I can think of only a few better bellwethers for heavy construction in the Western world than CRH plc (CRH). The building materials firm manufactures both light (glass, shutters) and heavy (aggregates, cement, asphalt) materials, but the bias has always been towards the heavy stuff. I’ve covered quite a few small/mid cap companies operating in this space domestically (US Concrete (USCR), Summit Materials (SUM)), and for all of those firms, the elephant in the room as far as competition goes is usually CRH.
Despite the $30B market cap, it isn’t a name most people know. As a foreign issuer reporting in Euros (“€”) that trades on the NYSE as an American Depository Receipt (“ADR”), CRH loses a little bit of attractiveness and visibility with some retail investors here. Interestingly enough, with two thirds of operating profit generated in the United States, CRH is a more pure play on American economic health than many more well-known multinationals. Given most trading volume takes place overseas (where companies tend to trade at less steep valuation multiples, particularly true today), CRH could potentially be a great way to get large cap construction exposure on the cheap.
Business Overview, Macro Trends
The asset portfolio at CRH is fairly balanced, but there is a slight bias: roughly 55% of revenue is generated from new build construction, with the remainder from repairs, maintenance, or structural improvement. Today, CRH generates roughly 40% of its revenues from residential construction, with 35% from non-residential and 25% from infrastructure spending. This is largely due to the quicker turnaround in residential construction health coming out of the Recession versus non-residential; residential construction has been growing at nearly double the rate of commercial and infrastructure coming off the bottom in 2008. This trend may break; residential construction barometers have been weak; permits were down in the September new residential release by the U.S. Department of Housing and Urban Development, and completions have been hit or miss this year. FMI’s forecasts call for non-residential to outpace residential in 2017 and 2018, with continued weakness (although signs of improvement) in infrastructure spending. Signs of spending there continue to wane, as an infrastructure improvement initiative seems to have fallen by the wayside at the Trump administration, with the focus falling on a (hopefully) easy win on tax reform, followed by a retackling of healthcare. In the meantime, the remnants of the Obama administration (via the FAST Act), will have to do to spur demand.
Consolidation has been a big story in the construction industry in recent years, and CRH has been a big part of that on a global scale. What is now LaFargeHolcim (OTCPK:HCMLY) merged in 2015 to form the world’s largest construction materials partner, and CRH paid €6,500mm for assets that the company was required to shed by anti-trust regulators: a massive position in Central Canada cement production, as well as large scale operations in Great Britain, France, and Germany. Purchase price for those assets was 8.6x EBITDA (7.7x when adjusted for synergies), which was a good enough bid to beat out a competing bid from a consortium led by Blackstone. That deal was followed by the $1,300mm purchase of C.R. Laurence, a U.S.-based manufacturer and distributor of glass glazing products. CRH paid 11.3x EBITDA; 8.4x including synergy estimates. The acquisition binge has continued this year; CRH’s bid for Ash Grove this year will go through as well after Summit Materials dropped out of the bidding, which will be another massive deal ($3,500mm, 8.8x EBITDA) that gives the company a stranglehold position within cement markets in the Midwestern United States.
This doesn’t mean CRH is not opposed to big divestiture deals either. In August, CRH agreed to sell its Americas distribution business to Beacon Roofing Supply for $2,630mm. The distribution business has been a part of the company’s results for some time, but the move was needed. It isn’t a core competency for CRH, and that vertical integration model has fallen out of favor in regards to business management. There just isn’t a pathway to growth within the division, and the low margins associated with distribution are dilutive to consolidated results. This follows moves by other construction manufacturers, big and small (see USG Corporation’s (USG) divestiture of its L&W Supply business as another example).
These moves don’t have to be large. On the acquisition front, €619 million was spent on 11 transactions in just in the Americas in 1H 2017, primarily bolt-on acquisitions of privately-held aggregates producers (e.g., Mulzer Crushed Stone, one of the larger private operators). CRH prunes small scale as well; throughout the year, CRH divested its clay products businesses in Europe, and within European heavyside operations, the company divested its non-core civil pre-fabricated concrete business in Benelux. The sale of a large German cement plant for €349 million will hit the balance sheet later on this year as well. Net proceeds of these smaller transactions (that have closed) ran €145 million company-wide thus far this year, and that level is not unusual as the company continues to position itself towards end markets and geographies where it believes it has competitive advantages.
Balance Sheet Health, Future Outlook
Despite the activity, leverage remains extremely light. At the end of Q2 2017 (keep in mind Ash Grove and American Distribution divestiture have not hit the balance sheet), CRH had $9,596mm in debt and $2,205mm in cash, which puts net debt/EBITDA leverage at 2.2x my estimate of 2017 EBITDA, which might move incrementally higher after the aforementioned transactions. The maturity ladder of the company’s bonds is just about perfect, with no cause for concern there either. Of note, the company has $650mm of 8.125% coupon debt coming due next year, which is going to be easily refinanced in the 3.5-5% range depending on maturity; expect CRH to save $20mm pre-tax annually once this debt is rolled over. The company has already redeemed some of these early via tender, but will hit the rest once the debt officially matures.
Earnings thus far have been solid; EBITDA through the first half of the year came in at €1,175mm, up 5% from the prior year. Revenue was up year/year in every reporting segment (both inorganic and organic) except Asia (which is solely the company’s operations in the Philippines), and margins were stable/up incrementally as well outside the Asia region. As a reminder, the company got exposure to Asia via the divestiture package from LaFargeHolcim, and it’s a non-core segment that generates less than 5% of EBITDA; weakness there should be of little concern. Overall, consolidated margin improved to 9%, up 20bps from the first half of 2016. Key here was stabilization throughout Europe; the recovery has been weaker in Europe, with some countries flirting with or in technical recession still.
Historically, roughly two thirds of EBITDA is generated in the back half of the year (Europe gets a later start on construction activity than the Americas, generally late in Q2), and management expects current strength to carry over through the end of the year. €3,300mm looks like the number for the rest of the year (excluding net impact from Ash Grove/Americas Distribution sale, which is highly sensitive to timing). On the net next year, this will be positive (shedding a $180mm EBITDA business, picking up a business that generates $375mm in EBITDA). Given the low margins at the Americas Distribution business, consolidated EBITDA margin should increase next year as well.
$4,200mm in EBITDA looks likely next year, which means CRH is trading at roughly 9.3x future EBITDA. In recent years, CRH has historically traded at the 10.5x range, which is a tiny discount to the company’s North American peer group that trade in the 11-14x EBITDA. I would expect some discount to that range, as smaller companies in this space have traditionally had a higher growth outlook and carried higher forward valuations, as well as the market placing a lower valuation on European assets, but the spread is wider than it has been historically. Unfortunately for income investors, CRH does not really place a lot of emphasis on its dividend and has not historically been a large purchaser of its stock. Free cash flow (which runs into the billions each year) is generally retained for business investment and growth.
Overall, I can see an easy path to 13-18% upside for the company’s shares over the next year as management continues their work on deal integration and margin improvement. Broadly, European and American aggregates markets should continue to improve at above GDP growth rates, and further acquisitions from retained cash flow, as well as integration of Ash Grove, should be enough of a catalyst to drive shares higher over the next year.
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