* All data are as of the close of Friday, January 9, 2015. Emphasis is on company fundamentals and financial data rather than commentary.
The General Building Materials industry is likely to be a very good bet for investors with a long term view. While some companies in the space have an advantage near term where others have an advantage longer term, many are assured to beat the broader market's earnings growth for years to come.
And with good reason. Industrial production in the U.S. is currently growing at a faster rate than the longer term average, as graphed below. Where industrial expansion usually ranges from 0% to 5% growth annually, with a solid average of 2.5%, the nation's output has been growing in the 3-5% range for almost all of the recent recovery, at least since early 2010.
As a result of such steadily increasing productivity, the nation's "capacity utilization" is being gradually used up. In the simplest of terms, capacity utilization measures the percentage at which the nation's factories, shipping and other infrastructure are being used. When an economy is utilizing 100% of its capacity, it is running at maximum output, and would have to build more facilities in order to further increase output.
Though America isn't quite at full output yet, it is near its longer term high of 80%. This means the nation is at the point where it needs to seriously consider expanding its capacity by building new factories and expanding its infrastructure from shipping to power supply. This is a good omen for the General Building Materials industry.
Of course, there hasn't been much need for expanding capacity for quite a few years since the economic crisis, during which time capacity utilization plummeted from about 81% to some 67%. Thus, two of the nation's three largest companies in the space - Vulcan Materials Company (NYSE: VMC), and Martin Marietta Materials Inc. (NYSE: MLM) - have been on a painfully shallow upward slope, as graphed below.
Since the economic recovery began in March of 2009, where the broader market S&P 500 index [black] has gained 205% and the SPDR Industrials sector ETF (NYSE: XLI) [blue] has gained 265%, Vulcan [purple] and Martin [orange] have gained a mere 95% and 60% respectively.
But take a look at the largest U.S. company in the space, Masco Corporation (NYSE: MAS) [beige], with a rise of 605%.
Why the difference in performance among the three, despite their being in the same industry? It's all due to the types of construction projects each company caters to. Here's a brief breakdown:
• Masco, headquartered in Taylor, Michigan, manufactures, distributes, and installs home improvement and building products including cabinetry, plumbing and lighting fixtures, bathroom fixtures, insulation and roofing products, and other home and office building hardware.
• Vulcan, headquartered in Birmingham, Alabama, produces and sells construction aggregates, asphalt mix, ready-mixed concrete, cement, crushed stone, sand and gravel used in public- and private-sector construction projects such as highways, airports, water and sewer systems, industrial manufacturing facilities, residential and nonresidential buildings, and railway construction.
• Martin, headquartered in Raleigh, North Carolina, mines, processes and sells construction aggregate materials such as granite, limestone, sand, gravel, and other aggregates for use in public infrastructure, nonresidential and residential construction, agriculture, railroad construction, and other construction projects. It also offers asphalt products, ready mixed concrete, and road paving construction services.
The top three companies, therefore, cater to two different construction markets, with Masco concentrating mostly on housing, while Vulcan and Martin focus primarily on industrial and infrastructure projects. Thus, where Vulcan and Martin have been hindered by the lack of capacity expansion, Masco has been riding high on the housing boom's momentum, as housing starts have doubled from 500,000 new units annually in 2010 to over 1 million new units annually currently.
However, things are about to change near term, as I explain in a recent housing industry comparison here.
In short, while new homes are being constructed at a rate of some 1 million new units annually, they are being sold at a rate of just 400,000 annually. This means America has a surplus of new homes, which should slow Masco's growth somewhat, at least over the short term.
At the other end, with capacity utilization already above 80% and with America's industrial production growing at a robust 5% annually as illustrated in the first graph above, the next couple of years should belong to companies like Vulcan and Martin, as the U.S. finally focuses on upgrading its factories and infrastructure - both areas of which are in sore need of upkeep and expansion.
We can now better understand the following table of the three companies' projected earnings growth, where green indicates outperformance while yellow denotes underperformance relative to the broader market's average growth rate.
For the current year (ending with Q4-2014 reports due out soon) and next year (Q1-Q4 of 2015), while all three companies are expected to outgrow the broader market's growth rate, Vulcan and Martin are seen outgrowing Masco by a significant degree, with Vulcan's growth rate being out of this world.
Over the next five years overall, however, it seems the residential construction market will once again resume its leadership over industrial and infrastructure construction, as Masco is expected to outgrow the other two as well as the S&P's average earnings growth rate by nearly three times the rate.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Martin delivered the greatest revenue growth year-over-year, while Masco delivered the greatest earnings growth. At the low end of the scale, Masco and Martin reciprocated their previous rankings, with Martin's earnings in shrinkage.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Masco operated with the widest profit margin, while Martin operated with the widest operating margin. At the low end of the spectrum, Martin and Vulcan split the narrowest margins between them.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, Masco's management team delivered the greatest returns on assets and equity, while Vulcan's and Martin's teams split the worst performances between them.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Masco provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Vulcan's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Masco's stock is cheapest relative to forward earnings and 5-year PEG, while Martin's is cheapest relative to company book value. At the overpriced end of the spectrum, Vulcan's stock is the most overvalued of the three.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Vulcan offers the greatest growth in the current and next years, while Masco offers the greatest growth over the next five.
The first two metrics do not factor in the comparison for the unavailability of their data.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Martin's stock offers the greatest upside potential and least downside risk, while Masco's offers the least upside and Vulcan's offers the greatest downside.
It must be noted, however, that Martin's stock is already trading below its low target. While this may mean increased potential for a sharp move upward, it may warrant a reassessment of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Vulcan is best recommended with 6 strong buys and 4 buys representing a combined 58.82% of its 17 analysts, followed by Masco with 9 strong buy and 4 buy ratings representing 52% of its 25 analysts, and lastly by Martin with 4 strong buy and 3 buy recommendations representing 46.67% of its 15 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Martin with a concrete victory, outperforming in 10 metrics and underperforming in 6 for a net score of +4, with Masco very close behind, outperforming in 12 metrics and underperforming in 10 for a net score of +2, with Vulcan not living well nor prospering, outperforming in 3 metrics and underperforming in 9 for a net score of -6.
Where the General Building Materials industry is expected to outperform the S&P broader market astronomically this and next quarters, underperform significantly next year, then outperform meaningfully beyond, the three largest U.S. companies in the space are all expected to greatly outgrow the broader market's earnings growth in the current and next reporting years with the advantage belonging to Vulcan and Martin for their industrial focus, while over the longer term Masco is set to dominate once again for its focus on housing.
Yet after taking all company fundamentals into account, Martin Marietta Materials Inc supplies investors with the most constructive portfolio building materials, given its lowest stock price to company book value, lowest debt over market cap, highest current ratio, highest trailing revenue growth, widest operating margin, highest EBITDA over revenue, highest dividend yield, and best price targets - narrowly winning the General Building Materials industry competition.