Eagle Materials – Cementing A Floor (NYSE:EXP)
Eagle Materials (NYSE:EXP) has not surfaced on my radar for a long time, in fact it was 2016 when I last looked at the prospects for the shares, a time when the company made a bolt-on deal to further expand its cement business. Ever since, Eagle has down quite alright, having demonstrated on reasonable operational growth, accompanied by some continued buybacks, creating real value for investors along the way.
Shares have seen a pullback after a strong 2021, as there are real clouds emerging with higher inflation and higher interest rates, yet value is apparent with Eagle being a solid long term capital allocator.
Eagle Materials was and still is a diversified building material producer. The company was hit hard by the 2008 crisis, yet the business has returned to growth despite the fierce headwinds in the oil & gas sector at the time.
The basis of the company is that it is a low cost cement producer, yet it produced other and adjacent materials as well, including slag, frac sands and ashes. These products are used in the infrastructure sector, with gypsum wallboard and paperboard being used in residential and commercial markets as well. Hence, Eagle was (and still is) a great play on the US housing market and infrastructure spending.
The company posted sales just north of $1.1 billion in 2016, a number on which it posted operating earnings of around $220 million, for margins equal to 20%, as EBITDA was posted at $320 million. The business was largely reliant on the cement and gypsum wallboard business, as there was real potential for improvement as well. After all, the oil and gas proppant business generated nearly $57 million in sales that year, but suffered a $68 million loss at the same time.
I furthermore praised Eagle for being profitable during the big recession as it avoided financial distress or serious dilution, a fate endured by many peers. Amidst the signs of optimism, Eagle announced a $400 million acquisition of a Cemex cement plant in Ohio. The deal was set to increase net debt to around $900 million, more or less translating into a 2 times leverage ratio.
With nearly 50 million shares outstanding at $78 per share, Eagle commanded a $4.7 billion enterprise valuation, equal to 4 times sales and 11-12 times EBITDA. With earnings trending close to $5 per share, I observed that the company was trading at a market multiple of 15-16 times, despite the cyclical nature of the business. The quality of the business and potential additional earnings from oil & gas could reveal some upside, yet the cyclicality argument made that I failed to see convincing appeal.
Caution Saves The Day
I am glad that I was cautious as shares were stuck around the $90 mark until the spring of 2020, as it took shares the remainder of 2020 to recover from the impact of the pandemic. Ever since, shares have seen a huge rebound amidst an increase in demand and inflationary pressures with shares hitting a high of $170 last year, before now selling off to $125 per share.
In May 2020, so just after the outbreak of the pandemic, the company posted its results for the fiscal year of 2020, for the year ending in March. Revenues rose 4% to $1.5 billion on which a $471 million EBITDA number was reported, translated into earnings of $5.57 per share. So while sales came in significantly ahead of the 2016 numbers, earnings per share have barely surpassed the $5 per share mark.
A year later, the 2021 results were outright solid as the company has proven to benefit from the pandemic. Sales rose 16% to $1.6 billion, EBITDA rose a hundred million to $571 million, with earnings up to $7.99 per share. The company furthermore put plans away to split up the business between a cement and gypsum operations (divided between a light and heavy materials business), as the company furthermore divested its Oil & Gas business, at a low point in the cycle.
Operating momentum continued in the first nine months of 2022 with revenues up another 13% to $1.45 billion, making a $1.8 billion annual number realistic. EBITDA is already reported at $442 million, making a $600 million run rate realistic, comforting as net debt is quite stable at $820 million.
This shows that the business has grown some 50% in terms of sales since 2016, yet the good news is that the balance sheet integrity has been preserved as the company has cut the outstanding share base from 50 million shares to 40 million shares, resulting in more rapid growth on a per-share basis, with earnings trending around $9 per share by now!
A cumulative 50% revenue growth since 2016, and 20% reduction in the share count makes that revenues per share nave nearly doubled since 2016. Hence, the share price action has been lagging a bit, with shares up just two-thirds since 2016. This makes that multiples have collapsed a bit to 13-14 times earnings here, all while leverage is still very much under control.
Hence, valuations look quite reasonable here, but it could be argued that we find ourselves already at a favorable point in the cycle, at least in terms of the strong results reported here. Furthermore, a clear trigger has been cancelled, as Eagle is no longer planning to separate its light and heavy materials business, as such a spin-off left potential for higher valuation of the standalone businesses, and potential suitors would perhaps be interested to acquire these assets.
While I have grown more appreciative of the business, there are real risks within the construction materials sector amidst scarce supply as rapid inflation and higher interest rates put pressure on the health of the housing market, and everything related to that. All of this makes that I have a cautious view on Eagle here from that point of view, yet further retreats to the $100 mark will be used to initiate a position, as management has proven to be a solid allocator of long term capital.