Saturday, February 5, 2011

Vulcan Materials' Shipments Peaked In 2005

The recession and it's impact on certain industries remains far from over. The aggregates industry, forgive the play on words, is bedrock to the U.S economy. However, it hasn't been very hospitable to owners in recent years. The lesson to learn is that even industries with scarce resources, difficult permitting, and central to the economy can experience significant troubles, especially if balance sheets get stretched. Vulcan [VMC ] is the poster child for this phenomenon.

Don James, Vulcan CEO, stated in the company's recent earnings release that shipments are down over 50% from the peak in 2005! He offered some positive comments about the tide turning, but pinned 2011 shipment growth on a resumption of residential building activity, no further deterioration in non-residential construction, and a timely passage by Congress of the Federal Highway bill. Three large orders. I don't envy Mr. James as he's in the hot seat, or should be.

James didn't create the Subprime building bubble, but he also did a poor job of protecting the downside of his business. At the peak of the mania, Vulcan made a large acquisition of Florida Rock for a premium price. To make matters worse he leveraged the purchase. Then VMC continued to pay a healthy dividend even while its payout ratio was very elevated. By comparison, Martin Marietta Materials [MLM], avoided the large M&A deals, didn't load up the balance sheet with as much debt, kept a reasonable dividend in relation to earnings, and has remained more profitable in spite of the same type of shipment declines.

The comparison i want to make is not that MLM is run better than VMC, but that extremely bad things can happen even in wonderful industries if stupid decisions are made. The recession is over, but VMC is still plagued by its section of the economy and its leverage. The same scenario can affect any commodity based industry that is mined or drilled. New supply has been flowing into most mining, and drilling arenas and an economic slowdown can wreak havoc on those participants that use lots of debt to bring on the new capacity.

My suggestion, in addition to staying away from VMC, is reposition portfolios to only include mining and drilling companies that have pristine balance sheets and management's that are not enamored with big acquisitions. When the next downturn arrives, and shipments fall in half, you want your companies to survive ala Martin Marietta as opposed to Vulcan Industries.

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