Martin Marietta Materials: Recent Correction Is A Buying Opportunity (NYSE:MLM)

Investment Thesis

I previously covered Martin Marietta Materials (NYSE:MLM) in July and, while I liked the company’s growth prospects, I chose to stay on the sidelines as valuations were a bit high. Since then, the company has reported strong Q2 results as expected and raised its guidance. However, the stock price has corrected 10% since my previous article as the market was concerned about high valuation and the hawkish commentary by the Federal Reserve.

I believe this correction is a good buying opportunity. Looking forward, the company has good growth prospects, helped by strong tailwinds from the government stimulus program as well as the likelihood of aggregate demand in residential end-market bottoming in Q3 2023. The carryforward impact of past price increases is also expected to meaningfully help the company’s revenue growth and margin improvement. The stock is trading at a discount to its historical valuation, making it a good buy.

Revenue Analysis and Outlook

MLM has seen strong revenue growth in recent years, helped by good demand as well as significant price increases implemented by management. In Q2, 2023, the company benefited from significant pricing increases across its businesses, which helped it post ~11% Y/Y growth. Product wise, pricing increased 18.6% Y/Y in aggregates, 21.8% Y/Y in cement, 21.9% Y/Y in ready-mix concrete and 7.9% Y/Y increase in asphalt and paving.

Looking forward, while the continued hawkish stance by the U.S. Federal Reserve is resulting in concerns about a macroeconomic slowdown, MLM’s revenue outlook remains positive.

The company’s largest end-market, infrastructure, is poised to benefit from a good multi-year momentum in projects helped by Infrastructure Investment and Jobs Act (IIJA) funding. On its last earnings call, management noted that the value of highway, bridge and tunnel contract awards recorded 25% Y/Y growth for the 12 months ended May 31, 2023. As the work begins to ramp up on these projects, so should the demand for the company’s aggregate and cement products from this end-market. In addition to IIJA funding, infrastructure investment in the U.S. continues to get bipartisan support and state level funding for these projects also remains solid. The good thing about this market is that it is not dependent on the broader macroeconomic cycle and should continue to do well as IIJA funding related projects continue to ramp up and governments prioritize infrastructure spending.

On the non-residential construction side, both heavy industrial as well as light commercial (eg. retail/ restaurants) have seen good demand till now. While there have been some concerns around light commercial demand given high interest rate and macroeconomic concerns, the demand for heavy Industrial projects should remain strong, buoyed by the recent trend towards onshoring manufacturing facilities and the government stimulus programs to encourage it.

On MLM’s last earnings call, the company’s CEO Howard Nye mentioned,

Since 2021, supported by enhanced federal investment from the Inflation Reduction Act and CHIPS Act, private companies have announced over $500 billion in commitments to invest in critical sectors like semiconductors and electronics, electric vehicle and related batteries and clean energy as those projects are both economic and national security consequence.

Further, the nation’s aim to be the global leader in artificial intelligence and machine learning is expected to drive substantial demand for new data centers for the foreseeable future. As a result, we expect an extended cycle within the aggregates intensive heavy non-residential sector.”

These investments by private companies should continue to boost heavy industrial construction demand. Now, the interesting thing is this heavy industrial construction work is more aggregate intensive compared to light commercial construction and good demand here should more than offset slowdown in light commercial construction business. Hence, I believe we can see continued growth in the non-residential end market as well.

Finally, on the residential side, the business has seen some impact from slowdowns due to high interest rates. However, this end market has performed much better than initially feared. After slowing sharply near the end of the last year, housing starts have seen a good sequential recovery and the residential market saw a strong spring selling season. Now, there is a lag between housing starts increasing or decreasing and MLM seeing its impact on its aggregate sales. Management expects residential sales volume to bottom in Q3 2023 as a result of the slowdown in housing starts late last year and then see a sequential recovery in response to good housing starts trends we have seen in the spring selling season. So, the outlook for this end market is also positive in the near term. Further, as I have explained in a previous article, there is a shortage of housing in the U.S. due to significant underbuild for over a decade following the great housing recession of 2008. So, once the interest rate cycle reverses, we could see strong momentum in this end market in the long term as well.

Thanks to the solid demand conditions, the company is seeing strong pricing power. The company has taken a mid-year price hike of $10 per ton in its cement business this year, in addition to earlier price increases in January. I expect the pricing increase to be a continuing driver for the company’s growth in the coming quarters.

In addition to good organic growth prospects from solid demand conditions and pricing increases, the company also has good inorganic growth prospects thanks to its solid balance sheet with net debt to EBITDA ratio of 2.1x and a good past track record of tuck-in acquisitions.

Overall, I expect MLM to see continued revenue growth despite macroeconomic uncertainty.

Margin Analysis and Outlook

The company posted good margin performance in Q2 2023 helped by strong pricing and moderating fuel costs which more than offset other inflationary costs like labor, etc. The company’s gross margin improved 490 bps Y/Y to 30.8% while its adjusted EBITDA margin improved 130 bps Y/Y to 32.7%.

Looking forward, MLM has good margin growth prospects, driven by strong pricing increases as well as lower fuel costs compared to last year. These should more than offset inflationary headwinds in other costs. The company is also focused on optimizing its portfolio mix to improve margins. Last quarter, the company finalized the divestiture of its Stockton, California cement import terminal. The company is also installing a new finish mill at the Midlothian, Texas plant which should add 450,000 tons of incremental high-margin production capacity by Q3 2024. I expect the company to continue divesting low margin non-strategic assets and invest in high-margin assets through both organic and inorganic routes, which should help longer term margins.

Valuation and Conclusion

MLM is trading at 22.87x FY23 consensus EPS of $17.78 and 20.16x FY24 consensus estimates of $20.17. This is a discount versus its 5-year historical average P/E (FWD) of 25.98x.

Since my previous coverage, the stock price has gone down while sell-side estimates have gone up as the company has raised its guidance. This has made the current valuation attractive. The company’s revenue should continue to see good growth thanks to government programs like IIJA, the CHIPS and Science Act, and the Inflation Reduction Act driving infrastructure and industrial construction demand. The residential market demand is also likely to see a bottom in Q3 and recover thereafter. Given the company’s good growth prospects and a reasonable valuation, I have a buy rating on the stock.