Earnings Call Transcript - VMC Q2 2022

Operator, Operator

Good morning, everyone, and welcome to the Vulcan Materials Company's Second Quarter Earnings Call. My name is Katie, and I will be your conference coordinator today. Now I will hand the call over to Mr. Mark Warren, Vice President of Investor Relations for Vulcan Materials. Mr. Warren, you may begin.

Mark Warren, Vice President of Investor Relations

Good morning and thank you for your interest in Vulcan Materials. With me today are Tom Hill, Chairman and CEO; Suzanne Wood, Senior Vice President and Chief Financial Officer; and Mary Andrews Carlisle, Vice President of Finance. Today's call is accompanied by a press release and a supplemental presentation posted to our website, vulcanmaterials.com. A recording of this call will be available for replay later today at our website. Please be reminded that today's discussion may include forward-looking statements, which are subject to risks and uncertainties. These risks, along with other legal disclaimers, are described in detail in the company's earnings release and in other filings with the Securities and Exchange Commission. Reconciliations of any non-GAAP financial measures are defined and reconciled in our earnings release, our supplemental presentation and other SEC filings. As the operator indicated, please limit your Q&A participation to one question. With that, I will now turn the call over to Tom.

Tom Hill, Chairman and CEO

Thank you, Mark, and thanks to everyone for joining the call this morning. We appreciate your interest in Vulcan Materials Company. Our teams delivered another solid performance in a challenging macro environment. The resilient nature of our aggregates-led business actually stands out in times like these. We've grown our cash gross profit per ton in 15 of the last 16 quarters and expanded our trailing 12-month unit profitability at a compounded annual growth rate of 5.5% over that 4-year period. These consistent results come from our unwavering commitment to executing on our strategic disciplines, which allows us to capitalize on pricing opportunities to mitigate cost pressures and to drive improvement in unit profitability. During the second quarter, we grew our aggregates cash gross profit per ton despite significant external headwinds. Importantly, our year-over-year improvement expanded sequentially each month. We are poised to carry this momentum forward and deliver both aggregates cash unit profitability growth and double-digit adjusted EBITDA growth this year. We generated $450 million of adjusted EBITDA in the quarter, an 11% increase over the prior year. These results include an approximate $20 million impact from the unexpected and arbitrary shutdown of our operation in Mexico in May. The results were also hampered by ongoing energy cost headwinds and other inflationary pressures. Pricing improvement was robust across all product lines. Year-over-year growth in aggregates mix-adjusted price has increased sequentially for 6 quarters. Both asphalt and ready-mix delivered strong double-digit price improvement, which helped offset rising energy costs. Turning now to each segment. Aggregates gross profit improved 8% to $402 million. Demand remained healthy across our footprint during the second quarter with the majority of geographies showing shipment growth. Overall, volume improved 9% or 2% on a same-store basis. Ongoing pricing momentum helped margins return to growth in the second quarter. Freight adjusted pricing increased 9% over the prior year's quarter. Mix-adjusted pricing improved 10%. We expect continued momentum through the balance of the year as second half price increases and new project work backlog at higher prices begin to flow through into the third quarter.

Operator, Operator

In the second quarter, aggregates cash gross profit improved 2% to $7.99 per ton. In the Asphalt segment, both volume and pricing improvements were geographically dispersed. Pricing actions that began last year usually resulted in a 19% improvement in average selling prices in the quarter and helped to mitigate a $33 million energy headwind. Volumes improved 9%, asphalt cash gross profit in the quarter held 2021 levels, despite the significant year-over-year increases in liquid asphalt and natural gas costs. Concrete cash gross profit in the second quarter benefited from the addition of U.S. Concrete, growing from $14 million in the prior year to $51 million this year. Volume, price and material margins all improved as higher selling prices offset higher material costs. Continued improvement in private nonresidential construction activity and the onset of infrastructure investment remain catalysts for the concrete segment. Now let's shift to the broader demand environment. We continue to expect private and public demand to grow in 2022. Residential construction activity in the second half of 2022 will remain good and multifamily permits and starts are showing particular strength. Headwinds to single-family construction have resulted in slowing permits and starts, but after multiple years of strong growth, single-family construction remains at high levels, and Vulcan states continue to outperform the U.S. average. Private nonresidential demand has returned to growth and broadened in 2022 beyond aggregate-intensive warehouses and distribution projects to now include other nonresidential categories like office, manufacturing and institutional work. On a trailing 12-month basis, square footage for total private nonresidential starts has grown 20% in bulk-and-serve markets and is now above pre-COVID levels. Other leading indicators like the Architecture Billings Index and the Dodge Momentum Index also point towards growth. The ABI remains in positive growth territory, and the Dodge Momentum Index hit a 14-year high in June. On the public side, we've entered growth mode. And while public demand has been somewhat muted in the first half of the year, we anticipate second half growth in both highways and infrastructure. The bidding and booking activity we saw in the second quarter reflected record levels of public funding. In addition, we anticipate that the federal infrastructure investment and Jobs Act funding will begin to flow into shipments in 2023 and for years to come. Now remember, the ultimate timing of the impact of the IIJA will depend upon the pace at which states continue to allocate additional funds and the time horizon needed to move from design to letting to construction. Overall, our markets are positioned to continue to outperform other parts of the country, and our strong execution and tireless commitment to expanding our unit margins will ensure that we continue to drive value for our shareholders. I will now turn the call over to Suzanne and Mary Andrews to comment further on our results and the full year outlook. Suzanne?

Suzanne Wood, CFO

Thanks, Tom, and good morning to everyone. As I reflect on the first half of this year, I'm pleased with our 14% adjusted EBITDA growth that was driven by a strong performance in aggregates, which Tom described, and SAG cost leverage. Our strategic discipline helped us confront and overcome macro challenges in the current dynamic operating environment. In regards to SAG, we reduced this cost as a percentage of revenue by 50 basis points in the first half to 7.3%, and we are positioned to further leverage cost by the end of the year. I'm also pleased that our net leverage was reduced to 2.5x EBITDA, the top end of our stated target range of 2x to 2.5x. Our balance sheet is strong, and our significant cash generation capabilities give us the capacity to continue to invest in both organic and inorganic growth opportunities. Disciplined capital management remains fundamental to our strategy. Our capital decisions are made with the goal of improving shareholder returns and return on invested capital, while maintaining financial flexibility and our investment-grade credit ratings. On a trailing 12-month basis, our ROIC at quarter end was 13.6%. Our adjusted EBITDA over the same time horizon increased by 13%, and we expect continued improvement. I'll now turn the call over to Mary Andrews to provide more details on our outlook for the remainder of 2022. Mary Andrews.

Mary Andrews Carlisle, Vice President of Finance

Thanks, Suzanne, and good morning all. It is a pleasure to take part in this quarter's call. In February, we communicated expectations for 2022 of delivering adjusted EBITDA between $1.72 billion and $1.82 billion. Today, we are providing an update to our full year guidance. Our update reflects both the previously disclosed $80 million to $100 million impact from the loss of our Mexico business, in addition to other adjustments related to higher-than-anticipated inflationary pressures. We now expect adjusted EBITDA for the full year between $1.6 billion and $1.7 billion. We expect mid-single-digit growth in aggregates cash gross profit per ton for the full year. The strong pricing momentum we have seen in the first half is expected to continue, and we now expect aggregates freight adjusted prices to increase between 9% and 11% for the year. We continue to expect aggregates volume improvement of 5% to 7%. We are also revising our expectations for the Asphalt segment due to the continued escalation of liquid asphalt costs. Asphalt earnings for the full year are now expected to approximate full year 2021, benefiting from solid shipment growth and aggressive pricing actions that are offsetting the significantly higher energy costs. I'll run through a few other components that may be helpful for modeling purposes. SAG expenses are expected to be between $495 million and $505 million. Interest expense for the year is expected to be approximately $165 million. Depreciation, depletion, amortization and accretion is expected to be approximately $565 million. The effective tax rate is estimated between 21% and 22%. We plan to spend between $600 million and $650 million on capital expenditures in 2022. These expenditures include both maintenance and growth projects. I'll now turn the call back over to Tom for closing remarks.

Tom Hill, Chairman and CEO

Thank you, Mary Andrews, and a special thank you to Suzanne. As we previously announced, this will be Suzanne's last earnings call. You hear me say this a lot, but it's the people of Vulcan that make this place special. And Suzanne is, for sure, one of those people. Suzanne, we're grateful for your tenure, and we appreciate your leadership. Your leadership has played a critical role in our success over the last 4 years in our ability to deliver enhanced profitability and higher returns on capital despite pressures like pandemics and inflation. And while Suzanne's business skills are tremendous, I think what I'll miss most is her caring touch. What the organization will miss is how she welcomes all in and made us feel a part of the Vulcan family. Suzanne, we wish you the best in your retirement. We'll miss you greatly. We want to thank you. Well, make sure you go take care of those grandbabies. I want to also thank the entire Vulcan team for your hard work and your success. I'm excited about where we've been, but I'm more excited about what we're going to accomplish for the rest of 2022 and beyond. First and foremost, on keeping our people safe as we've shown in our industry-leading safety performance. We are focused on delivering value to our shareholders by executing at the local level, driving unit margin expansion through our strategic disciplines and maximizing the synergies from recent acquisitions. We look forward to seeing all of you in New York in September for our Investor Day. Now Suzanne, Mary Andrews, and I will be happy to take your questions.

Stanley Elliott, Analyst

Starting off, I mean, there's a tremendous amount of volatility in the market right now. Has it changed your view on where we are in the cycle? And maybe could you point to some things that you're seeing in the market that give you confidence that things really haven't changed all that materially?

Tom Hill, Chairman and CEO

Stanley, I think as an investor, I'd ask 3 critical questions. The first question would be what's going to happen with price? I think that's a pretty easy question to answer. Price is very good. It's getting better, and it's going to continue for the foreseeable future. We've seen times where we had double-digit pricing, and usually when that happens, it's a multiyear trend. Second question would be, okay, in the face of inflation, can you take that price to the bottom line? And simply, yes. We saw an inflection point in the second quarter. Margins were back in growth in May, kind of low single digit, then they grew to mid-single digit in June. So margins are in expansion mode. And then we're going to have mid-year price increases. So pricing is now outpacing inflation. I'd like to take you back to a critical fundamental of our aggregates business, which is that aggregate pricing is inelastic, but diesel costs are not. The third question would be what's going to happen with demand and shipments in the foreseeable future? I think the answer to that one is we see demand continuing to grow, maybe in a little bit different format, so less single-family, more multifamily, really growing non-residential, and a lot more infrastructure. So you put all those three questions together, I think our business is set up for success for the next few years.

Suzanne Wood, CFO

Thank you, Stanley.

Trey Grooms, Analyst

The cash gross profit, I wanted to touch on that. Cash gross profit per ton increased in the quarter, which is pretty impressive given the headwinds, and you're looking for, I think, the revised guide is a mid-single-digit improvement for the year, which does imply a pretty strong pickup in the back half. So how should we be thinking about the progression there? And I'm assuming that, that will imply a pretty strong exit rate and bode well for profitability going into next year. So any color you could give there would be helpful.

Tom Hill, Chairman and CEO

Yes. So as I talked about earlier, if you looked at May, we were up, say, 2% of unit margins; June, say, 5%. You've got another price jump in July. We’re also adding higher bidding prices in the second half. We see — the cost inflation, it's not just going to go down, but it's not going to continue accelerating like it has. And that would point us to what I'd say high single-digit unit margins in the second half. So really, we've recovered — as we always do, we'll take the inflationary hit. Our pricing lags, but we'll jump it and we'll go back in the growth mode. I'd say that unit margins will be very good in the second half, and we'll carry that momentum into 2023.

Suzanne Wood, CFO

And best wishes to you.

Garik Shmois, Analyst

Just wondering if you could speak a little bit more on the infrastructure side. Coming into the quarter, you were still expecting this — the first half of this year to reflect a bit of an air pocket due to bidding activity that was a little bit slower in the back half of last year. I'm just wondering, you've got some slides that have reflected an increase. I'm just wondering if what you're seeing on the ground and kind of what the expectations are moving forward...

Tom Hill, Chairman and CEO

I'm sorry, I couldn't hear the first part of your question. Are you talking about the entire market or specific end use like highways?

Garik Shmois, Analyst

Yes. Sorry, I was speaking specifically to highways.

Tom Hill, Chairman and CEO

Sure. I think it was slow as we had predicted in the first half because states kind of hit the pause button in the second half of last year to see what's going to happen with their budgets. The fundamentals for multiyear growth in infrastructure and highways are very good. At this point, you've got state, county, and city tax revenues at extremely high levels, and that is prior to the IIJA. We've seen substantial bidding booked work in infrastructure in the last 90 days. Embedded in that in the recent backlog are a number of multiyear big projects, again, prior to the IIJA. So the bidding and backlog growth should continue for the balance of this year. The DOT budgets as we look forward to next year are starting to reflect the 38% funding increase from IIJA plus, on top of that, their substantial funding going into this. We predicted the growth, and we saw it in the biddings in the second quarter. We think that continues for this year and well into 2023 and 2024.

Anthony Pettinari, Analyst

On the updated guidance, if we strip out Mexico, I think there's $30 million from higher costs, if I got that right. I'm just wondering if you can put any finer point on that $30 million diesel energy, I don't know, labor, or if there's other things that we should be thinking about there?

Tom Hill, Chairman and CEO

Yes. It's really energy. From the first half to the second half is probably about in line, but you still have other inflationary pressures in there, and labor continues to escalate a little bit. But it's primarily just all the flow-through of all the inflationary inputs and services that we have in that business.

Suzanne Wood, CFO

Yes, Anthony. I'd just add that, that extra $30 million, you'll see the majority of that in the Asphalt segment due to continued higher liquid in the back half. You'll also know we raised the SAG guide just a bit, which is related to some business development expenses and other legal costs related to Mexico.

Anthony Pettinari, Analyst

Okay. That's very helpful. And then just on Mexico, understanding the guidance adjustment, can you just remind us of the timeline for potential NAFTA arbitration and sort of the remedies that you're pursuing there?

Tom Hill, Chairman and CEO

Yes. So with the shutdown in May, we filed an application in the NAFTA arbitration to seek additional claims because of the shutdown. In July, the Tribunal granted our application to seek those further claims, and we should hope to hear a decision sometime in 2023.

Anthony Pettinari, Analyst

Okay. That's very helpful. And Suzanne, thanks so much for all the help over the years.

Suzanne Wood, CFO

Sure. I enjoyed it. Thank you.

Jerry Revich, Analyst

Suzanne and Mary Andrews, congratulations once again to you both. Suzanne, we'll miss working with you. I'm wondering if I could just ask, as you folks look at what the outlook for aggregates percent margin performance is embedded over the balance of the year, if we back out the impact of the unfortunate situation in Mexico, do you expect year-over-year percent gross margin expansion in the fourth quarter just based on the pricing actions that you folks have announced? And similarly, can you just talk about the cadence of organic volume expectations now that we have to contend with not being able to ship from Mexico, it looks like over the next couple of quarters?

Suzanne Wood, CFO

Yes. I think on the gross margins in the back half, like Tom said, we really view the second quarter as having been an inflection point with pricing beginning to accelerate faster than the cost. We would expect to see gross margins begin to improve in the back half.

Tom Hill, Chairman and CEO

Yes. You asked about volumes, and I would tell you that what's in the guidance is growth of roughly low single digit. I would tell you to point out that the underlying demand in the market is a lot stronger than that, particularly with the growth we're seeing in non-res and infrastructure. The second half, as I said, we'll see growth, but you've got some headwinds there. The biggest one is going to be Mexico. The second would be lack of rail service. We just can't get enough product to the coastal markets. The third and fourth ones would be just truck shortages at peak time capacity and then some cement charges in the market. As we look further out, I think the demand drivers are shifting. You've got single-family leading indicators that are not as robust, but we think that's offset by three factors: One, multifamily construction remains extremely strong; two, non-residential construction continues to improve; and three, as we talked about, highways and infrastructure bookings are showing considerable strength in the last 90 days, and that's prior to the IIJA and will only get better in the second half of this year going into 2023. Remember that Vulcan markets enjoy considerable population growth, so our demand profile will grow faster than the rest of the country.

Brian Biros, Analyst

This is actually Brian Biros on for Kathryn. We've been hearing increased concern from state DOTs that inflation is beginning to impact their ability to address their work programs. So I guess, in addition to labor and material shortages, are you seeing inflation impact the public work programs at all?

Tom Hill, Chairman and CEO

You hear about jobs not being awarded due to being over the engineers' estimates because of inflation, and we think that's really the exception, not the norm. The place that we've seen a little bit of that is in Georgia. But even in Georgia, they postponed 8% of work where they normally do about 1%. I would underline postpone; they don't go away with it, they just said, hey, we're going to wait and see what happens with inflation. Those jobs don't go away. But most states, that's more of the exception of the rule. Most states are pushing work through despite inflationary costs; for example, I think Texas and Arizona DOTs have been real clear that they are going ahead with their scheduled programs. The DOT funds are at extremely high levels right now, and that's prior to the big increase in federal funds. You've got gas tax revenues at incredibly high levels. You got extra COVID funds. At this point, the DOTs have been aggressively bidding their work since February and March, and we're seeing that in our bookings and backlogs as we talked about. I don't think it's a big issue for most of the DOTs.

Chris Kalata, Analyst

It's actually Chris Kalata on for Mike. Just going back to the Mexican quarry disruptions. I was hoping you could help flesh out more detail how you plan to backfill those lost shipments. I mean, is there an opportunity to potentially backfill that through M&A, still plan to utilize the ships you've made over the years? And how do you plan to address the disruptions and continue to serve those Gulf markets?

Tom Hill, Chairman and CEO

Yes. At this point, that's not in our guidance. In fact, we took the $80 million to $100 million hit. We're not backfilling those tons. You'd say, well, can't you just rail down there? The fact of the matter is we can't get the rail service for our normal business increases that we normally use. So at this point, we don't have that in our plan.

Michael Feniger, Analyst

You're hosting Investor Day in September, and the provider framework was in 2019. So now you're seeing strong cost control, higher pricing, that is likely to stick as diesel costs peak. So would that not lead to a higher cash gross profit per ton long term? Just trying to assess as we go forward now the incremental margin, operating margins that you kind of see in 2023 and going forward based on how pricing is going to exit this year and the costs have likely peaked?

Tom Hill, Chairman and CEO

Now, you're going to steal my thunder for my Investor Day. Yes, you pointed out. Look, as we said in the prepared remarks, we're at $7.99 per ton. Our long range has been $9. So we're rapidly approaching that. Obviously, this is a continuous improvement journey. We hope to give you guys some new goals and a path to those goals as we talk in September, and I think we'll have a full morning of that at the end of September.

David MacGregor, Analyst

Tom, in responding to an earlier question, you talked about a number of factors that were influencing volume. And one of those you mentioned was just cement tightness. So I'm just wondering if there's a way to talk about the extent to which cement availability or lack thereof may be adversely impacting your aggregates business, not just this quarter, but heading out through the next 5 or 6 quarters.

Tom Hill, Chairman and CEO

Yes. So the cement issue — for aggregates volumes, it's not as big a deal as the Mexico or the rail. It's a little bit here, a little bit there. I'm not sure that if you have the cement, you would have the trucks to deliver the aggregates or the trucks to deliver the concrete itself. That's why I put it with the cement and the trucking. So it is there. I don't see it as a big headwind. I think there would be other governors that would take over if all the cement was there.

David MacGregor, Analyst

Okay. And then the second part was just the business that you see booked over the last 90 days, that inflection. What's your best estimate in terms of the timing of that becoming visible in revenues for you?

Tom Hill, Chairman and CEO

Well, I think it became visible in May. It became more visible where unit margins were up 2% in June. They went up 5%. We're predicting them to go up high single digits in the second half. I think we're here and we're in the middle of it, and it's growing rapidly.

Adam Thalhimer, Analyst

Tom, I wanted to ask about the demand rotation. When do you think the percentage of revenue from infrastructure could increase significantly?

Tom Hill, Chairman and CEO

I think you see it ramping up in the second half of this year, and then it ramps up some more in 2023 and a lot more in 2024. What's really impacting this year is not the federal fund increase, and federal funds, it is gas tax and COVID funds. That probably is the majority of the ramp-up in the first half of 2023, and then you've got the big jump in federal funds, I think, hitting second half in 2023 and 2024.

Michael Dudas, Analyst

Maybe for Suzanne or Mary. You highlighted the capital spending outlook this year. So if it's going to accelerate in the second half versus the first half, could you give a little bit of where that's spending the growth? And is there growth projects without giving out budgets for next year that could be multiyear ahead given some of the delays from COVID? And is there a target on the 2x to 2.5x level on the net debt ratio, but given the spending and with deposit cash flow you're generating, that more capital allocation to shareholders could be bought for? Is that something maybe we save for the September Investor Day?

Suzanne Wood, CFO

Yes, sure. As Mary Andrews has indicated, the CapEx outlook for this year remains at $600 million to $650 million. We've talked about this before. That's a little higher than what it has been in the last couple of years just because we had various things impacting that, namely the pandemic, and most recently, the supply chain has made it difficult to take in some of that equipment that we had planned to be delivered last year. So this year is a little bit higher. Probably 2/3 or so of that is directed towards what we refer to as operating CapEx. That's the first pillar of our capital allocation strategy because it's important that we maintain the value of the valuable franchise we have. It's also important that we keep our equipment in very good working order. Looking forward, potentially volatile times from a macro perspective, it's essential that your equipment remains in good shape and good utility because that gives you the ability if you needed to reduce CapEx going forward for a few years. We're comfortable with where we are on CapEx. With respect to growth, we have invested in numerous sales yards over the years in certain markets that act as virtual quarries for us and help us distribute aggregates to customers. We also have a number of greenfield projects, which we do a number of those if we have a growth quarter in which there isn't a company that we're interested in from an M&A perspective. Some of those more recent greenfield sites have been California, Georgia, Texas, and South Carolina. We're comfortable with the level of spending and think it's appropriate for the size of our business now and puts us in good shape going forward. With respect to the leverage target, it was important for us following the U.S. Concrete acquisition to get ourselves back within the range. We were pleased to get to the top end of that range at 2.5x. Having gotten within that range, we will continue down the path of it's important to stay within the range with what we have in front of us. I think we are well able to do that. The capital allocation priorities have been in place for a long time, and they have put us in good shape. Our return on investment has increased 40 or 50 basis points over the last 2 or 3 years. We will continue to follow those capital allocation priorities.

Collin Verron, Analyst

This is actually Collin on for Phil. I just wanted to touch on aggregates pricing. You guys are implementing the midyear price increases. You talked about increasing bid work pricing. And even one of your large competitors talked about targeted 4Q price increases. So just given these dynamics, can you talk about how you're thinking about the magnitude of sequential price improvement in Q3 and Q4? And help us think about the magnitude of carryover pricing that you would expect in 2023?

Tom Hill, Chairman and CEO

Yes. In the quarter, as we said, it was up 9%, 10% of mix-adjusted. It's important to note the cadence of pricing within the quarter. So April was up 7%, May was up 9%, June was up 10%, and we'll continue to see that sequential pricing as we progress through the second half. To your point, it's supported by widespread July price increases, you've got bid work continue to go up, you're replacing old work with higher price bid work. If you look at the second half, we're probably in the 12% or 13% range for the total second half, 6 months, we’re probably in the 12% to 13% range. We ended the quarter at 10%, so that will continue to step up as we go through the year. That will also set us up really well for 2023 as most of the work that we bid in the third and fourth quarter will ship next year. So we'll go into it with significantly higher prices as we start the year, giving us a big advantage.

Jean Ramirez, Analyst

This is Jean Ramirez for Brent Thielman. My first question is, to what extent are cement outages and allocations impacting your volumes and ready-mix? Should that innovate in the second half?

Tom Hill, Chairman and CEO

So I would tell you minor, a little bit here and there at peak times. It's not just cement, it's also trucking for aggregates. It's also ready-mix truck operators. So there's a bunch of things that play into that. So it's a little bit, but there's a lot of other factors besides just cement.

Jean Ramirez, Analyst

Great. And if you don't mind, just a quick follow-up. Given the impact of the Mexico operations, are there any plans today to try and alternatively serve those markets that rely on that product?

Tom Hill, Chairman and CEO

Not at this point, and that's driven by lack of rail service.

Operator, Operator

At this time, I am showing no further questions. I will now turn the program back over to Tom for any additional or closing remarks.

Tom Hill, Chairman and CEO

Thank you all for your interest and your time for Vulcan Materials this morning. We appreciate it very much. We hope that you and your families remain safe and healthy, and we really look forward to seeing you at the end of September for our Investor Day in New York. Thank you and have a great day.

Suzanne Wood, CFO

Thanks, everyone.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes today's event. You may now disconnect.