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.

Secular Bull Markets Don't Guarantee Short Term Success

It's Tuesday and the wife is positively giddy as she watches Glee on television. That same giddiness and glee is also present in the commodities space of the stock market. The trend is up, the trade has worked, and the story is intact. Investors/speculators continue to pile into any and all real asset plays as an inflation hedge, a dollar hedge, and a participation in emerging markets. I've done so myself. But I worry.

"What the commodity markets are telling us is that we're living in a finite world, in which the rapid growth of emerging economies is placing pressure on limited supplies of raw materials, pushing up their prices. In other words, commodities are in a real, secular bull market, not a bubble." The forgoing quote is a sentiment that I encounter daily in articles, newsletters, and analysis. I don't disagree, but that does not mean that a nasty correction cannot happen in spite of the commodity shortages.

An example. The aggregate industry in the U.S. is a wonderful, regionalized monopoly. Supply is limited by the inability of operators to easily obtain permits for new quarries, mines, and facilities. The scarcity is real. Until 2008 the share prices of all aggregate companies marched steadily upward based upon their ability to raise prices, even in the face of declining volumes, due to limited supplies. It was a secular bull market in rock. Then as the real estate recession moved from residential real estate development to commercial development to road building, the price increases no longer stuck well enough to offset the huge volume declines. Share prices declined. I was on the right side of that trade and did well.

The aggregate business is still a good one, if your balance sheet is conservatively financed, and the permitting of new projects hasn't become any easier, but the share price declines show that shortages can become oversupply rapidly. That oversupply can affect the conservatively financed and the aggressive companies alike [MLM and VMC, respectively]. Commodities, and commodity companies, face the the same dilemma as the rock suppliers.

Should China experience a "hard landing", commodity volumes will drop drastically, prices will be slashed, and share prices will no longer enjoy a positive trend. Inflation and a weak dollar won't be able to compensate for a stalled China. Emerging markets are going to emerge and use huge amounts of raw materials, but their progress doesn't have to be in a straight line. Raw materials are in a secular bull market, but they aren't immune to dislocations caused by retrenching markets.

If China were to stall, the secular bull market in commodities goes into neutral for several years. I don't have an opinion on China's ability to manage their economy, but I do have an opinion on how my raw material/commodity investments are structured. If China craters, I only want to own companies with pristine balance sheets that can easily survive until the emerging markets bounce back. I don't own "junior" miners, rare earth hopefuls, and leveraged operations that are taking on large, debt funded, expansions to supply China.

I don't have the conviction to sell materials stocks short, like I did the aggregate operators, but that could change! In the meantime I hope the China led recovery continues, and should it not, that my conservative materials positions perform well enough to get me to a prosperous resumption of the secular bull in commodities.

Glee's over so I can quit typing.

Vulcan Appears Vulnerable Again

Vulcan, and other similiar companies, has nearly doubled in the past several months as infrastructure rebuilding and stimulus mania has taken hold. The thesis holds that stimulus funding will fill the hole that developed in residential, commercial, and state road budgets. It won't. At best, it will halt the decline in volume, but it won't get the company on a fast growth track. The price surge reflects the beginning of good times being here again.

In 2007/2008/2009 I rode puts and shorts on both VMC and MLM. It's time to start nibbling at negative bets again as these companies are priced too richly.

LAST WEEK I WAS A SUPER BOWL STAR. THE PRIOR WEEK I WAS THE GROUNDHOG AND ENGULFED IN MY SHADOW

My missives from this past week were worthy of wearing a Steelers uniform. Flowers Foods was up $.50 today for a nice percentage gain. My Vulcan puts and shorts gained value as that stock continued its slide. Best of all, I followed my own advise and did not short any of the for profit education companies such as ESI. ESI charged upward today as it always does when the market in general is having a down day as investors seek the perceived safety of this sector. Finally PSD edged closer to it's February 6th merger closing date and its price rose a few pennies.

The prior week I thought the pounding of the nation's best airline was overdone and opined that it was a buying opportunity. Southwest [LUV] stutter stepped for a few days and has gone down ever since. That brilliant decision, so far, was worthy of  Punxsutawney Phil  being engulfed in his shadow. It's a gloomy feeling. 

Todays results were approximately a push financially since I put more money into LUV. I'm hoping that the Steeler in me makes a continued comeback tommorrow and I can lift that cloud as making money sure feels good.

Vulcan materials Issues Junk Bonds. The Dividend Is Not Safe.

Is Vulcan run by managers that understand business or kids playing in a big sandbox? For shareholders sake I hope management isn't just a feel good bunch, but logical thinkers that will do what is right for the company. You can't fix a company by avoiding tough decisions. 

Today VMC filed a SEC document detailing $400M of new long term debt. The bonds yield 10.375% and 10.125%. That's about 8% more than Treasuries. The rates are punitive. The proceeds will be used to repay short term debt and maturing long term debt. Since they're paying 10+%, rather than using internally generated funds, for the funds necessary to repay debt,  I assume that cashflow hasn't been robust. 

If cashflow hasn't been robust, borrowing costs have risen, and projected net income is approximately 100% of VMC's dividend, why pay a dividend? Or why pay as large a dividend as they have been paying. With 110M shares outstanding and a $2 payout, cessation of the dividend would free up $220M to boost liquidity.

That's what a good businessman would do. Conserve the cash until better times. Don't gamble with having to go back to the banks again and pay a higher interest rate. Yes, shareholders will be disappointed, but the price will drop further if the company gets into really hot water down the road.

Every day it becomes clearer that the Obama stimulus is not going to be a road and bridge building bonanza. The numbers are puny compared to original hopes. That means that road building will not rescue residential and commercial shortfalls. Improvements in diesel and liquid asphalt pricing won't either. The quarterly numbers to be announced in early February will fall short of easily earning their dividend. Their guidance is likely to be hedged and paint 2009 as another difficult year.

At the high multiple that VMC is presently valued at there isn't any room for dividend cuts, lowered guidance, or the media tallying up the pittance in the stimulus devoted to roads and bridges. My short position can only improve.

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.