one of the largest banks in the world and a division of New York Life insurance company (MacKay Shields, known for being a longer-term holder than a hedge fund focused only on the current quarter).

Furthermore, the largest investor is increasing its position even as the price continues to rise (Whippoorwill Associates bought ~359,000 shares this year).

Valuation

Despite these positive fundamentals, USCR only trades at the peer average multiple.

USCR deserves a premium as it generates virtually all of its revenue in the U.S. including several of the strongest local markets. CX said last month that strong U.S. volumes offset weakness in Mexico.

The strong balance sheet (with a fixed charge coverage ratio of 4.25x) compared to some of its higher levered peers such as CX and HEI is another factor in favor of a higher multiple. The debt profile is further improved by the proposed $200 million senior secured notes due 2020, which would be used to repay outstanding credit facility borrowings and redeem the outstanding 9.50% senior secured notes due 2015. An expanded credit facility with an extended maturity provides even more financial flexibility.

Risks

USCR operates in a highly cyclical industry with high fixed costs. Additional risks include:

  • Lower commercial/residential construction activity.

  • Lower local/state/national government infrastructure spending on street, highway or other public works projects.

  • Unfavorable weather conditions as rain and concrete do not "mix".

  • Increased competition from the fragmented market. USCR competes against multiple vertically integrated manufacturers as well as independent producers.

Conclusion

The target price is based on a 10x EBITDA multiple. This is more than reasonable given the factors mentioned above.

More aggressive investors may wish to gain exposure via the warrants that were originally given to common stockholders when USCR emerged from bankruptcy in August 2010. The Class A warrants have an exercise price of $22.69 while the Class B warrants have an exercise price of $26.68. Both classes expire on the seventh anniversary of the effective date (8/31/10).

An important note regarding risk management: The warrants are inherently riskier than the common. The Class B warrants are the riskiest given that they are ~20% OTM.

The stop loss should be placed below the recent breakout area of ~$20.75 or ~6% below. The time frame is 12-18 months.

Disclosure: I 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.