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Aggregates price-setter Martin Marietta to benefit from US infrastructure spend

Mark Sherlock, Lead Portfolio Manager of the Hermes US SMID Equity Fund at Hermes Investment Management, believes aggregates giant Martin Marietta Materials exhibits consistently strong pricing power and is well-placed to benefit from greater infrastructure spending in the US following years of under-investment in the nation’s highways, making it an attractive long-term holding.

Pricing power
Martin Marietta is the second-largest aggregates and heavy building materials company in the US. The firm makes materials used for roads, footpaths and building foundations and has operations in 26 US states, Canada and the Caribbean.

Since it is uneconomical to transport materials more than 50 miles by truck, the aggregates sector consists of a number of local oligopolies. The aggregates sector also has high barriers to entry; in an industry which is consolidating, only 10 new quarries have been approved in the last decade, benefiting existing operators.

Martin Marietta has achieved strong pricing power within this market structure due to its dominance in many geographical areas – it has set prices that have on average risen more than 3% each year since 1970, with no declines during recessions.

Positioned for an infrastructure boom
There are a number of dynamics supporting the long-term investment case for Martin Marietta. Population growth is resulting in increased per capita aggregates consumption, population density is creating demand for greater infrastructure networks, and the superior finances of states in which the company operates supports infrastructure spending. The average lifespan of a federal road in the US is nine years, and we expect the company to provide greater volumes of materials as more money is spent restoring highways and infrastructure.

The firm itself has the potential to expand its operations in both Texas and Colorado, which provided half of its 2015 sales, while its strong cash flows enable it to buy back shares and make acquisitions in future. According to one analyst note, EBITDA could double to $1.7bn-2bn by 2020[1].

Announcing its results for the first half of 2016, the group reported record net sales and net earnings. The first multi-year US highway bill in a decade, in addition to improving employment and substantial backlogs for contractors, should fuel growth as the recovery in the nation’s construction industry continues.

Sustainable growth
We seek companies with a strong durable competitive advantage that are trading at a discount to their intrinsic value. As a high-quality cyclical stock, Martin Marietta meets our criteria because it is among the top one or two players in its respective markets, and its pricing power provides strong potential for sustainable future growth.

We first invested in the stock in 2012, as we believed the materials sector could benefit from a recovery in capital expenditure amid the US economic recovery. In 2014 we increased our holding as the earnings potential of the business became clearer, and we still find the company’s fundamentals attractive.

Taking the high road: Martin Marietta stock price, Oct 2012 to Aug 2016

We hold stocks for the long term, and over the next three-to-five years we expect a combination of greater volumes, high margins and rising prices to increase the company’s profitability. Given the structural case for highways investment in the future, we think Martin Marietta should continue to grow profits in the long term.

[1] Martin Marietta: Potential for EBITDA to double. Increased delivery of aggregates by rail, by Mike Betts. Published by Jefferies International Limited in 2016

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