The lifeblood of any economy starts with the foundation. In the case of the U.S., that foundation starts with infrastructure. The U.S. construction market should be driven higher in 2014 by a rebounding economy and a loosening of the credit markets.
The major aggregates companies, Vulcan Materials (VMC -0.99%) and Martin Marietta Materials (MLM -1.84%), are up only 4% and 5%, respectively, over the last 12 months, meanwhile the S&P 500 is up 19%.
The entire market looks to be robust
There are three big angles for the construction market: residential, non-residential, and highway. All three are expected to see a solid rebound in 2014. As far as residential construction, the Portland Cement Association projects that housing starts will rise 8% this year. Non-residential construction tends to lag residential, thus, its improvement won't be as robust, but nonetheless should be positive.
Martin Marietta's CEO voiced his expectation for growth across all three markers during the company's third-quarter conference call. He noted that 2014 shipments should grow at a double digit rate for the residential construction market. Meanwhile, nonresidential is expected to grow in the high-single digits and the government and highway segment is expected to grow in the low-single digits.
Highway contract awards were up 14% for the year ended December. Suggesting that highway funding is stabilizing and that the highway bill is leading to construction spending growth. Assuming all three major aggregate markets rise in 2014, this could mark the first year in many that all three construction end-markets experience positive growth.
Could the industry be getting a little smaller?
Just last week it was announced that Martin is looking to buy up aggregates company Texas Industries (NYSE: TXI). However, the move might not be all that positive. And Texas is already trading near the potential takeout value. The merger includes Texas shareholders getting 0.7 shares of Martin Marietta stock per share of Texas Industries stock. As of Feb. 24, that values Texas Industries at $81.70, and it trades at $81.05.
On the positive side, Martin and Texas compete in Texas, which is Martin's largest market. Thus consolidation would benefit pricing in the market. On the flip side, Texas Industries has a stronghold in California, where Martin has no presence. However, Texas Industries' presence is with cement plants; thus, the move would actually bring Martin into unfamiliar territory. Martin does not currently produce cement.
Why Vulcan is the top industry pick
Vulcan is the largest producer of construction aggregates in the U.S. The aggregates industry includes crushed stone and gravel, which are used across a large part of the construction market. What separates Vulcan from Martin is that Vulcan is a bit more expensive, but it does have a lower debt load as measured by its debt to equity. As far as valuation, Vulcan trades at 3.1 times sales, while Martin Marietta is at 2.5 times.
Both stocks are great ways to play the rebounding construction markets, and analysts expect Vulcan and Martin to both grow earnings at an annualized 8% over the next half decade.
However, Vulcan could surprise analysts and beat expectations because it operates in more growth markets. Some of its major markets were hit the hardest by the during the financial crisis, and these same markets could see impressive turnaround over the next few years. This includes Texas, California, and Arizona.
Vulcan also has some aggressive cost-cutting measures in place to help boost margins. It's undertaken an asset sale initiatives, where it is divesting its non-core assets, which include cement and concrete operations, and real estate. Vulcan also sold off its California assets and various other assets. Through the third quarter of 2013, Vulcan had raked in over $370 million on asset sales . As part of this initiative, Vulcan is selling off cement and concrete businesses in Florida for over $700 million.
The aggregate business has high barriers to entry and the demand for aggregates should see boosts in demand thanks to a continued housing recovery and higher spending on highway construction. Thus, for investors looking for exposure to the construction rebound they should take a closer look at Vulcan.