Two Materials Stocks That Can Ride Out a Recession, or a Trade War

October 21, 2019October 16, 2019 Editor

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Building-materials stocks have had a huge 2019, with some up 50% or more since the start of the year. This past summer’s drier weather, and greater certainty about the outlook for next year’s earnings, could help them maintain the gains, according to one analyst.

Bank of America Merrill Lynch’s Timna Tanners raised her ratings on Vulcan Materials (ticker: VMC) and Martin Marietta Materials (MLM) to Neutral from Underperform on Tuesday.

Vulcan and Martin Marietta are among the largest miners of aggregates like gravel, sand, or crushed stone. Add cement and water and you have concrete, the most basic building component of practically all forms of infrastructure, residential, and nonresidential construction.

Martin Marietta stock has returned 55% this year, including dividends, and Vulcan has returned 50%. That compares with a 20% return for the S&P 500.

Vulcan stock now trades for 26.3 times forward earnings, while Martin Marietta stock commands 24.7 times earnings forecast for the next 12 months. The S&P 500 index trades for 17.3 times.

Tanners says those premium valuations could be here to stay. The companies look likely to report strong third-quarter results, and investors are interested in the concrete companies’ ability to maintain their pricing power and sales through a broader downturn.

“While we had been wary of high multiples into what we consider near peak earnings growth, we see some stickiness to the elevated multiples given a ‘flight to safety’ among cyclicals, and the group’s relatively more stable, defensive outlook relative to peers,” Tanners wrote in a research report.

Garbage-disposal companies like Waste Management (WM) and Republic Services (RSG) are another group that have enjoyed premium valuations. They, too, are recession-resistant stocks that aren’t exposed to tariffs in the U.S.-China trade war. Demand is steady and local: It makes no sense to ship gravel, or garbage, across the Pacific Ocean.

Last year, Hurricane Florence and a particularly wet summer flooded quarries and disrupted construction projects in many parts of the U.S., hitting earnings at both Vulcan and Martin Marietta. In the summer of 2019, however, rainfall was below average across the northeastern, southern, and western U.S.

That meant work was interrupted less often in the construction industry and at the companies’ production sites. Tanners expects Martin Marietta’s production of aggregates to have risen 8.5% from a year ago in the third quarter, while prices increased 5.5%. At Vulcan, she estimates, output of aggregates rose 6% and prices rose 7% year over year.

in 2020, Tanners says, a large federal infrastructure-spending bill isn’t likely, given the presidential election and other higher-priority issues commanding attention in Washington. But she noted that healthy state budgets could boost state and local spending on roads. Private demand for residential and nonresidential construction has stalled in 2019, and Tanners doesn’t see it rebounding next year either.

That means it is up to price increases and the aggregates companies’ defensive characteristics to maintain the stocks’ lofty valuations.

“U.S. aggregates have more attractive pricing and state demand support relative to other cyclicals that may be vulnerable to U.S.-China trade war concerns or other macro news flow,” wrote Tanners. “We continue to like their long-term pricing power, but find valuation steep relative to historical levels, and other companies with greater dividend yields and stronger cash flows.”

Tanners also sees potential for dividend increases at both Vulcan and Martin Marietta. Each currently yields below 1%. She has a $278 price target for Martin Marietta and $157 for Vulcan, about 5% and 7% above the stocks’ respective recent levels.