Vulcan Materials Company (VMC) — Q3 2016 Earnings Call Transcript

Good morning, everyone, and thank you for your interest in Vulcan Materials Company. Joining me today for this call are Tom Hill, Chairman and CEO; and John McPherson, Executive Vice President, Chief Financial and Strategy Officer. To facilitate our discussion today, we have made available during this webcast and on our website supplemental information for your review and use. Rather than walk through each slide, we will focus on the highlights. We hope this approach will provide more time to respond to your questions. With that said, please be reminded that comments regarding the company's results and projections may include forward-looking statements which are subject to risks and uncertainties. These risks are described in detail in the company's SEC reports including our earnings release and our most recent annual report on Form 10-K. Additionally, management will refer to certain non-GAAP financial measures. You can find a reconciliation of these non-GAAP financial measures and other related information in our earnings release and at the end of our supplemental presentation. Now I'd like to turn the call over to Vulcan's Chairman and Chief Executive Officer, Tom Hill. Tom?

Thank you, Mark. Thank all of you for joining us for our third quarter earnings call. We'll keep our remarks fairly brief today since we discussed many of the key business trends and our outlook just a few weeks ago during our Aggregates Day event in Atlanta. Looking at the third quarter and our recent performance, four main points stand out. First, we saw shipments decline in the third quarter. However, we see it as localized, not cyclical. Second, our profitability continues to grow. And third, our prospects for sustained growth remain very exciting. Let me address each in just a little more detail. First, we've seen a drop in year-over-year shipments. This is due in part to a period of relative weakness in new construction starts across much of our footprint. It's also influenced by weather and other location-specific factors impacting our business in California, Texas, Virginia, and Illinois. Third quarter year-over-year shipments in these four states were down 15% collectively. In contrast, our other markets experienced combined year-over-year shipment growth of 6%, and several markets saw strong double-digit growth to the order of 12% to 21%. Second, we continue to view these volume headwinds as temporary or a transitional lull in a multiyear recovery that is still intact and sound with a long way to run. To this point, the variation in results across our footprint reveals volume challenges that are clearly localized rather than cyclical. Notably, our daily aggregate shipment rate increased from August to September and from September to October, with October exceeding the prior year period by about 3%. Furthermore, according to Dodge reports, trailing 12-month construction starts showed sequential improvements in both August and September, picking up from a noticeable slowdown in March that lingered through July. In short, the fundamental drivers of a multiyear recovery remain firmly in place. To point number three, our core profit engine remains very powerful. We're on track to deliver $1 billion of adjusted EBITDA this year despite volumes that are below our original expectations. In our aggregates segment, third quarter freight-adjusted selling prices were 7% ahead of third quarter 2015, and gross profit per ton rose 9%. For the 12 months ended in September, gross profit per ton has increased 25%. The flow-through of incremental freight-adjusted revenue into incremental gross profit has exceeded 80%. Also for the 12 months ended September, the total business delivered net earnings of $371 million and $981 million of adjusted EBITDA with an adjusted EBITDA margin of more than 27%. This is an improvement of 430 basis points over the prior year. Fourth and finally, we remain excited about our long-range growth prospects. We are well on track to achieve our profitability goals. Near-term, we like the volume, pricing, and profitability momentum we see for 2017. We also like the robust pipeline of projects that we see building for 2018 and 2019. Now John will share a few thoughts regarding our current momentum and outlook in a minute, but first I'll offer a bit more insight into how our business has been performing across our footprint. As we discussed during our Aggregates Day in Atlanta, the recent demand climate has made it hard to distinguish the signal from the noise. For example, there has been clear accelerating growth in the longer-term project pipeline. The impact of the federal highway bill, the FAST Act, and higher state-level funding are beginning to show up in the mix. At the same time, there has been a softening in the rate at which this water behind the dam has been released in the form of construction starts. There was also a lull in state highway spending during the first half of the year as states worked their way through the remainder of a fiscal year that didn't include new FAST Act points. Notably, this has now started to turn in a positive direction. The latest OTMA report on highway contract awards shows them increasing by 30% in September, marking the second consecutive month of growth following weak contract award activity during the first half of the year. Looking closely, this isn't too surprising as many states have entered a new fiscal year with FAST Act money flowing into their pipelines and a backlog of projects ready to go. During the slowdown period early this year, some markets saw adverse weather conditions, shortages in skilled labor, and other factors that constrained the rate at which existing construction projects could be completed. Many of our customers found it difficult to catch up in the near term on work deferred due to bad weather earlier in the year. Generally speaking, our operations across the Southeast and mid-Atlantic states continue to post solid gains in volumes despite these challenges. Florida, Georgia, and North Carolina enjoyed robust double-digit volume growth to the tune of 12% to 21%, accompanied by strong pricing and unit margin performance. Virginia, conversely, has seen good pricing momentum, although volume momentum hasn't picked up yet. Turning to Texas and California, shipment levels in these states remain challenged in the third quarter, below our expectations at the beginning of the year. Shipments in Texas were down 21% in the quarter, driven in part by Coastal Texas shipments which were down 27%. As a whole, Texas was impacted by bad weather throughout the quarter, most notably in August. Business in North and South Texas fell off accordingly from what would otherwise have been a much stronger performance in those areas. Houston and the Coast, alongside the well-known downturn in the oil and gas industry and extensive flooding, also experienced delays in TxDOT work. So when we talk about Texas and volume declines, it is largely isolated to the coastal area of the state, separating out statewide weather impacts. But despite a transitory period of volume headwinds, there is ongoing pricing momentum in Texas, highlighting the underlying confidence and continued growth in the Lone Star State. At the same time, our core profitability, which has also been strong, keeps improving. Overall, we expect continued recovery in the Texas market. In California, shipments were down 17% from last year's quarter. We continue to see a slowdown in large project work in the public and private sectors, work we are well-positioned to serve. Caltrans also continued to grapple with highway funding related to diminished excise taxes, creating a larger slowdown in project work than anticipated. We have reason to believe that political leaders will ultimately reach an agreement on new state funding measures for California roads, which are rated the worst in the U.S. Putting it together, we expect to see a return in 2017 to a pattern of recovery and growth in California. Our sales force is aligned to take advantage of these growth opportunities. Large projects are getting back on track. The pipeline of major projects continues to get bigger and bigger. Construction starts are back on the upswing, and there will ultimately be improvements in state funding for roads along with local highway improvement initiatives. In fact, we are already seeing early signs of improvement. Highway contract awards in California were up 98% in September, as these new FAST Act funds started to flow into the system. Underlying these facts are fundamental strengths. In our California business as well as Texas, our core profitability continues to improve. And in California, despite the lull in shipments, pricing has remained strong in the high single digits, underscoring the basic confidence in the trajectory of California markets. Across our company, our focus on core profit improvements, the little things that make us better every day, is keeping us on track towards our longer-term goals, evident in our results. Now I'll hand it over to John for some brief additional comments regarding our outlook for 2016 and the momentum we see heading into 2017.

Thanks, Tom, and good morning to everybody. I'd like to quickly touch on a few points regarding our forward outlook, but let me first note that our views have not changed meaningfully from those that we communicated during our late September event in Atlanta. First, as Tom noted, we continue to project $1 billion of adjusted EBITDA for fiscal year 2016. Due to continued gains in unit profitability and overall margins, we think we can reach the low end of our beginning-of-year guidance range despite shipments falling well below our original forecast. To put this outlook into some context, let's take a look at results and trends, particularly with respect to our improved profitability over the trailing 12 months. As you heard Tom say and as you've seen in our release, during that period, we generated net earnings of $371 million and adjusted EBITDA of $981 million. But behind that, it's important to note that our average freight-adjusted selling prices in our aggregates segment have increased 8% over that time. Our average gross profit per ton has increased 25% over that time, and our overall gross profit as a percentage of freight-adjusted revenue for the company has risen from 34% to 39%. As we consistently call out, fourth quarter results can be significantly impacted by weather and the effective length of the construction season, and our strong results from Q4 of 2015 present tough comparisons. But our improved core profitability should be sufficient to allow us to reach our stated goals for 2016 if recent shipment momentum holds up through the quarter. Turning to 2017, I’ll begin by reiterating that it remains too early for us to give specific or firm guidance. We're primarily focused on finishing the current year strong and we're just at the beginning of our internal planning cycle for next year. But from what we see today, we expect continued volume recovery in 2017 along with further improvements in pricing and overall margins. In other words, continued progress on track with the longer-range goals we've outlined previously. With respect to volumes, and again, we’re not yet in a position to share specific numbers, we currently expect growth in each of our primary end-use segments next year: residential, private non-res, highways, and other public infrastructure. Furthermore, we also expect to see broad-based growth across our geographic footprint and growth in substantially all of our key market areas. We've noted that construction start data points have recently turned back up after several months of softening. Highway contract awards in our key states have also turned up recently. Additionally, longer-term project pipelines continue to strengthen from our already strong levels. However, the relative start weakness we've experienced earlier this year, combined with strong first quarter 2016 comparisons, suggest that 2017's volume growth on a year-over-year basis could be back-half loaded. We expect the pricing climate to remain positive and constructive for 2017. The strength of longer-term project pipelines and significant increases in dedicated public transportation funding reinforce confidence in a sustained recovery. Moreover, materials producers and others in the construction supply chain remain focused on earning adequate returns on capital. Competition remains intense; however, we are generally battling over value and not just volume. Given these dynamics, we expect our free cash flow profile and overall financial condition to strengthen further next year. We should have the financial capacity and flexibility needed to support reinvestment in our franchise for growth, including but not limited to M&A, as well as additional returns of capital to shareholders. Tom, back over to you.

Thanks, John. We're pleased with the continued strong earnings growth and margin expansion we saw in the third quarter despite lower shipment levels. The drivers of recovery in shipments remain very much in place. Our core profitability continues to improve and our fundamental outlook for the future of the business remains unchanged. Given that positive outlook, I can assure you that we will invest in our business accordingly. We will keep investing internally. For example, we will plow about $125 million into internal growth projects this year. These projects will help us serve our customers better, increase efficiencies, and add to the bottom line. They include five new rail yards: three in Texas, one in Charleston, South Carolina, and another one in Savannah, Georgia, along with six greenfield sites that are new quarries we are developing in growth markets across the country. At the same time, we will continue to aggressively pursue bolt-on acquisitions in key markets as well as other strategic acquisitions, all of which will further strengthen our leading position in the industry. I want to conclude by thanking our employees for their commitment to improving every day, to working safely, to finishing this year strong, and to delivering another year of even stronger results. Thank you for your interest in Vulcan Materials. And now, if the operator will give the required instructions, we'll be happy to respond to your questions.

Hi. Thank you for taking my questions today. I really just want to focus on certain geographies and I know that you gave some color in your prepared comments, I just want to dig a little bit deeper. First on California, a lot of their budget with Caltrans has been tied to gas prices. Do we see gas prices move up? How has that impacted your conversations with Caltrans regarding the budget? Also, when you look at the volume softness in that state, how much of it was large project delays versus the budget-related issues that seem to be apparently tied together, or any other relevant factor that we should take into consideration?

Good morning, Kathryn. Let me comment on California overall. I think we feel optimistic about demand in California. We see sustained strength in residential and smaller private work. The headwinds we faced this year shouldn't repeat next year. If you look at the pipeline data, start data, and listen to our customers, we feel better about California, even though we haven't seen the shipments come back yet. We feel good about the public funding situation in California. The elements are in place for this to come together for state funding. Remember that California still has the worst roads in the country. We will start to see the FAST Act kicking in and we saw an August redistribution of federal funds at just under $0.25 billion to California. Also, the local initiatives that are on the ballot for next week, if they all pass would total about $2.5 billion annually. So for us in California, as we say, it's not if, it's about pace, particularly the pace of large projects. We feel optimistic about 2017 and the longer-term outlook for California.

Thank you. And then on Illinois, that state has been a little tougher when you think about just kind of the state from not only the public side but also from private sector spending. How should we think about Illinois as we go forward?

I think that's a real contrast to California where we feel like California's fundamentals are really good and coming back strong. Illinois is a weak spot for us, and it's really about public funding. The private side is actually not too bad in Illinois, but the public side is just tough for us. I would say this much: Even with volumes down, I'm proud of our team in Illinois. Their profitability is up despite facing some pretty good headwinds.

And Kathryn, just to add a little color on those two states, I think it's instructive to contrast Illinois and California a bit. Illinois, for us, the business is doing quite well as Tom said. There are some green shoots in their funding: some toll road funding and other funding that's not as dependent on overall public sources. But Illinois is the one place we called out where we just don’t see the path to long-term growth that we see in the rest of our footprint. If you contrast that with California, which yes, is going through a bit of a lull right now, particularly on some large public funding, the outlook for California next year is quite bright. We see growth in California in 2017 and beyond, so those are very different situations in our view. One is doing well and profitable but lacks long-term growth visibility, while California has a clearer path.

Thanks. That was a good segue for my next question just for the consolidated aggregate pricing in the quarter. How much was product mix and/or geographic mix impacting the total average price of the quarter?

There was an impact from geographic mix, probably just under 1%, negative impact.

And Kathryn, a lot of that is due to how much our business in a place like Coastal Texas was down, and that's one of our higher-priced markets. Even that by itself has a significant impact on total pricing for the business.

Okay. Perfect. And then finally, could I get your thoughts on whether you're starting to see FAST Act dollars flow through these states and how much was that a contributor to strength in the markets that did have solid growth?

I think that you're starting to see FAST Act dollars flow through in lettings. I don't think they've flowed through to shipments yet. I think you'll start to see that in the first and second quarter of 2017. We're backlogging jobs right now that are in the letting phase. The lettings are picking up because of FAST Act spending, but I don't think we've seen much of that impact our shipments yet.

Yeah, not into shipments yet. But we've begun to see a real uptick as several state DOTs turned into their new fiscal year. We're seeing some FAST Act money, as Tom noted, be more aggressively allocated, including a reallocation of funds to California that happened recently. So the money is getting put to use, but we really haven't seen it impact our aggregate shipments very much yet at all.

Okay. Great.

Thank you.

Good morning, gentlemen.

Morning, Trey.

I guess a quick question on one of the comments you had in the prepared remarks about October. I think you mentioned that it was trending up around 3%. First, was that pretty broad-based across your enterprise? Or was it more geographically isolated to certain markets driving that improvement?

It was pretty broad-based. We’re still facing some challenges as we said in California, but outside of that and a little bit of weather on the East Coast, it was broad-based. What you're seeing there is some of the projects starting to come through, both residential and non-residential, and that will pick up as we move into 2017.

Trey, just for a little more color for you all – and as Tom says, obviously very broad-based. But to clarify further, it has bounced back in Texas. It has not bounced back yet in California. However, if you took California out of the numbers, that 3% increase would be about 5% to 6%. Just to give you a feel for how broad-based the relative strength is excluding California.

Yeah.

Just to be clear, when we say that's the daily shipment rate – we're shipping a little more than 800,000 tons per shipping day.

Okay.

I just want to clarify that it's per shipping day, not per calendar day.

I got you. So if we assume October is behind us now, and at the Analyst Day, you mentioned that you would have trouble hitting the 190 million tons of the original guidance you had. Now that October is behind us, can you help us tighten up that volume range for the year as far as how we should think about it if we get normal weather in November and December?

I think as always, the fourth quarter is about weather and timing, and the number of workdays will be important. Will our customers have enough wherewithal to get the work done in those days? I think the demand is there. We're seeing the projects coming. Our customers want to get the work done because they see what's coming in 2017. So the work is there and the desire is there. It’s just about timing and whether they can get it all done in the days left in the year.

To give you a number, we’re probably looking at 182 million tons to 184 million tons for the year.

Okay. Perfect.

And again, keep in mind, there's a lot of variability around that. We're shipping 800,000 tons a day right now. So that's what we're looking toward, and at those levels, we think we're still in line with the overall EBITDA guidance we've provided.

Got it. Thanks. And my last one is more looking into next year. Directionally, you've talked about volume and price very broadly, which I understand why you don't want to provide too much detail. But can you give us broad thoughts on gross profit per ton and how we should think about that looking into next year, considering the expected volume growth, pricing growth, and any potential impacts from geographic mix?

I can start with price. We see a really healthy environment for pricing, and that’s driven not just by demand but by the visibility that our customers and the market see with the pipeline that's coming. Many of our markets have already announced price increases for our fixed plant work. Those will be effective from January 1 to April 1 at varying timings. When looking at pricing alone, our markets are healthy and that’s driven by visibility and confidence in the growing pipeline. So that gives you some idea of what we're seeing on pricing. In terms of costs, our folks are doing a good job managing costs and operating efficiencies while keeping our people safe, and volume will only help that.

Okay. Thank you very much for the color. Good luck, guys.

Thank you.

There's nothing we see on the cost side that would throw us off track on recent trends of improving profitability, whether that’s flow-throughs well above 60%, our ability to achieve operating leverage, or leverage each step in the P&L. As we continue our internal planning cycle, which we're just starting, we focus quite a bit on our profit per ton one market at a time. We’d be quite surprised if our profit per ton doesn’t continue to grow faster than just pricing alone would indicate.

Good deal. It's encouraging. Thanks a lot.

Thank you.

Hey, guys, good morning. Thank you for taking my question. My question is regarding Illinois. I know you have a Safe Roads Amendment coming up. Assuming it passes, when would you expect to see money flow through from a project perspective? Additionally, what do you need to see to help that piece of the market recover? Because generally speaking, it looks like the other markets in your portfolio are going to do well next year.

I think that what that really does is not create new funding or additional funding. It protects the funding that’s there, which is important because in Illinois, those funds have been appropriated in the past. So it safeguards that funding, which is a good thing. Illinois's public side needs to rectify its funding issues, and as John and I mentioned earlier, we don’t see that happening for 2017. It’s going to take a while. However, the private side is still doing quite well in Illinois.

And, Stanley, we don’t want to give the impression that Illinois is in freefall. It has stabilized at a lower level. The business is doing quite well, as Tom said. Our team is doing well, but we don’t have the same view of long-term growth that we see elsewhere.

No, that's fair. I wanted to see if there was any sort of inflection point coming that could help the market recover.

We're hoping the negative inflection point is behind us.

Could you help us understand the cost side being favorable? Can you talk about the enhanced sales initiatives mentioned in the press release?

Sure. That’s just an area of investment in the business. As we see long-term business growth, we are focused on providing better service and greater value to our customers. We are continuing to invest in our customer and sales support systems. They’re important investments to support growth and customer needs. For many of our customers, we want to position ourselves as more than just a materials supplier, but as a catalyst for their success, which in turn helps our success.

To add to that, we see the growth coming in the next four to five years in all market segments. We need to invest in our sales group so we can add value for our customers and stay ahead of that growth curve.

It sounds good. And last question for me, how should we evaluate the internal initiatives in terms of payback or hurdle rates?

This is a normal part of our growth. We don’t grow solely through acquisitions. This is about protecting and adding value to our franchises. Greenfields are normal projects for us, whether it’s rail distribution or quarries. They take time to develop, and we have to stay ahead of that growth curve. But these are standard projects for us and well above the cost of capital.

These investments are generally quite attractive. We’re making these kinds of investments in markets where we already operate, particularly on a risk-adjusted basis. They're good investments, and we’re happy to have the financial flexibility to invest in that growth.

Thank you. Best of luck.

Thank you.

Hey, good morning, guys.

Hey, Timna.

Good morning.

Not to hammer home, but on the Q4 commentary, I was confused because you talk about if the shipment momentum continues then you're on track to meet guidance. But I thought October was usually the strongest quarter. Do you mean that adjusted for the seasonality if shipments continue? Or what did you mean by that? And could you clarify?

What we're seeing is jobs pick up that we’ve been talking about and start coming through. We feel good about the fourth quarter. But as always, you have a limited number of days to work through as you approach winter months. It’s really about timing and whether we’ll provide enough days for customers to get the jobs done.

Timna, unless something odd happens to shorten the construction season significantly, we expect to be on track with our $1 billion of expected adjusted EBITDA for the year.

Okay. Great. You have previously discussed utilization rates and commenting on raising utilization. Can you provide an update?

From a plant utilization perspective, the majority of our facilities are still well below optimal operations. We have a lot of operating leverage available to us. As we've ramped back production, we’ve had to manage periods of higher maintenance costs, particularly in mobile equipment. That said, we should be well set up to continue delivering good operating leverage in what's still largely a fixed-cost business for some time.

We've got plants still running part-time. Even with the volumes we've seen come back, we’re not near optimal operating leverage. Our teams have been successful at managing costs effectively, keeping them flat over the trailing 12 months, which is commendable given the fluctuations in production.

Are we talking 60%, 65% in utilization?

Yes, probably every market's different. Demand differs based on production runs, but yes, we’re talking in that range.

Okay. Given your low dividend yield, what is the outlook for growth vs. shareholder returns? Should we expect a sizeable increase in the dividend?

It’s a board decision, and I don’t want to preview their decision. They review it at each meeting, and if past patterns hold true, we’d be announcing something in February. However, nothing has changed from previous communications, and we expect the dividend to grow roughly in line with earnings throughout the recovery period. February is probably the most likely announcement date.

Appreciate it. Thank you.

Hi, thank you. Just have a follow-up question on pricing. How should we think about that moving into 2017? Given some comments around mix and the announced percent increases, should we expect pricing growth in 2017 to be back-half weighted, especially with volume growth potentially back-half weighted?

As always, the pricing increases we provided are for fixed plant pricing which will vary. A lot of pricing for our work is bid work, which is quoted one job at a time. Gradual pricing increases will be seen throughout the year, but the acceptance of increases is good across the board.

Thanks. And one last question on asphalt. How should we think about asphalt margins moving forward, given oil price dynamics and potential inflation on the cost side?

Inflation in liquids will lead to price increases. Our teams manage material margins effectively and create value for our customers. In terms of the short term, increases in liquid may have an impact as we work off oil work, but overall, pricing will follow it.

Material margins in asphalt are inherently more volatile, but they are generally quite attractive through the cycle, yielding good returns on capital. We are satisfied with this part of our business.

The underlying demand for asphalt will rise, especially as public funding flows through. Much more highway work can be expected, which will boost demand. Our customers see that visibility too, and we’re optimistic about profitability in asphalt moving forward.

Thanks so much, and good luck.

Thank you.

Hey, guys. This is actually Marshall on for Bob this morning.

Good morning, Marshall.

How are you all doing?

Good.

We bought back about 790,000 shares in the quarter and a little over 1.4 million shares for the year. This aligns with our capital allocation priorities. We will keep returning excess cash to shareholders in the form of opportunistic share repurchases. We assess capital needs relative to M&A and growth investments.

We see a positive outlook both for our internal investments and for growth through acquisitions. Our market presence continues to expand, and we hope to announce acquisitions soon.

Our fundamental outlook on the business has not changed and we have a lot of confidence in our profit engine. The long-term demand recovery fundamentals are stronger now than they were during our Investor Day nearly two years ago.

That's it. Thank you.

Thank you very much for your interest in Vulcan Materials and your time this morning. We look forward to talking to you over the next few months. Thank you.