Description

Summit Materials Inc. (SUM) – Long, $40/share ~12-24 month target

Market Cap: $3.3b (Last Sale: $28.79)

TEV: $4.7b ($1.4mm Net Debt)

3-month Avg Daily Volume: 1.3mm shares/day ($37mm)

Investment Horizon: ~12-24 months

Overview

Summit Materials (SUM) is an integrated supplier of construction materials (aggregates, cement), products (ready-mix concrete, asphalt) and paving services.  I’d encourage members to read jso1123’s recent pitch on MLM for background on the aggregates/cement industry and where we are in the various cycles.  SUM was founded in 2008 by industry veteran Tom Hill, and in the decade since its founding has completed more than 60 acquisitions.  We are constructive on SUM for several reasons including:  a) achievable 2018 guidance (following a relatively disappointing 2017), b) favorable medium term cyclical tailwinds from public construction and residential construction markets, c) further value-enhancing M&A deals, and d)  potential for additional M&A related tax benefits thanks to the revised US tax code.  On the whole, we believe SUM will earn ~$2.50/eps in 2020 – applying a 16x multiple on that estimate provides a ~$40/share target, almost 40% above the stocks last sale

Valuation

Base Case: $40/share (+39%) – SUM trades at 16x ’20 eps on my base case estimate (~$2.50).  Since its trading inception, SUM has traded at a median 2-year forward P/E multiple of 16.3x.

Down Case: $20/sh (-28%) – SUM trades at ~13x ’20 eps on my down case estimate (~$1.50)

Bull Case: $52/share (+85%) – SUM trades at 16x ’20 eps my up case estimate (~$3.25)

Thesis

Our long case on SUM is supported by:

• SUM is run by a very capable management team with decades of operating experience in the US building materials space.  In particular, Tom Hill, founder and CEO of SUM, spent decades at CRH, with his last position at the company being CEO of OldCastle (CRH's North American building materials unit).
• SUM, like other building materials plays, experienced a tough 2017, due mainly to challenging weather conditions and project delays.  Assuming a more normal operating environment in 2018, we believe SUM has laid out achievable/beatable guidance, which bakes in <5% organic EBITDA growth.
• We believe there is a long runway for growth in public construction spending.  Jso1123's MLM write up did a good job talking about the bullish cyclical view and I'd encourage readers to look at that report.  In short, given a pick up in public construction spending at the state level, plus some catch up from projects delayed over the last 18 months, we believe public construction levels can grow at a mid-single digit rate for the next several years, at least.
• We are attracted to SUM's M&A roll-up strategy:
• SUM has a proven M&A strategy, and given the fragmented nature of most of their markets, there remains many small and midsized targets to roll-up.  Since its founding, SUM has completed more than 60 transactions.  On average, SUM has acquired businesses for 7x-8x EV/EBITDA - with SUM's median EV/EBITDA multiple since its IPO at 10.2x, the strategy has proven attractive.
• Additionally, SUM's M&A strategy is advantaged in this climate.  Per Goldman Sachs: "The company’s M&A strategy provides additional benefits under the new tax law. Under the revised US tax code, SUM will be able to immediately expense up to 30% of an acquisition purchase price - that’s the typical value of depreciable plant and equipment. If SUM completes $400 mn of acquisitions per year as it has over the past four years, accelerated depreciation on those acquisitions would offset about $120 mn (68%) of current run-rate pre-tax income of $176 mn. Future acquisitions will preserve SUM’s tax shield ($375 mn) and as a result defer the company’s tax receivables agreement payment beyond 2026.

Risks

Some of the key risks to SUM are:

• General deterioration in US construction levels.  Namely, there is risk that the nonres construction cycle deteriorates beyond expectations
• Capital allocation - given SUM's focus on M&A there is some risk that they do a deal that is not taken well by the market.
• Multiple compression, especially as SUM's product mix is widely considered inferior to comps like VMC/MLM who have a much higher exposure to aggregates.
• Weaker than expected pricing for cement and other downstream products.
• Leverage - at ~3.4x net debt/ EBITDA, SUM is more levered than most peers, and would suffer in a selloff.
• Higher than expected costs for raw materials, labor, equipment, etc,

Catalysts

Over the next 24 months I believe the catalysts for SUM will be:

• M&A - SUM has indicated a normal/robust pipeline of M&A opportunities, and we expect deals to be the primary use of free cash flow in the foreseeable future.
• Meeting/beating 2018 guidance - assuming normal weather patterns and no major project delays we believe 2018 will fare better than 2017 for SUM.

Catalyst

- M&A: SUM has indicated a normal/robust pipeline of M&A opportunities, and we expect deals to be the primary use of free cash flow in the foreseeable future.

- Meeting/beating 2018 guidance - assuming normal weather patterns and no major project delays we believe 2018 will fare better than 2017 for SUM.