Q1 Construction Materials Update

The construction materials (CM) industry celebrated the close of 2021 with the passage of the Infrastructure Investment & Jobs Act (IIJA).

This once-in-a-generation piece of legislation earmarked $1.2 trillion in infrastructure funding, including an additional $550 billion increase over baseline federal funding. Most importantly for the CM sector, the IIJA established a new surface transportation reauthorization act and a 30 to 55 percent increase in spending for roads and bridges – overall a positive outlook for the industry (Figure 1).

As of now, the CM sector also has some challenges on the horizon. Will departments of transportation have the employee bandwidth to get the work out to bid quickly? Are there sufficient construction crews to perform the work?

Additionally, other economic issues have come to light, including raging inflation rates, expectations around interest rate hikes, supply chain issues, the war in Ukraine and the ever-lingering COVID pandemic. FMI has investigated some of the issues and their impact on the CM sector, as well as the effects on mergers and acquisitions (M&A) in the industry.

Inflation

Inflation has been the boogeyman economists warned about for many years. However, the nightmare is becoming a reality at historic proportions.

In March, the Consumer Price Index (CPI), a measure of the average change in prices paid by consumers for a basket of goods and services, jumped 8.5 percent from the previous year – the most since 1981 (see Figure 2).

Gasoline prices, a component of the CPI, had the highest year-over-year jump at 48.8 percent. The drastic rise in fuel prices will be something to watch as the year progresses.

For CM firms, those who can pass on increased costs to customers with timely price increases will be successful in navigating this inflationary period.

Labor market

The "war on talent” has been a tagline throughout the industry for several years, and unfortunately, this is still the case.

The Wall Street Journal recently published a piece highlighting the mass exodus of blue-collar workers. These individuals are moving to tech companies, where hiring practices have been adjusted to consider candidates without a college degree.

These jobs typically offer higher pay and benefits, as well as work flexibility. These “new collar” workers – individuals who have transitioned from traditional blue-collar work to more white-collar roles – are directly impacting the CM industry.

According to a survey conducted by W.E. Upjohn Institute for Employment Research, the construction industry is seeing a significant reduction of workers. In the fourth quarter of 2021, “41,500 workers in construction, oil-rigging and extraction jobs reported moving into professional work – a 65 percent jump over the same period in 2019.”

The Wall Street Journal piece also notes that industry leaders are grappling with the dynamics of “job hopping” where workers move from one company to another for slight pay increases. These trends have become more normalized, and there are fewer consequences for individuals who leave a job because the demand for labor is so high. When comparing the data of labor force participation and monthly job openings, there is still room for improvement from prior to the pandemic. Therefore, CM firms will have opportunities to bring on new hires, but the challenges will be in recruiting and retention. The CM firms that can both attract and retain talent will fare far better than their competitors.

Rising interest rates

In mid-March, the Federal Reserve raised interest rates by 0.25 percent – into a range of 0.25% - 0.5%) – in an effort to curtail inflation. This was the first time the Fed raised rates since December 2018.

In addition to raising rates at the last meeting, the Fed indicated that more rate hikes are likely coming this year with the goal of reaching 1.9 percent by the end of 2022. Rising rates increase the cost of financing equipment purchases and taking out mortgages on homes. CM firms with residential exposure are more vulnerable to interest rate changes.

Sentiment indexes & backlogs

Despite all of the headwinds on the horizon, industry sentiment remains positive.

Both the Heavy Civil Construction Index (HCCI) and the Nonresidential Construction Index (NRCI), FMI’s two proprietary indexes that measure construction outlooks, earned scores of 57.7 and 53.8 in the second quarter of 2022, respectively (see Figures 3 and 4). A score above 50 indicates expansion, and a score below 50 represents market contraction.

The one caveat is that the second-quarter 2022 score for the NRCI was lower than the previous quarter’s report, which coincides with the cautiously optimistic undertones in the market. Additionally, backlogs, which are a health indicator in the construction industry, appear to be trending at near-term historic averages (see Figure 5). Overall, sentiment and data point to near-term optimism.

The CMI

The Construction Materials Index (CMI), FMI’s proprietary index of publicly traded construction materials companies, ended 2021 on a high note with most companies hitting or exceeding top- and bottom-line analyst expectations for the fourth quarter of 2021. Still, strong operating results do not always translate to stellar stock performance.

The CMI has lagged the broader indices over the last 12 months (see Figure 6). The downward pressures weighing on the CMI include high input costs due to inflation and issues brought on by supply chain constraints.

Additionally, six of the companies that make up the CMI are headquartered in Europe, and the war in Ukraine has created immense uncertainty leading to fluctuations in the equity markets. As a result, it will be very interesting to review earnings reports in the upcoming quarters.

Will CMI companies be able to maintain margins and pass on costs to customers? Time will tell.

M&A activity

The momentum of a strong operating year in 2021, combined with the passage of the IIJA, has continued to fuel M&A transactions in the CM space. 

2022 is on pace with some of the stronger years for M&A. FMI anticipates a robust year for M&A in the space due to the supply-and-demand dynamics between buyers and sellers.

Buyers have cash, borrowing capacity and expectations for continued strong earnings. Sellers, particularly family-owned businesses, face generational pressures and are concerned about missing the window of opportunity to exit.

Keep in mind, too, that buyers face human capital limitations in both pursuing deals and integrating acquisitions. Therefore, FMI believes both public and private CM companies will pursue logical M&A targets that possess achievable synergies in strong markets. The upcoming earnings season will be a great indicator for near-term M&A expectations.

Conclusion

After weighing the pros and cons, there is still momentum for the CM industry. Historic federal funding for roads and bridges combined with a strong near-term outlook for the residential sector should boost CM through this period of tumultuousness. As public companies report their first-quarter earnings, we will be able to see how impactful some of the potential “roadblocks” have been for the sector.

 

A version of this article was originally published in Pit & Quarry.