Aside from falling face-first into it a few times, thanks to my innate clumsiness, I'm no expert on concrete. But all the same, shares of U.S. Concrete (NASDAQ:RMIX) intrigue me, because I think it's a good business at a compelling valuation. Shares could get cheaper after a weak first-quarter outlook, too, so I definitely think they're worth a look.
Rock-solid business?
I usually take notes when I look at companies, just so I have something to refer back to. A couple of months ago, I read competitor Florida Rock's (NYSE:FRK) annual report and noted the following, with clarifications in brackets:
"Awesome business, 25% ROEs [return on equity], 23% EBIT [earnings before interest and taxes], no competition because of transport cost, building boom really helping. Stock down [because] of Florida construction exposure, but looks like a great company, did $200 million FCF [free cash flow] in 2005, looking for $1.5-2 billion."
Basically, even a non-concrete expert such as I could've easily seen that Florida Rock had a great business. Unfortunately, I never got to capitalize on my $1.5 billion-to-$2 billion target market cap, because Vulcan Materials (NYSE:VMC) made a bid for the company that sent shares soaring.
Cold snap
On a similar note, U.S. Concrete could be worth a hard look at these levels. The company just announced solid fourth-quarter numbers, but a weak first-quarter outlook should give the shares a haircut.
Over the past year, U.S. Concrete's shares have plummeted as a result of macro issues. The company thought that strength in the commercial construction business would offset a moderate decline in the residential construction business. But the tremendous pressure on U.S. housing has hurt U.S. Concrete's business, and the rebound in commercial construction has not been as robust as expected.
I'm not worried about the weak first-quarter outlook. I'm not in the business of predicting weather, and weather fluctuations will normalize over the long run, so that's of little concern to me.
Instead, let's take a look at what the company did in 2006. U.S. Concrete posted $790 million in sales and $76 million in earnings before interest, taxes, depreciation, and amortization. (I use EBITDA in an attempt to compare apples to apples, because different companies use different depreciation methods.) Looking forward, we see that the company expects to post $900 million-$950 million in sales and $90 million-$100 million in EBITDA for 2007.
The company believes it is gaining some traction on pricing. Management tentatively noted that the material spread may not be pressured by current adverse weather conditions. The material spread is the difference between U.S. Concrete's selling price and its raw material costs -- in other words, a measure of its pricing power. The material spread has been falling for three years because of surging commodity costs, but management believes that widening the material spread could be a key driver for 2007.
Management is also doing some positive things with its acquisition integrations. Most notably, sales, general, and administrative costs as a percentage of sales dropped 100 basis points to 8.4% for 2006. The company achieved this leverage by idling plants, reducing workforce, and cuttings its fleet size.
Valuation
There are two ways to do a valuation. We can look at comps if someone tries to buy U.S. Concrete, and we can try to forecast its free cash flow yield. Let's start with comps.
Comparable multiples
U.S. Concrete has about a $326 million market cap and almost $291 million in net debt, for roughly a $617 million enterprise value (simply add them up). This gives the company a multiple of about 6.5 for our forward EBITDA estimate and 8.2 times for the trailing estimate. According to a CNNMoney article, ABN AMRO analyst Scott Thackray pegged Florida Rock's buyout multiple at 11.3 times forward EBITDA and Cemex's (NYSE:CX) offer for Rinker (NYSE:RIN) at an 8.8 multiple. Florida Rock, the best of the bunch, deserves a higher multiple than the others. For comparison's sake, though, if U.S. Concrete were to command an EV/EBITDA ratio as high as that of Rinker, it would be a roughly 54% premium from where U.S. Concrete's shares currently stand. It's easy to see why management believes their shares to be undervalued.
For free cash flow yield, let's plug in some numbers and see what happens. On a trailing basis, U.S. Concrete's $75 million in EBITDA and $790 million in sales equals about a 9.5% EBITDA margin. Let's assume that EBITDA margins stay flat and the company hits the bottom of its sales range at $900 million. That would give it a 2007 EBITDA of $90 million -- actually a little less, but we'll say $90 million because that's the bottom of the EBITDA forecast and about equal to run-rate EBITDA.
So, now that we've forecasted $90 million in 2007 EBITDA, let's cut out interest costs. The company noted that its cost of debt was 8.4%, which equals about $25 million on $300 million in outstanding debt. Subtracting out $25 million from $90 million leaves us with $65 million. Now we need to subtract out maintenance capital expenditures. Management noted that maintenance capital spending runs at about 2.5% of revenues, which gives us about $22 million in maintenance capex (2.5% times $900 million in estimated 2007 sales). Actual capex will run higher in 2007 because of some developmental and plant-relocation projects, but those are excluded to provide a "normalized" free cash flow number.
If we subtract $22 million from $65 million, we get about $43 million. Now we need to cut out taxes. I wasn't able to get a good sense of the company's normalized tax rate, so we'll plug in a 35% cash tax rate here. (Notice that the maintenance capex is about equal to depreciation, so there's no need to add back for a depreciation tax shield). Thus, our after-tax normal free cash flow (65% times $43 million) would be $28 million. This quick and dirty calculation results in a free cash yield of 8.6% on the current market cap -- a relatively cheap price. U.S. Concrete produced about $24 million in free cash flow in 2005, so I wouldn't feel too uncomfortable saying that $28 million for 2007 could be conservative.
Keep in mind, my numbers are hastily calculated. They're more meant to ascertain whether U.S. Concrete is a strong candidate for further due diligence -- and the answer seems to be a resounding yes.
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates your comments, concerns, and complaints. The Motley Fool has a disclosure policy.
