Martin Marietta: Headwinds, high valuation ratios and lack of insider buying activity

Martin Marietta Materials, Inc. (NYSE: MLM) recently released their Q2 2024 results, showing a challenging second quarter with lower-than-expected EPS and revenue.

In this article, I will go through the headwinds and the pressures on them The company is currently facing, including weather disruptions, high interest rates slowing the residential and commercial real estate sector and an inventory adjustment of the recent acquisition.

In the outlook section, I will give you the rationale behind my Hold rating, including an overview of their recent insider buying transactions.

As always, I like to start with a brief overview of the company, for those readers new to this stock.

Company overview

Martin Marietta Materials is a supplier of construction aggregates, cement and related construction materials used for infrastructure, residential and commercial projects.

They operate a network of 360 quarries, mines and distribution sites in 28 states in the United States, as well as in Canada and the Bahamas.

Martin Marietta operates through three main business segments:

• Building Materials: This is their core segment, focused on the production and sale of aggregates, cement, ready-mixed concrete, asphalt and paving services. This segment is divided by geography into East Group and West Group.
• Magnesia Specialties: This segment is focused on the production of magnesia-based chemicals used in industrial, agricultural and environmental applications. It also includes the production of dolomitic lime for the steel industry and soil stabilization.

I thought I’d include a breakdown of their revenue by segment and product line below to represent each segment’s share of total annual revenue.

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An author’s compilation of the most recent 10-K. Please note that Aggregates, Cement, Ready-Mixed Concrete, Asphalt and Paving Services and Inter-Product Revenue are product lines within the Building Materials segment.

As mentioned earlier, the building materials segment, which accounts for 95% of their revenue, is further divided by geography. I thought I’d include a breakdown of their income by each geographic group below.

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From an ownership perspective, I would prefer to see more ownership spread among all directors and officers. As of their last 14A, the aggregate common stock of all directors and officers is just 0.68%.

However, I am in favor of there being no PE firms involved that own a significant portion of the company (>25%). There are only 2 funds that have more than 5% ownership: Vanguard (11.6%) and BlackRock (6.7%).

Headwinds in Q2 2024

I like to start dinner with cake, so I’ll cover the headwinds first.

In Q2 2024, revenue fell 3% YoY, gross profit fell 8% YoY, and net earnings from continuing operations fell 16%.

I thought I’d point out below what I believe are the three main drivers for this decline, starting with the increase in fair value of inventory from their recent acquisition, Blue Water Industries.

Martin Marietta acquired this company for $2.05 billion with the idea of ​​strengthening its aggregates segment by expanding its presence in Tennessee and South Florida.

However, the stock that came with the acquisition had to be marked down to its fair market value as part of the acquisition accounting process. This implied that COGS also had to be marked up.

Why is this important? Well, if you sell products at the same price, but suddenly your COGS goes up (artificially) due to inventory revaluation, your gross profit goes down.

This accounting adjustment resulted in a $20 million decrease in their gross profit in Q2, 2024, or $0.37 per ton on aggregate gross profit.

Another factor was weather disruptions, particularly in the Dallas-Fort Worth area, a key metropolitan market for Martin Marietta, which saw a 119 percent increase in precipitation compared to historical averages. Unsurprisingly, the rainfall led to delays and cancellations in the area’s construction sector, resulting in a 2.8% drop in aggregate shipments for the quarter.

Finally, the last pressure I am concerned about is high interest rates, which have put pressure on the private construction sector, particularly in residential and commercial real estate. Aware that the Fed is likely to cut interest rates in September, I believe this pressure will continue to be present for at least a year.

Outlook

Let’s start with the share price. Looking at the weekly chart below, you will notice a sharp rise in the share price, especially between October 2023 and March 2024. Given this 50% increase, I think the current 13% pullback is a healthy indication.

In addition, the revised guidance provided in Q2 was a decrease compared to their previous expectations, which I believe exacerbated the effects of the pullback.

When looking at the financials, operating income, net income and EBITDA have all increased since 2021 (which is also reflected in the share price).

In addition, their margins have increased, as you can see below.

From a debt perspective, they have a debt-to-asset ratio of 0.3 and a current ratio of 1.86, which I see as a good indication of their ability to pay short- and long-term debt. Plus, their publicly traded bonds are priced decently, which is a good sign in my view.

However, when we look at their free cash flow, things are not looking good for the last two quarters.

Given that they pay a quarterly dividend of $0.79 per share, I’m a bit put off by the negative free cash flow.

From a valuation perspective, I think the company is overvalued, especially compared to the materials sector. Among the key ratios I observe, EV/EBITDA, price-to-sales and price-to-book are all above the materials sector median and also above the company’s 5-year average.

Additionally, the lack of insider buying activity, especially during the pullback, is not a good indication of management confidence in the stock price, in my opinion. A quick look at year-to-date transactions shows the CEO selling $12 million, or 9 percent of his ownership in the company, and an EVP selling $6 million, or 14 percent of his stake.

This, coupled with the fact that management only owns 0.64% of the total common stock, makes me feel discouraged. This, along with high valuation ratios, has led to my Hold rating.

Conclusion

In closing, Marietta Materials faces some headwinds, including lower revenue and profits in Q2 2024, primarily due to inventory build-ups from the Blue Water Industries acquisition, weather disruptions in Texas and the Midwest, and ongoing high interest rates.

I believe these pressures will ease in the second half of the year, but despite a possible rate cut in September, the positive effects of lower interest rates will take some time to feed through.

Additionally, their high valuation ratios and lack of insider buying activity during the recent pullback make me rate this stock a Hold.