Vulcan Materials Corporation (VMC, Financial) reported relatively weak results this week, but the stock moved higher.
The company's cost inputs for diesel fuel increased 17 percent, reducing pretax earnings $4 million and unit costs for liquid asphalt increased 14 percent, reducing pretax earnings $6 million. Vulcan missed on earnings, reporting 0.10 cents per diluted share against expectations of 0.18. Anticipating weaker results due to reduced demand for aggregates, Citigroup downgraded shares back on October 19. Shares trade about 10% higher than the price at the time of the downgrade.
Why would shares rise on an earnings miss? Pessimism has pervaded most of the shareholder base as single-family, condominium, and commercial real estate building have reached multi-decade lows in most markets. Weak earnings over the last several quarters have caused investors to question Vulcan's ability to maintain its dividend. Third, state funding for infrastructure projects has been questionable given their poor fiscal condition. Currently, short shares constitute over 11% of the float.
In light of this trifecta of known, persistent gloom, shares are cheap on a discounted cash flow basis.
The investment community is discounting abysmal results from Vulcan over many years into the future in order to justify the current share price. To reach $39 per share, revenue growth must be flat over the next several years, with no real growth in volume and below-inflation increases in aggregate pricing. Margins over Vulcan's business cycle would hover in the mid to low teens.
This flies in the face of likely revenue increases as soon as next year. In the most recent conference call, CEO Don James noted that:
“Contract awards for highway construction in Vulcan-served states continue to out-pace other states... Through September 2010, the Federal Highway Administration reported that only 42 percent of the total stimulus funds obligated for highways in Vulcan’s 10 largest revenue states had been spent – which bodes well for increased construction activity from federal stimulus spending for the remainder of 2010 and 2011.”
We base our discounted cash flow model off of reasonable expectations for mid-single digit revenue growth over the next several years. Aggressive price increases to offset the volume declines over the next several years will continue to abate, but they will most likely continue to out-pace inflation.
The net result should be a share price that trades just above $60 per share, making VMC an interesting opportunity for value investors.
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The net result should be a share price that trades just above $60 per share, making VMC an interesting opportunity for value investors.
If you're interested in reading more of our free value investing research, check out our website at InvestmentUnderground.com. And if you'd like to know which two companies are set to benefit from the Republican win this week, download our new e-book...for free here.
