Vulcan Materials Company (VMC) — Q2 2019 Earnings Call Transcript

Good morning. And thank you for joining our second quarter earnings call. With me today are Tom Hill, Chairman and CEO; and Suzanne Wood, Senior Vice President and Chief Financial Officer. A question-and-answer session will follow their prepared remarks. Before we begin, I would like to call your attention to our quarterly supplemental materials posted at our website vulcanmaterials.com. You can access this presentation from the Investor Relations homepage of the website. Additionally, a recording of this call will be available for replay at our website later today. Please be reminded, the comments regarding the company's results and projections may include forward-looking statements, which are subject to risks and uncertainties. These risks, along with other legal disclaimers, are described in detail in the Company's earnings release and in other filings with the Securities and Exchange Commission. Finally, management will refer to certain non-GAAP financial measures. You can find a reconciliation of these measures and other related information in both our earnings release and at the end of our supplemental presentation. Now, I'd like to turn the call over to Tom.

Thank you, Mark, and thanks to everyone for joining our call today. We truly appreciate your interest in Vulcan Materials. Our second quarter results reflected our continued strong performance, a 15% improvement in adjusted EBITDA, and an 11% improvement in Aggregates' gross profit per ton. We are relentlessly focused on unit margins. It is one of our most important metrics and it increased in the second quarter by $0.58 to $5.74 per ton. On a trailing 12-month basis, our Aggregates' gross profit per ton has increased at a 12% compounded annual growth rate from the second quarter of 2013. We remain on track to achieve our full year EBITDA expectations. Our overall results for the first half of the year, and the trajectory of the principal drivers of profitability in our Aggregates business, volume, price and cost were in line with our expectations. I'll spend a few minutes giving you some highlights of our performance in these areas. Aggregates' shipments in the quarter increased by 4% year-over-year or 3% on a same-store basis. This growth in volume reflects the solid underlying fundamentals in our markets. Shipments in our Southeast and Mid-Atlantic markets were particularly strong. California experienced another wet quarter. But despite this, shipments increased compared to the same period last year. Wet weather also affected shipments in Illinois, Tennessee, and Texas. The second driver of our profitability is price and we performed well here also. Freight-adjusted average sales price improved by 5.9%, compared to the same quarter last year. On a mix-adjusted basis, the increase was 5.4%. The 50 basis point difference was due to favorable geographic mix. These increases were in line with our expectation and the pricing gains were widespread. Every key market across our footprint posted improved pricing. Our third key profitability driver is our cost disciplines and our operational efficiencies. Our management teams and our leaders across the company are keenly focused on this. And we're making good progress. We measure our operational efficiencies in a number of ways, but one key financial metric for Aggregates is same-store gross profit flow-through. On a trailing 12-month basis, it was 65% at the end of June. Our operational execution at the plant level keeps improving, and it's rewarding to see that the hard work of our men and women at Vulcan is translating into strong incremental earnings. We will continue to focus on these disciplines because they are a significant contributor to the quality of our earnings and our ability to compound our unit margins. As we look to the second half of the year, the overall view of our markets is unchanged. Shipments in the private construction end markets are good. On the public side, demand is healthy and continues to strengthen with the increases in state and local highway funding being converted into backlogs and shipments. We believe that we are in the early stages of a longer-term growth in highway demand, which is a function of increased state and local investment in infrastructure. Since our last call, another Vulcan state, Illinois has passed legislation to increase revenues for roads. Since 2013, 11 states that make up 85% of our revenue have increased fuel taxes or increased other ongoing sources of revenue for highways. This supports our positive highway demand outlook and the improved visibility underpins improving pricing. In summary, our backlogs are good, and our geographic footprint and capabilities put us in a strong position to take advantage of market opportunities. Now I'll turn the call over to Suzanne for some additional comments on the results.

Thanks and good morning to everyone. As Tom mentioned, our trailing 12-month same-store incremental aggregates flow-through rate of 65% was quite good, while price is certainly an important driver of this metric, I also want to touch on the impact of our operating cost performance. Operating disciplines, accountability and cost management significantly benefited our results again this quarter. Our same-store unit cost of sales increased by less than 2% as compared to the prior year's quarter. The largest single component of this increase related to greater stripping activity, which is a function of anticipated future shipments. This accounted for about 40% of the higher costs. And for your information, the effect of diesel fuel cost was minor in the quarter. Our second quarter SAG cost increased mainly due to compensation-related expenses, including incentives that are tied to earnings expectations and the share price. Our incentive plans are designed to reward our people for good execution and improved earnings, both of which we have experienced. We also made investments in people and processes to accelerate the benefits derived from our sales and operational initiatives. Our trailing 12-month SAG expense, as a percentage of revenues, declined this year and we will continue to focus on further leveraging our SAG costs. I'll briefly touch on our non-aggregates segments. Asphalt gross profit was $28 million, an increase of $2 million, as compared to the prior year. Shipments increased by 8% or 5% on a same-store basis, due to large projects in the Arizona market. While the year-over-year shipment growth was good, it was less than we expected due to the adverse effects of weather on California and Texas volumes. Asphalt pricing in the quarter rose by 8%. This was partially offset by liquid asphalt unit costs, which were 16% higher this quarter compared to the second quarter last year. Our concrete gross profit was in line with Q2 last year, with higher prices offsetting reduced volumes. Turning now to the balance sheet, little has changed from the first quarter, except that our net debt-to-EBITDA leverage ratio declined to 2.4 times within our target range. The average maturity of our debt is 15 years, and our weighted average interest rate is 4.5%. Our leverage position and debt structure provide us with significant flexibility as we continue to grow our business. On page 8 of the supplemental slides, you'll find information on our discretionary cash flow expectation for the full year, using the midpoint of our EBITDA guidance as the starting point. As a reminder, we define discretionary cash flow as EBITDA less working capital change, interest, taxes, and operating and maintenance capital. On this basis, our discretionary cash flow for 2019 is projected to be $815 million. While there were no share repurchases and no M&A during the quarter, these remain important parts of our capital allocation priorities. For the full year, we reiterate our expectation of spending approximately $250 million on operating and maintenance CapEx and approximately $200 million on internal growth projects. And now, before I turn it back over to Tom, I'll take this opportunity to reaffirm our 2019 adjusted EBITDA guidance of between $1.25 billion and $1.33 billion. We try to be thoughtful when we gave our initial 2019 annual guidance in February. And we have performed consistent with those expectations through the first half of the year. We believe we are well positioned to continue this execution in the second half of the year. We are mindful, however, of the storm-related challenges that can characterize the third quarter and therefore, we remain comfortable with our initial guidance range, and with finishing the year in the middle of that range. And now, I'll turn the call back over to Tom for some closing remarks.

Thanks, Suzanne. I'm very proud of how our people have performed so far this year. And I want to take this opportunity to thank the men and women at Vulcan, especially our operations and sales teams, for taking care of our customers, holding each other to a high standard of operational excellence and delivering on our financial results as promised. Our financial performance is important, but safety is always our number one priority. Our safety culture is strong, and our safety metrics are industry-leading. It is critically important and remains our number one priority to send our employees home safely every day. As we move forward, we will continue to capitalize on our outstanding geographic footprint, execute at the local level, take advantage of market opportunities, and continue growing our Aggregates' unit margin. Now, we would be happy to take your questions.

Good morning, Stanley.

Hey, good morning. How are you all doing?

Good.

Good, thanks.

Congratulations on the quarter. Can you share a high-level overview of what you're observing regionally, especially considering the positive outcomes this quarter despite the weather challenges?

At a high level, looking at performance by geographic area, starting in the East, the private demand in the Mid-Atlantic states is slow and steady, while public highway demand is very strong. We are experiencing good pricing and margin growth in this region in 2019. Moving to the Southeast United States, most markets here are performing very well. However, on the private side, growth in areas like Nashville and Miami is somewhat cautious. Nashville is experiencing growth on the private side, but it's maturing, while Miami is seeing a slight decline. The rest of the Southeast states continue to show healthy private demand from highways, resulting in good volume and significant margin expansion due to effective pricing and responsible cost management. In Illinois, we are starting to see a rebound in private demand related to airport and tollway work, especially with the recent passing of the highway bill. Demand on the public side is increasing, and both non-residential and residential sectors are improving, which is encouraging for a state that has faced challenges in recent years. In Texas, the DFW/North Texas area has healthy public growth, though the private sector is slower and there are some pricing concerns. In South Texas, public demand is very strong, while the private sector shows mixed results with residential doing okay and non-residential slower but acceptable. Prices remain robust. Coastal Texas is a strong market for both public and private sectors, with impressive pricing and margin expansion. There hasn't been much movement from the energy sector, but there's anticipation for growth in 2021 and 2022. In California, despite weather challenges, there's solid growth in the public sector, especially in Central and Southern California, although the Bay Area is becoming expensive on the private side, so that will need monitoring. Our focus remains on highways, and the public side is accelerating with growing backlogs. Pricing in California is very good, showing high single-digit growth this year, along with effective cost control despite the adverse weather, leading to considerable margin growth. While there are concerns about California, I'm actually very pleased with our performance despite the wet conditions.

Yeah. And I'd just add one thing to that. I think in the first quarter, you will remember us saying in terms of pricing that the pricing gains were very widespread across the country with all the markets. Our key markets up in pricing year-over-year save one, which was Illinois at the time and it was winter. So that wasn't of a particular concern to us. In the second quarter, Illinois has joined the rest of our key markets and each of those key markets had pricing that exceeded second quarter last year. So we thought that was a very positive sign as well.

Perfect. And then last from me, on the cost environment. Are you seeing anything in the second half of the year, be it labor, whatever it would be that would be a pause for concern in terms of what's going to happen on the pricing environment? And then kind of as a corollary to that, you've done a nice job of putting a lot of growth CapEx and cost reduction at the quarry level and at the distribution level. Help us with that in terms of how we think about managing that cost structure going forward?

Yeah, I think you saw a very good performance in cost in the second quarter. Our total cost of sales was up 2% in spite of wet weather through a number of our states, which really eats up operating efficiencies. So we overcame that. The biggest driver of the increase is, you heard Suzanne say the second quarter was stripping in anticipation of sales volume growth. So I'll take that problem all the time. We saw good improvements on operating efficiencies and the things that drive our costs. Our folks are very focused on this, more to come. I can't tell you how focused our operators are on improving their operating efficiencies that really drive the cost. But based on our performance in Q2, they are winning. This is so important as you know because it's a big driver of those unit margins and being able to take that incremental revenue to the bottom line. So as I would describe the rest of the year, more to come, and I would expect us to keep improving our operating efficiencies.

Perfect, thank you very much. Congratulations and best of luck.

Thank you.

Thank you.

Good morning, Jerry.

Hi, Jerry.

Hi, Tom, Suzanne, Mark, how are you?

Good.

Good. Can you talk about the pricing cadence on the spot market heading into the back half of the year? Now that we have six months in the book, I'm wondering if the high end of your initial pricing guidance is still achievable? Or if there are mixed factors we should keep in mind as well?

We often discuss pricing, and it's important to remember that most of the fixed plant pricing was established in January and February. We did experience some success with mid-year price increases at fixed plants in various markets including Virginia, Alabama, parts of the Gulf Coast, and Arizona. The remaining 60% of our work comes from bidding, which we are currently engaged in. We want to clarify that this isn’t about a spot market price increase; it’s a long-term campaign. We feel optimistic about our backlogs and our booking pace, and we anticipate that prices will increase throughout the rest of the year as we continue to bid. This optimism is driven by our confidence and visibility in a growing market, particularly in the rapidly expanding public market and highways. Overall, as we evaluate our booking pace and pricing, we are quite confident that price increases for the remainder of the year will align with our guidance.

Is there any potential to get to the high end of the guidance? So to get to the high end, you'd have to put up pricing north of 8%. It sounds like we're probably gravitating toward the midpoint of the guidance which implies pricing closer to, call it 6.5% in the back half compared to that…

I think we are more likely to be in the middle of the range of guidance. That seems like a realistic and achievable goal.

Okay. And then to shift gears for asphalt, in the past you folks have gotten that business to be in the mid-to-high teens from a gross margin standpoint. I'm wondering, is there anything structurally different in this cycle compared to the past, because when we're looking at 8% gross margins in a business that has about 8% SG&A to sales. That's not a fantastic profit contribution even with a great flow-through that you're getting in aggregates. So I'm wondering, is there something structurally different in asphalt mix this cycle versus the past? Or when can we get back to those teens type gross margins?

The simple answer is no, there are no structural changes in Asphalt. This situation is influenced by liquid pricing and costs. We are seeing a positive shift, with overall profitability in the Asphalt product line improving in both volume and unit profitability. In Q2, volumes increased by 8%, despite wet weather in Tennessee, Texas, and California, which are some of our largest asphalt markets. Liquid costs rose by $11 million, but gross profit per ton remained flat. This ended a six-quarter trend of declining unit margins in asphalt due to spiking liquid prices, which leveled off from the fourth quarter to the first quarter and have mostly stayed flat through the first half. Looking ahead, I expect unit margins to increase as asphalt prices rise and liquid prices stabilize. For the full year, I might anticipate that we finish near the lower end of guidance in asphalt, mainly due to the wet weather in the first half of the year. The excessive rain in Tennessee, Texas, and California could limit the number of shipping days we need to meet our volume expectations by year-end. However, our backlogs are strong, lettings are increasing, and unit margins are rising. With growing unit margins, substantial backlogs, and significant enhancements in our funding and lettings in Vulcan states, the future of this product line looks very promising.

And I would add to that with respect to the guidance for the remainder of the year, Tom's right, you know we're just being a bit cautious in evaluating the number of shipping days we have left and the ability of our contractors to perform all of that work in a very compressed timeframe. If you go back to the guidance we gave at the beginning of the year for the non-aggregates segment, which is asphalt, as well as Concrete and Calcium, we said that we expected that to grow year-over-year the gross profit by 15% to 20%. We now think that that gross profit year-over-year growth will probably be toward the lower end of that, at about 15%. Again, being a little bit cautious on that. And I think that in terms of consensus, most of the consensus is at about 15% anyway.

Okay. I appreciate the discussion. Thank you.

Thank you.

Good morning, Scott.

Good morning.

Hi, Good morning everyone. So last 12 months, you had 65% incremental margins. They are over your company norms and your target levels. It looks like you have good cost control, you have volumes to support the fixed cost absorption, pricing in the mid-single digit range, you've got you're stripping out of the way this quarter. Is it possible to maintain a 65% run rate given the compounding profitability characteristics of Aggregates? I'm not asking you to commit to it of course, taking into account all your comments on guidance, but I'm curious what would be needed? And is it possible to sustain an elevated level of profitability?

I want to clarify that I did not mean to imply the stripping is behind us; it is not. Stripping will continue throughout the year due to demand, especially from the highway sector. Therefore, stripping costs will remain elevated for some time, and I expect them to stay high for at least the next six months. This is positive as it indicates anticipated significant volume growth driven by public demand. I know it may sound repetitive, but we always refer back to 60; while it is possible to experience periods above that number, there are many factors that can affect this, including some challenges alongside the positive aspects. Based on experience, it is possible to have periods above or below 60, but we will always return to that benchmark.

Got it. Understood. And then I wanted to ask another one on the cost side of things and your cost containment. And I'm curious, if you could speak to some of the efficiencies of profitability you're seeing in some of the long-haul markets, either through your vessels and container road or the rail networks and also a little more on that, we've been hearing about some moderation in transportation costs. I'm wondering if there's some puts and takes there. One of the things that we've heard or you have spoken about in the past is higher transportation costs generally enhance the economic moat of the Aggregates business, but is there the potential that moderating costs could actually potentially open up some more competition in pressure pricing? Thank you.

First of all, the cost I'm discussing refers to our actual operating costs, excluding transportation. It specifically pertains to the cost of producing and selling rock, without considering logistics. So, I'm talking about our total cost of sales to produce stone, not including transportation. Regarding your question about transportation, we are experiencing increasing costs for long-haul transportation, especially by rail. This is a significant rise that we are witnessing this year. The Mississippi River and its associated transportation costs have been impacted and are higher than usual due to flooding. I want to emphasize that, particularly for long-haul transportation, we continue to see costs escalate rather than decrease; they are actually increasing at a notable rate.