The construction industry is highly cyclical. When the general economy is doing well, or even booming, the industry usually isn't far behind. When growth slows or a recession strikes, the appetite for construction projects takes a big hit. Luckily for investors, we're currently in the midst of a broad economic expansion.
Continue Reading Below
That has made construction companies, and specifically those of cement and concrete manufacturers, some of the best-performing stocks over the last three years. Vulcan Materials and Martin Marietta Materials have nearly tripled the returns of the S&P 500 during that period, while the smaller U.S. Concrete (NASDAQ: USCR) has gained an incredible 181%.
Although there are great fundamentals supporting the stock's rise, investors appear to be suspicious. Slightly over 28% of the the company's shares are traded short, according to numbers compiled by Yahoo! Finance. There's no denying that shares have outperformed most other stocks, but I think investors are wrong to bet against U.S. Concrete. Here's why.
Image source: Getty Images.
Why short-sellers are wrong
The stock trades at an eye-popping 125 times trailing earnings, but there's an innocent, if not downright weird, explanation. It may sound odd, but the better the stock performs, the bigger the company's GAAP net loss becomes. That's because U.S. Concrete must account for non-cash derivative gains and losses from fair value changes in its issued warrants when the stock price moves down or up, respectively, in any given period.
Continue Reading Below
The good news is that recent quarterly GAAP net losses have no impact on the company's cash position and have not had major impacts on the share price. The great news is that operations have maintained a strong level of performance for several years in a row.
U.S. Concrete notched $75 million in operating income and $1.17 billion in revenue in 2016. Those metrics grew 235% and 95%, respectively, from the performance achieved three years ago. Operating cash flow reached $112 million last year, which was well above the $24 million achieved in 2013.
In other words, the stock has certainly earned its 181% gain in the last three years.
That said, there's a strong case to be made that the company's growth isn't over. Unlike other cement and concrete manufacturers, U.S. Concrete has strategically (and almost exclusively) focused on major metropolitan areas in Texas, New York/New Jersey, and northern California. Those markets were responsible for 38%, 31%, and 25%, respectively, of total revenue in 2016. There are several advantages to that strategy that short-sellers may be overlooking.
First, it allows the company to strategically acquire assets to become a major and dominant player in each region and city. Consider that in 2016 alone, U.S. Concrete acquired four smaller ready-mix concrete operators in the Bronx, Queens, and Brooklyn. The acquisitions provided the company with 10 ready-mix concrete plants and 189 mixer trucks. In addition to swiping away competition, the acquisitions allow the company to make more competitive bids on larger projects. And in New York City, there are some pretty big projects.
In fact, the company supplied the concrete that built the new World Trade Center Complex, including Freedom Tower, which was the highest height concrete has ever been pumped in North America. Expansions at LaGuardia Airport and the Modern Museum of Art were also aided by the company, as are other major ongoing projects in the New York, Dallas-Fort Worth, and San Francisco metropolitan areas.
Second, extending its leadership position in each major market allows U.S. Concrete to have a greater influence on product pricing. The fourth quarter of 2016 marked the 23rd straight quarter that the company achieved year-over-year ready-mix concrete price increases. That has an obviously beneficial impact on revenue and margins, and it has played a huge role in the company's industry-leading margins in the ready-mix concrete segment. Whereas the average material spread margin in the industry was 45% last year, U.S. Concrete achieved 49.2%.
Third, operating in urban environments allows the company to benefit from environmental considerations and initiatives, such as LEED building certifications. Humans manufacture more cement than any other material. Unfortunately, cement is also one of the most carbon-intensive materials to produce, accounting for 5% of total global CO2 emissions each year. While certain materials can be substituted into cement production processes, they can significantly alter the performance of mixed concrete. In other words, it's not easy being green.
Luckily, U.S. Concrete is a leading producer of low CO2 concrete. The company's EF Technology can reduce the greenhouse gas emissions associated with cement production by between 42% and 46%. Today, over 30% of concrete used by the company benefits from the technology. That allows it to place highly competitive bids on major construction projects with LEED requirements -- an increasingly important consideration. That's especially true in environmentally conscious San Francisco, where the company has won projects including the Google Bayview Campus, the Workday Campus, and even the Golden State Warriors Arena.
What does it mean for investors?
It takes a bit of digging around the company's primary strategy and the driving forces for the industry at large, but I think short-sellers are wrong about this stock. The only way short-sellers could be right about U.S. Concrete stock is if the American economy heads for a slowdown, which would have much broader consequences. While that's not impossible -- in fact, with recessions occurring every eight years or so, we're "due" for one -- it's unlikely to sneak up on investors. The company works off of a backlog of projects that are agreed to years prior, which provides fair warning to shareholders of potential trouble on the horizon.Right now, though, there appears to be consistent growth ahead for the foreseeable future.
10 stocks we like better than US Concrete
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now...and U.S. Concrete wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of February 6, 2017.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Maxx Chatsko has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and Workday. The Motley Fool has a disclosure policy.