Friday, January 9, 2009

Vulcan Materials' Dividend And Share Price Are Not As Solid As Rock

Vulcan, the country's largest aggregate company, is like an easy first date. It's easy to get interested as it is going to make you feel good, but it is also real ugly. The whole experience is a one bagger.

This company, and industry, is fundamentally sound. It makes money year in and year out. It can do extremely well when construction is on a roll. It has even done well the past several years when construction has been constrained. But it didn't do well by selling more rock,gravel,cement, concrete, and asphalt. While volumes were decreasing, the industry had the pricing power to increase prices. Rare, but factual. Can that phenomenon continue in 2009?

The upcoming Obama stimulus has created many believers and the stock has moved up from a November low of $40 to the $70s. It has recently traded down to the low $60s, but has still enjoyed a large stimulus move. Last year the stock advanced on the thesis that it was very difficult to obtain permitting for new mines and any company that already had  facilities permitted and near  metropolitan areas possessed unlimited pricing power [I buy that rationale in good times]. This year it has moved on the hope for an Obama stimulus that is heavy on road and bridge construction. 

The stimulus will help, but it won't turn this ugly date into a beauty. Aggregate companies are three legged stools. They depend on housing, commercial, and road building. The first two legs of the stool are broken. The third, government sponsored road building, is about to get a boost from the US taxpayer. It comes at the right time as state and local tax revenues are falling and state and local road building funds are under pressure. My guess is that the stimulus is going to replace lost tax revenues and will not result in an explosion of road construction activity. The VMC bull bet is that the stimulus spending will juice  governmental spending enough to offset the continued weakness in housing and commercial construction. I believe that the koolaid  drinkers will be disappointed.

Analysts currently expect Vulcan to earn $1.96 in 2009, approximately the same as '08. If pricing power holds up, they may. That level of performance results in a EV/EBITDA of 12. In today's market that is a high cashflow multiple for a company that makes less money each year, sells less product each year, and is paying out 100% of earnings in dividends. That's right, a 100% payout ratio when they pay a dividend of $1.96. That largesse doesn't make sense in our present economic climate. I also won't make sense to the company's bankers. You conserve cash in bad times, you don't keep paying it out unless you are Bernie Madoff and still have an unlimited source of funds.
Vulcan is going to reduce their dividend. How much I can't predict, but they will need to reduce their payout.

It's likely that analyst earnings estimates will be cut, quarterly earnings comparisons will be poor, revenue will decline, and, finally, a dividend cut will lead to a decrease in share price. I am short this company and even though it may be swept up in another bout of Obama stimulus in the coming weeks, I believe it will be heading downward as reality sets in and the pixie dust wears off.  VMC is going to be a pretty date only if you are short or wearing a bag.

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