Reason 1. Positive market conditions

Summit Materials is manufacturer of goods used in the construction of buildings and roads, with among which:

“aggregates” (crushed stone, sand, limestone, gravel, etc.), used as the foundation of buildings and the basis for building mixtures. The company supplies aggregates throughout the United States, as well as British Columbia and Canada (the category accounts for 30.83% of total revenue in 2023);
cement is the main material used to produce concrete. Cement is sold in production regions and also supplied to neighboring states along the Mississippi River from Minnesota to Louisiana (the category accounts for 13.74% of total revenue);
concrete concentrate – a ready-made construction mixture consisting of cement and aggregates (the category accounts for 28.44% of total revenue);
asphalt concrete mixture is the main material used for laying road surfaces (the category accounts for 11.94% of total revenue).

Concrete concentrate and asphalt mixtures are sold in the United States and international markets, and are also used directly by Summit Materials in providing asphalt paving services as well as in the private as public sectors. Service activities accounted for 20.29% of the company's total revenue in 2023.

Company revenue by product; source: compiled by the author

The products produced by the company are indispensable for the construction industry: both for the private sector and for the public sector. At the same time, market conditions are currently in favor of Summit Materials for several reasons:

1. Positive impact of infrastructure laws. There are currently 3 regulations in force in the United States that require large investments in the country's infrastructure. Among them is the Infrastructure Investment and Jobs Act (IIJA), which assumes allocation of $1.2 trillion in 2022 - 2026 on infrastructure, $347.8 billion of which will be spent on road construction. More than $100 billion within the framework of the law will be highlighted in 8 states that bring the company the most revenue (Texas, Utah, Missouri, Kansas, Florida, Georgia, Texas and North Carolina). Road construction is Summit Materials' primary end market, and IIJA has a positive impact on demand for the company's products and services. In the image below you can see that the budgets of departments of transportation in US states in fiscal year 2024 showed a significant increase year on year, which is associated with an increase in road construction. For example, in 8 key states Summit Materials grew by 16%.

Growth of budgets of Departments of Transportation in US states; source: presentation

Another significant regulatory act, authorized large infrastructure spending in the US, is The Inflation Reduction Act (hereinafter referred to as IRA), adopted in 2022. It commits more than $400 billion in energy spending to reduce the American economy's dependence on fossil fuels and accelerate the transition to a low-carbon future.

Another major piece of legislation in the area of infrastructure investment was accepted in 2022, the Chips Act (hereinafter referred to as CA). Most of the funding, or $39 billion, was staked for the construction of plants and factories for the production of semiconductors in the United States, the implementation of which is impossible without building materials.

It is important to note that more than 60% of the funding pledged by the IRA and CA is allocated to those US states where Summit Materials operates. In other words, infrastructure laws have and will continue to have a positive impact on the demand for building materials in the regions where Summit Materials operates.

The majority of IRA and CA are in Summit Materials' operating states; source: presentation

2. A significant increase in capital construction spending by businesses in the United States. Due to other things, the influence of the above laws, the private sector in the United States has recently increased investments in the expansion of production, construction of new buildings, plants, factories, etc., which has a positive effect on the demand for building materials.

Expenses for the construction of new production facilities; source: presentation

At the same time, at a teleconference with investors following the results of the 2nd quarter of 2024, the company’s management noted that major clients are planning to intensify construction projects in 2025, which could further increase investment in capital construction in the near future.

3. Unsatisfied demand for private houses. As can be seen in the graph below, the indicator “Housing starts”, reflecting the number of starts of construction of private houses, grew from 2010 to mid-2022 (excluding pandemic). In March 2022, the US Federal Reserve for the first time since the beginning of the COVID-19 pandemic raised the key rate, which led to an increase in mortgage rates and a slowdown in construction.

Dynamics of the “Housing starts” indicator; source: THE

The current situation has created pent-up demand, which could lead to a “boom” in housing construction amid the Fed rate cut cycle. For example, in August 2024, the “Housing starts” indicator unexpectedly increased immediately by 9.6% compared to July 2024 to 1.36 million units year on year, which significantly exceeded market expectations: analysts believed that the increase would be only 3.2%. This remarkable trend could be a sign that pent-up housing demand is starting to materialize amid dovish Fed rhetoric.

4. Historical growth in demand and prices for aggregates. Due to the development of the American economy, the country is constantly increasing construction volumes, which has a positive effect on the demand for building materials. In 70 of the last 75 years, the price of aggregates increased, and since the beginning of the 20th century - the average selling price (ASP - Average Selling Price) grew up almost 3 times. The dynamics for cement are similar; since 2018, the price for it has also been growing, albeit at a slower pace.

Increase in prices and production volumes of aggregates; source: presentation

Rising prices for cement and aggregates; source: presentation

At a teleconference with investors following the results of the 2nd quarter of 2024, company management noted that by the end of 2024 a double-digit increase in prices for aggregates and a single-digit increase in prices for cement is expected.

5. Long-term growth in cement demand. Summit Materials believes that the volume of its consumption from 2023 to 2028. will grow with a CAGR of 2.3% and will exceed 115 million megatons per year.

Dynamics of cement consumption; source: presentation

Thus, Summit Materials is currently in a very positive environment: infrastructure laws are driving demand for construction from the public sector, the business is investing record amounts in capital construction, and falling rates are setting the stage for a “boom” in housing construction as borrowing becomes cheaper. All this is happening against the backdrop of consistently rising prices for the company's products. This adds up to excellent financial performance for Summit Materials, which will be discussed in more detail in the next section.

Reason 2. Active participation in mergers and acquisitions

Summit Materials management has repeatedly stated that part of the company's strategy is to participate in M&A transactions to scale its business more quickly.

One of these deals became a merger with Argos USA, which took place in early 2024 and it worked out for Summit Materials at $3.1 billion. Argos USA was a major manufacturer of building materials in the south of the country and its East Coast. The company's assets included 4 integrated cement plants, 2 grinding plants, 140 ready-mix concrete plants, 8 ports and 10 inland terminals in the East Coast and Gulf Coast regions.

Argos USA assets; source: presentation

Due to the Summit Materials merger it could significantly increase the scale of the business, and the effect of the transaction continues to improve to this day. The key results of the transaction, in addition to the acquisition of the above infrastructure, were the following facts:

1. United company became 4th largest cement manufacturer in the US.

Effect of merger with Argos USA; source: presentation

2. Summit Materials will increase annual revenue by approximately $1.7 billion to $4.2 billion, and EBITDA by $300 - 330 million to $1.0 billion. At the same time, the synergistic effect from the merger will be about $100 million.

Effect of merger with Argos USA; source: presentation

3. Increasing convertibility of adj. EBITDA to free cash flow (FCF). In 2019 - 2023 about 32% of adj. EBITDA transferred to FCF, then after the merger the company targets growth of the indicator up to 40%.

At a teleconference with investors, Summit Materials management noted that the integration of the company's business with Argos USA is going according to plan and even ahead of schedule. In particular, the first synergistic results emerged that were achieved through economies of scale. By the end of the 2nd quarter of 2024, the merger brought already $17.5 million adj. EBITDA, and by the end of the year Summit Materials expects this value to increase to $40 million. At the same time, the company in question is only starting to introduce our own know-how into Argos USA production processes, which will become an important factor in increasing the margins of the combined business in the future.

One example of this activity was the completion of an upgrade at the plant in Martinsburg, where Summit Materials has made $17 million in kiln improvements that will increase production, reduce costs and CO2 emissions and, as a result, allow the company to better meet growing demand in the Mid-Atlantic states.

In addition to the transaction described, during the first half of 2024 Summit Materials carried out two additional purchases of small aggregates operations in the Eastern and Western United States for $65.0 million, which also improved the company's production base.

The described business development, in particular the successfully progressing integration of Summit Materials and Argos USA, allowed the company's management to confirm stated at the beginning of 2024 forecast for adj. EBITDA for 2024 Summit Materials is currently expected to reach $970 - $1010 million according to this indicator, which assumes growth from $921 million at the end of 2023, and margin by adj. EBITDA for 2024 or will reach forecast at 23-24% at the upper limit, or even exceed it.

Thus, over the past year, Summit Materials has confirmed its commitment to growth strategy through M&A transactions and market consolidation. Due to the merger with Argos USA, the company significantly increased its production capacity and expanded the geography of its activities. At the same time, the effect of the transaction is just beginning to manifest itself and in the future its positive impact on the overall business may lead to an increase in the value of the company.

Reason 3. Availability of buyback program

In March 2022, the Board of Directors of the company approved a $250 million share repurchase program with no duration restrictions. As of the end of June 2024, the company's authorized buyback amount amounted to $149 million or 2.2% of the company’s capitalization.

Given the large merger deal with Argos USA, as well as positive market conditions, we believe that Summit Materials may increase its buyback or begin paying dividends, which should boost the company's share price.

Financial performance

Summit Materials' financial results over the last 12 months (TTM) can be summarized as follows:

Revenue amounted to $3.38 billion, which is 28.97% more than at the end of 2023.
Adj. EBITDA increased from $578.01 million to $762.46 million. The margin on the indicator increased from 22.07% to 22.57%.
Net profit amounted to $272.23 million compared to $285.86 million at the end of last year.

The growth in revenue and operating profit was mainly due to the synergies from the merger with Argos USA and the organic increase in prices for the company's products, which also had a positive impact on the results for 1H 2024. In turn, the decrease in net profit is associated with an increase in interest expenses.

Dynamics of the company's financial indicators; source: compiled by the author

The results for the first half of 2024 are presented below:

Revenue grew by 65.15% year-on-year and amounted to $1.92 billion.
Adj. EBITDA grew from $232.95 million to $417.39 million.
Net profit amounted to $39.21 million versus $52.83 million a year earlier.

Dynamics of the company’s financial results for the first half of 2024; source: compiled by the author

At the end of the last reporting period, operating cash flow increased to $456.22 million compared to $438.86 million at the end of 2023.
Free cash flow decreased from $183.24 million to $130.14 million at the end of 2023.

Operating cash flow increased primarily due to adjustments to cash expense items. The decrease in free cash flow was mainly due to increased capital expenditures in 1H 2024.

Company cash flow; source: compiled by the author

The company has an increased debt burden:

Total debt is $2.87 billion.
Cash equivalents account for $538.71 million.
Net debt to adj. LTM EBITDA is 3.1x.
The interest coverage ratio is 4.7x.

This level of debt burden indicates increased risks to the company's sustainability. However, the bulk of the loan portfolio repayment will not occur earlier than 2029, and therefore we consider this risk to be insignificant for the company.

Evaluation

Summit Materials is trading at a discount to the industry average: EV/Sales – 2.17x, EV/EBITDA – 9.62x, P/E – 17.70x, Fwd P/E – 17.39x.

Comparable assessment; source: compiled by the author, Finviz

The average price target from the top 10 Wall Street investment banks is $47.7 per share. According to our consensus, the company is undervalued at industry average multiples; the fair market value of the shares is $52.5, implying an upside potential of 29.2%.

Price targets of investment banks; source: compiled by the author

Key risks:

The US private construction market may take longer to return to strong growth than currently expected. There is no guarantee yet that the August surge in new construction by more than 9% can be repeated in the following months, despite the start of a reduction in the US Federal Reserve's key rate.
To maintain growth rates, Summit Materials is pursuing M&A transactions. In this regard, there is a risk of purchasing an ineffective or overvalued business, which may become an additional burden for the company. Investors are also actively monitoring the integration of the Summit Materials and Argos USA businesses. If the company does not achieve its own targets, this may lead to a decrease in its capitalization.
Bad weather negatively affects the company's business, as it complicates the extraction and transportation of construction materials. Major Hurricane Milton, which hit the United States in October 2024, could have damaged the company's production facilities in Florida. If the risk materializes, the company may face a decrease in capitalization.

* This investment idea is provided to you as part of the additional service "Investment Research and Financial Analysis" in accordance with License 275/15.

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