Dear readers/followers,
I’ve been pretty damn lukewarm on Martin Marietta Materials (NYSE:MLM) since I initiated coverage back in 2022. The company is surprisingly resilient for a volatile materials/construction company, and it has an interesting background, coming from aerospace and going into aggregates and gravel. I like investing in companies that are in the building sector – that’s why my HeidelbergCement (OTCPK:HDELY) stake is over 6% of my core portfolio. However, I haven’t been “sold” on Martin Marietta Materials, and there are, unfortunately, good reasons for this.
We’ve seen underperformance from this company for some time due to its valuation. You can look at the returns from both my articles – and you can see that following my thesis/stance would have been a good idea.
Now, let’s look at what the company could deliver going forward here.
Martin Marietta Materials for 2023 – it remains somewhat problematic
Now, don’t get me wrong. I like construction and building companies. It’s why I own not only local ones like Skanska (OTCPK:SKSBF) and NCC but also European ones like HOCHTIEF (OTCPK:HOCFF) and many others. I’m also open to forays into the building and construction materials sector outside of these geographies. However, MLM has something that these other companies do not. Typically, a good construction business has a high yield and a decent amount of volatility which allows investors to buy it cheaply, get a good dividend, and hold until it’s time for trimming.
Skanska recently finished such a cycle, and I trimmed with over a 30% profit in the end. However, MLM doesn’t offer this.
Now, MLM isn’t a construction company per se – it does materials, specifically aggregates, cement, concrete, asphalt and paving, and specialty materials.
It’s not as though these are materials only needed for parts of the process – they’re needed even for basic maintenance and the like, and the company’s market position and market share means I can accept some lower yield in exchange for this. Some, but not where the company is in terms of valuation and yield to its competitors.
MLM continues to show a significant likeness to other companies in similar fields – when it comes to aggregates, cement, asphalt, and the like, you don’t want to be shipping those materials for a long way. The company has constructed its SCM with this in mind.
The latest set of results we have is the 3Q22, with 4Q22 around the corner in a week or so – so I may do an edit of this article at that point if it materially changes the thesis I’m presenting here, but I doubt it. Overall, Martin Marietta is delivering the sort of single-digit EBITDA growth, profit, and revenue growth that’s been forecasted for some time. Overall, these results are very solid and go a long way towards justifying the company’s more “premium” sort of valuation that we have going on here.
On a segment-by-segment basis, the company’s various operations did well, with increased shipments and selling prices in aggregates and good results in cement, asphalt, and ready-mix concrete.
In fact, there wasn’t a single company segment that really saw negative trends during this quarter of 3Q22.
The company continues to delever, and this reduction in debt is showing some real progress here, with debt down from 3.2x to 2.6x in late 2022. This represents a reduction in gross debt of almost $775M in less than a single year, with a maturity schedule that calls for no significant maturities at all in 2023, and only a single $400M maturity in 2024. 3.5% average coupon is the rate the company has, 100% of that debt is at fixed rates and safe, and the average maturity is 13 years.
I’m not exaggerating when I say that the company is one of the most conservative leveraged businesses in the entire sector.
On a high level, I’ve spoken to the dangers we see in the single-family residential macro, with a slowdown due to increased interest rates and people opting to rent as opposed to building. How is the company going to handle this?
Well, we again see likenesses here from the EU. While residential is indeed slowing down, the same is far from true for public works and nonresidential. The same trends in public infrastructure projects and nonresidential, such as industry trends, are things we see both in the USA and Europe. The passage of IIJA and the budgets here only makes the US geography in terms of construction more appealing here – and that’s why I’m currently fairly heavily exposed to contract-based builders like Skanska. They’re at the forefront, even in the US market.
I don’t model, in my forecasting for MLM, that these are entirely weighed up or offset due to the volumes from Nonresi and Infrastructure – that would be too optimistic, but the trends in key operating areas in terms of geography for MLM are undeniable. Looking through reporting and numbers, it’s clear that MLM is very Texas- and California-Centric, and the way these states are developing – yes, even California – speaks to positive trends for MLM. Texas alone is set to invest dozens of billions into infrastructure over the next 10 years that have MLM exposure, and several other state funds are also non-trivial in their budgets/funds. All of this speaks to MLM’s strengths.
The impact of IIJA is a massive change in the funding of Federal highways. Not since the late 50s have we seen this massive sort of spending, in terms of annual increases in percentages. IIJA represents a 38% increase – the last time we saw over 35% was back in 1958. The historical growth models for companies like MLM need, therefore, to be adjusted to account for this.
To this also comes that the outlook, domestically, for every single nonresidential industry that sees MLM exposure is positive – especially domestic manufacturing, with recent pushes in semis, batteries, and EVs above all, but also in the energy sector, in data, in light commercial and warehousing and so forth. Unlike residential, this demand is expected to remain solid for years going forward.
This is really what makes MLM hard to forecast here, and value. Because the company, at its heart, is very attractive and something I really do want to own. But I cannot bring myself to overpay or even put myself in a position where overpaying is a possibility (to myself).
For that reason, and while I fully confirm that MLM has done extremely well, I’m moving on to the valuation of the company with the following view.
Martin Marietta’s valuation remains expensive for gravel, asphalt, and concrete business, even in 2023.
So, the problem with MLM remains the company’s valuation. First off, I’m dubious about any construction/basic materials company wanting to trade at a premium of 20-30x, and that range is what we’ve seen from MLM for the past few years. The company has been as high as 35x P/E in fact, which I view as utter insanity no matter what market position and contracts the company has.
MLM yields less than 0.75%. It doesn’t have all that impressive dividend growth. It’s unlikely to start paying out more. And while we have very impressive growth estimates in terms of earnings, those estimates come at failure ratios of more than 40% on a 1-2 year basis with a 10-20% margin of error. This does not spell well for Martin Marietta and its safety in actually reaching those targets, at least not conservatively.
This isn’t to say you can’t make money with the company. Given the current valuation of around 28x, and the premium of 29x on 5-year normalized, a current 2025E calls for an upside of 17.6% annually, or a near-60% RoR. But I will not be investing capital in a business in MLM’s field, valued at nearly 30x, which is more than twice as much as some A-rated basic materials businesses in chemicals, or even companies that also have gravel and asphalt in Europe, but that trade at yields that are 10 times as high.
Also, MLM has only the past 2 years often times normalized back down to 21-23x P/E. If this were to happen going forward, your 17% annually would turn into around 7-9% depending on the estimated growth rate, which is barely market safety.
If these growth rates materialize, there is a certain leeway that can be given to Martin Marietta because of its quality, and you still might see good returns. However, here are my reasons for doubting, or not going for this.
- Peer valuations. The company trades among international peers that are half, or less than half the valuation of MLM while being 5-12x more in yield. The estimated growth rates might be more uncertain even than MLM, but the peer valuations, but I’d rather own any of the aforementioned materials or construction companies mentioned. The company trades in peer fields like Construction Materials, Construction/Engineering, or Trading companies. In every single sector, this company stands out as overvalued compared to most peers. That’s strike one.
- Forecast accuracy, as described above. This company does not warrant the same premium P/E because it does not have the historical record, nor the company-specific foundations to trade at 25-30x. That is my view. It’s not LVMH (OTCPK:LVMUY) – it trades in gravel and concrete and should be closer to that. Forecast accuracy is less than 60% here, and that’s not good enough for me.
- While street targets call for a valuation of 12% upside, with a PT of $401 from a range of $280 to $480/share, this is something I view as being far too positive for this company, and the analysts have been averaging $400+ price targets while the company has dropped below $300/share. They’re far too positive about this company, and it shows with the range of errors they have been making in the last 1-4 years.
- Even if you use DCF, which is relatively valid here given the stability in EPS growth on a historical basis, at least for the past few years, we can forecast the company at extremely high discount rates and high growth rates of 6-7%, while still getting no higher fair-value ranges than $310-$330. In order to go above that we need to allow either for discount ranges that are incompatible with today’s markets or interest rate developments, or we need to start estimating extremely high growth rates – that’s what many of these analysts are doing.
I say “no”. The contributors that have recommended to “BUY” MLM at these, or close to these levels, have failed to generate alpha. The same is true for the last article on the company, which at the time of writing here generated negative RoR, compared to a 4-5% S&P500 return.
I won’t shift my price target an inch here. Above $320, this company is not buyable as I see it.
I believe these latest trends at least in part confirm my current thesis, which is as follows:
Thesis
My thesis for Martin Marietta is as follows:
- This Is an excellent, well-managed company with a decent upside – the problem is that it’s based on the sort of multiple premia you find in luxury companies like LMVH – and MLM makes concrete and aggregates. I respect the company’s achievements, but I won’t pay more than 2X peer multiple for this sort of business.
- Superb credit safety and record-low yield compete with one another, turning the upside less than 20% annually even to a 30X forward multiple.
- I consider the company a “HOLD” in today’s chaotic market with a $320/share price target – no more than that. At such a price, the upside is what I consider to be worth it. It’s getting close to it, but it’s not yet consistently at or below my target.
Remember, I’m all about:
- Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized).
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
Based on current growth rates, I can’t argue that the company doesn’t have an upside – I just believe it to be too unlikely to materialize, and you’re better off investing elsewhere.
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