Description

GVA: Long PT $115+/sh—Still Room for 45% Upside Even After 50% YTD Gains

Overview:

Granite Construction (GVA) is a smid-cap company in the construction sector that flies under the radar—relatively unknown, lightly covered, and with limited analyst following. Paradoxically, these characteristics are what create the investment opportunity. GVA stands at the intersection of several multi-year, powerful tailwinds (IRA, IIJA, CHIPS, AI infrastructure build-out), presenting a deeply undervalued asset with significant potential for long-term appreciation. It's a direct peer to larger players like KNF and ROAD, both of which operate in similar construction and downstream paving sectors.

In the past, GVA has been written up on VIC as a short candidate (pre-2020) and, subsequently, as a turnaround story around $20/sh in 2020. The short thesis played out, in part, due to a mismanaged period under previous leadership, which involved an SEC investigation into accounting fraud over revenue recognition, further amplified by underbidding major projects pre-COVID. Cost overruns due to labor inflation only worsened the situation. However, the long case emerged as the company began its strategic turnaround, led by new CEO Kyle Larkin. Although the stock is no longer trading at those depressed levels, GVA still offers substantial value and considerable upside from both absolute and relative valuation perspectives.

Mr. Market’s Miscalculation:

• As of September 27th, 2024, the market is valuing GVA at a total enterprise value (TEV) of approximately $3.9 billion, representing an 8.9x multiple of current-year earnings and a free cash flow (FCFF) yield of around 6.2%. On the surface, this already looks attractive—you're looking at a business tied to essential, government-backed infrastructure spending, capable of 7%+ long-term organic growth, yet priced with a 6% FCFF yield. Furthermore, leverage is modest, and the balance sheet is solid.
• The relative valuation is equally compelling. ROAD has become a darling of momentum investors, as it offers South-East exposure that many see as a high-growth play, particularly in Florida. KNF trades at an even higher multiple, despite its striking similarities to GVA. While KNF has the advantage of a larger liquid asphalt segment—which has been a high-margin business in recent years—this is, by nature, a cyclical and commodity-driven profit stream. Even KNF acknowledges that it has been over-earning in this area. The disparity in valuation between KNF and GVA feels unjustified given the similarities, offering a clear relative value opportunity for investors.
• While consensus assumes higher EBITDA growth for ROAD and KNF, largely driven by the Street's more favorable perception of these companies, we see things differently. The few analysts who cover GVA have set expectations that, in our view, underappreciate the company's potential. We believe that GVA stands to benefit from the very same tailwinds propelling its peers—growth drivers that will lift all boats, including GVA’s, to a similar degree. It's a classic case of market sentiment clouding what should otherwise be a more balanced perspective. In any case, for the sake of illustration below we assume ROAD can grow orgnically at close to 10% y/y and that KNF can attain 8% y/y growth vs. GVA at just 7% y/y organic growth.

Investor Deck Slides to give context on what GVA does: 

The Story

• Background and Shift in Strategy: Historically, GVA pursued large-scale construction projects, often leading to delays and cost overruns. A notable example was the TZ Cuomo Bridge in NYC, which contributed to significant profitability issues for the company. However, since Kyle Larkin took over as CEO in 2021, the company has pivoted away from these massive projects. Instead, GVA has refocused on its core markets in California and Texas, prioritizing smaller, more manageable projects and expanding its Materials segment. Today, the average project size stands at ~$5 million, reflecting a more disciplined approach to project risk assessment.

• Portfolio Transformation and Margin Improvements: This strategic shift has driven margin expansion. In 2022, GVA’s EBITDA margin was 6.4%, and its operating cash flow margin was 1.7%. By 2024, management expects these figures to increase to 9.5%–10.5% for EBITDA and 7% for operating cash flow. This improvement is being achieved without shrinking the business; GVA's committed and awarded projects (CAP) amounted to $5.6 billion as of Q2 2024, a 32% increase compared to Q2 2022.
• Public Funding Tailwinds: While the stock doesn't trade this way, GVA is actually a-cyclical. The reason is that a vast majority of the revenues come from government fiscal spending that are tied to population growth and usage and not the typical business cycle. Public sector projects now account for 80% of GVA’s portfolio, underpinned by strong funding from initiatives like the Infrastructure Investment and Jobs Act (IIJA), the Inflation Reduction Act (IRA), and state Departments of Transportation (DoTs). These sources provide long-term visibility into GVA’s core markets. Despite a mixed outlook for private construction, where institutional spending remains robust but office spending is weaker, GVA’s exposure to public projects provides a strong foundation for future growth. In GVA’s primary markets, it’s estimated that only about 15% of IIJA funding has been allocated, with even less having been spent. This implies a multi-year runway for significant federal funding, with additional upside potential from future stimulus.
• Vertically Integrated Business Model and Inorganic Growth: GVA remains the largest vertically integrated, pure-play construction company in its sector and has positioned itself as the main consolidator of vertically integrated assets. This positioning gives GVA a competitive advantage when bidding on vertically integrated businesses, reducing competition and providing opportunities for inorganic growth. Coupled with favorable secular trends in public infrastructure spending, this positions the company for continued growth over the next 3–4 years.
• Operational Reorganization:Previously, GVA operated through three regional groups, with each managing both the Construction and Materials segments. The Materials business was often used as a loss leader to support the Construction segment. However, in Q1 2024, management restructured the company to align its operations more closely with its two main reportable segments: Construction and Materials. This realignment allows management to focus more effectively on segment-specific expertise and to better capitalize on opportunities within the Materials business.
• Looking ahead, management has committed to providing new key performance indicators (KPIs) for the Materials segment, along with longer-term financial targets for the overall business, in its Q3 2024 update. Given these developments, GVA appears to be in the early stages of its margin improvement story, with an estimated 200–300 basis points (bps) of margin expansion potential in the Construction segment and 500-600 bps in Materials.

Risk-Reward Skew favorable:

See above for a rough valuation targeting >$115/sh. We are still in the 2nd inning of this story and we believe that looking out over the next 6mths provides significant remaining upside.

Thank you and we welcome feedback.

Catalyst

Potential Takeout Target?
GVA stands out as the most attractively priced paving company in the market, with an enterprise value of just over $1 billion. Given the overlap in operations, particularly in Mississippi, it wouldn’t be surprising if ROAD, with its significantly higher valuation multiple, sees an opportunity for a strategic acquisition. Such a deal would be highly accretive for ROAD, as it trades at roughly twice GVA’s multiple, offering immediate financial synergies.

Guidance Increase on the Horizon
During the previous earnings call, GVA’s CEO signaled the possibility of raising guidance to reflect the recent acquisition. We anticipate an upward revision in the range of $100 million, directly tied to the acquired EBITDA. Additionally, the company’s growing backlog supports a further positive outlook, making a guidance bump in the upcoming Q3 results highly likely.

Undervalued Earnings Power
In past calls, management committed to providing detailed revenue, EBITDA, and cash flow targets for 2025–2027. From our conversations, it’s clear that investors are largely overlooking GVA, failing to grasp the company’s true earnings potential. This disconnect presents a clear opportunity, as the market is severely underestimating the underlying growth story here.

Improving Transparency
KNF offers quarterly disclosures on materials' gross profit margins, breaking down key metrics like volume, pricing, and margin—data that investors highly value. GVA, by contrast, has acknowledged that its current level of disclosure is lacking. Encouragingly, management is working to enhance transparency, with plans to provide more detailed information to investors in early 2025, likely alongside full-year results. Our view is that GVA’s margins on resource sales are solid, and that the company is competitive with its peers in this area, further reinforcing its investment case.

Disclaimer: The information contained herein is for informational purposes only and should not be construed as financial advice. We may have material holdings in the equity discussed, which could create a conflict of interest. Readers should conduct their own research and consult with a qualified financial advisor before making any investment decisions. Past performance is not indicative of future results.