Aggregates, the pure-play on US infrastructure spend
With only four days to go until the US presidential election, one of the issues at the forefront of investors’ minds is the potential for a significant increase in infrastructure spending in the event of a “blue wave” next week; that is, Democrats winning both the presidency and Congress.
There are a number of ways of gaining investment exposure to the US infrastructure theme. Steel stocks like Nucor should benefit, as should machinery businesses such as Caterpillar. It is also likely that a boost to infrastructure spending would benefit equipment rentals companies like Ashtead, or distributors like Fastenal.
But perhaps the most direct way of playing the theme is through aggregates. These products – such as crushed stone, sand and gravel – are among the most basic and essential of building materials, and they are used in virtually all types of construction. By themselves, aggregates function as a base material under foundations, roads, and railroads, while also having important drainage applications. Combined with other materials, they form economically important composites such as asphalt (95% aggregates by volume), ubiquitous as a surfacing material, and concrete (80% aggregates by volume), which is essential in the construction of a wide range of structures.
“Despite their commoditised nature, aggregates have unique economic characteristics that create strong pricing power.”
Despite their commoditised nature, aggregates have unique economic characteristics that create strong pricing power. In fact, so enduring are the competitive advantages of aggregates producers that pricing in the industry has grown at more than 4% per annum over the past 45 years, even during economic downturns. Perhaps the most important reason for this is that aggregates have a high weight-to-value ratio and, in most cases, must be produced near where they are used; otherwise, transportation can cost more than the materials themselves – in other words, aggregates quarries are local monopolies. Relatedly, although aggregates are often the largest material by volume in a construction project, they are generally only a small proportion of overall cost and not, therefore, a key determinant of project viability. Another important factor that confers economic advantage on aggregates is their limited substitutability: recycled concrete and asphalt have certain applications as a lower-cost alternative to virgin material, but they fail to meet the standards required in many types of construction projects. Finally, identifying and acquiring viable quarries with long-term high-quality reserves, not to mention obtaining the necessary regulatory approvals, is an increasingly long and difficult process, creating high barriers to entry for would-be competitors.
Unlike pricing, demand for aggregates is undoubtedly cyclical. However, an attractive feature of the industry is that production is a simple mechanical process, and capacity can therefore be easily flexed to meet market demand. This makes the aggregates industry more resilient to the cycle than is the case for other heavy building materials, such as cement or concrete. Demand is driven by both private and public sector construction projects, with a broadly even split between those end-uses. Private sector demand, which can be divided into residential and non-residential construction, tends to have lower aggregates intensity, and is also more affected by general economic cycles. Public sector demand has more consistent levels of funding throughout economic cycles, and because it is heavily weighted towards large infrastructure projects such as highways, roads and bridges, it makes more intensive use of aggregates.
“Infrastructure investment should be among the main demand drivers for aggregates in the US in the near to medium term.”
Infrastructure investment should be among the main demand drivers for aggregates in the US in the near to medium term, owing to the high content of aggregates used in surface transportation, decades of underinvestment in the country’s critical infrastructure, and bipartisan support for increased funding in this area. At the federal level, recent proposals for multi-year transportation legislation by the Democrat-led House of Representatives and the Republican-controlled Senate, respectively, have failed to achieve cross-party support. However, the Republican proposal did provide for a 28% increase in highway spending compared to the previous legislation, while the Democrats’ bill provided for a 42% increase. These figures suggest that a political compromise on the matter would still imply a significant uplift to federal spending, but that a Democrat clean sweep of the presidency and the Senate would be the best outcome for infrastructure spending. Furthermore, while there has been a bipartisan failure to agree on another round of stimulus before the presidential election, any subsequent stimulus measures might also include an allocation to infrastructure.
“…so enduring are the competitive advantages of aggregates producers that pricing in the industry has grown at more than 4% per annum over the past 45 years, even during economic downturns.”
Within the private sector, meanwhile, the prospects for residential construction are positive: there is an undersupply of housing in the US, household formation is strong and mortgage rates are low. More recently, there has also been a post-COVID-19 tailwind from pent-up demand and a desire to upsize. Non-residential construction, however, faces a more uncertain near-term future, as corporates seek to reduce spending and cut costs in the wake of the pandemic. Longer term, however, opportunities exist in areas such as manufacturing, which could benefit from reshoring, and energy, where growth in renewables should drive aggregates demand.
Vulcan Materials Company, based in Birmingham, Alabama, is the most aggregates-focused public company in the US, with 76% of group revenue and over 90% of gross profit attributable to aggregates, a significantly higher proportion than any of its competitors. Its 75 years’ worth of aggregates supply is concentrated in economically attractive states in the south and west US, with strong demographic and fiscal profiles. According to Moody’s Analytics, 72% of US population growth, 68% of household formation and 65% of new jobs will occur in Vulcan-served states over the next decade, driving long-term aggregates demand. These areas are also fiscally strong, and provide high and growing state-level transportation infrastructure funding: six of Vulcan’s top-10 states, accounting for c.60% of revenue, have triple-A credit ratings and only one is not high grade. Over the past 25 years, through several economic cycles, Vulcan shares have achieved an average annual total return of 10.4%, comfortably beating the return of the S&P 500 Materials sector (7.5%), and also exceeding that of the S&P 500 Index itself (9.2%). This is a remarkable achievement for a cyclical business, engaged in what is one of the oldest industries in the world, and it reflects the inherent competitive strengths and pricing power of aggregates assets.
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