A Vulcanic Infrastructure Play

01/19/2009 11:14 am EST


Paul Larson

Editor, Morningstar StockInvestor

Paul Larson, editor of Morningstar StockInvestor, and analyst Patricia Oey find what they think is a good way to invest in a coming infrastructure boom.

Vulcan Materials (NYSE: VMC) is a leading provider of aggregates and enjoys a "wide moat" (a strong competitive advantage-Editor) because of its collection of quarry assets from California to Florida and its ability to enjoy economies of scale.

Over time, we believe VMC's quarries will be an increasingly valuable asset. Quarries are large, noisy, and dusty places, and it is becoming increasingly difficult to open new quarries due to tough permit requirements and stiff regulations. This firm would be a prime beneficiary if increased spending on infrastructure were to come to fruition.

More than half of [VMC's] aggregate volumes go into public infrastructure projects, and we expect infrastructure spending in the south (Vulcan's main market) to outpace national averages over the long term. Another major market for aggregates is nonresidential private projects, which account for about 25% of Vulcan's aggregate shipments. It also manufactures cement, concrete, and asphalt, which account for about 35% of total sales.

In the near term, the company stands to benefit from a number of large-scale industrial projects, including a new steel plant in Alabama and a new refinery in Texas. We expect residential construction, which accounts for about 20% of volume shipments, to continue to drag on growth in the near term and eventually return to a normalized rate of growth.

Over the last ten years, Vulcan has grown via sales and acquisitions. [It] further strengthened its network when it purchased Florida Rock in 2007 for $4.2 billion. While it has been difficult to measure the benefit of this acquisition, we believe that most of [it] will be realized over the longer term, given the anticipated continued growth in population density in Florida and concomitant increase in demand for aggregates.

Although the company faces headwinds due to possible near-term funding issues for public infrastructure projects and a slowdown in residential construction, we believe Vulcan is well-positioned to sustain its wide moat and benefit from positive secular trends in the long run.

In 2009, we expect revenue to decline at a low-single-digit rate. We have maintained our medium-term revenue growth forecast of around 8%, driven by low-single-digit growth in volume, and mid-single-digit growth in pricing. We think VMC will be able to sustain its pricing power in the long run, due to its improving supplier position in its main markets.

We expect that potential rivals from other regions will find it harder to compete with VMC due to higher fuel and transportation costs-many of VMC's quarries are located near areas of faster population growth, and it has an extensive and efficient distribution network.

We expect price increases for aggregates will outpace inflation and drive margin expansion in the long term. Our fair value estimate is $85. (The stock closed below $59 Friday-Editor.)

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