|  | | | | Vulcan Materials (VMC): Smart as rocks |
| Some folks out there may take the view that rocks are boring. The average age of a rock is, at least according to the Internet, 1.3 billion years old. Generally speaking, rocks just sort of sit there and do nothing, for a very long period of time.
But you know what’s not boring? A company that sells rocks that has significantly outperformed the S&P 500 over the past 10 years. (Unless you feel making money is boring—if that is the case, we can’t help you!) |
|  | Vulcan Materials Company (VMC) is America’s largest producer of “construction aggregates.” Aggregates are crushed stone, sand and gravel. They are primarily used to make concrete and asphalt, two of the most important materials in all construction activity.
To form concrete, you essentially just mix aggregates (crushed rocks) with water and cement. Cement is often confused with concrete itself but in reality is just the paste that holds the rocks together. Only about 10% to 15% of concrete is cement, by volume.
Asphalt, used for road paving and other surfaces, is similar. You mix aggregates with liquid asphalt (also called bitumen), which is made from refining crude oil.
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| The S&P 500 has delivered exceptional returns over the past ten years—approximately 13% annualized. These returns were to a large extent driven by the big social media platforms and other innovative technology companies.
VMC has compounded at 16% over the past 10 years. This is meaningful outperformance for any company, let alone a supplier of crushed rocks. Perhaps even more impressive, VMC has performed essentially as well as the Nasdaq 100 (QQQ) over the past 25 years. |
|  | To be fair, the starting point of the chart above is right before the tech crash. But the 25-year time frame also includes the housing bubble, which was the best of times, then the worst of times, for VMC. We had a front row seat for this as one of Vulcan’s largest institutional shareholders when it almost lost control of the company to an industry rival (of which we were also a top shareholder).
More on that later. But it’s worth reflecting on the fact that a basic materials company, whose business model has barely changed over a quarter-century, performed essentially as well as QQQ going all the way back to a point in time when people were still using pagers. |
| As you might surmise at this point, Vulcan is what investors like to call “a good business.” There are some very specific factors that make it a good business. These have not always been understood and appreciated. In fact, some very smart investors have gotten it totally wrong.
What makes Vulcan such a good business is an important discussion on two levels.
First, we want to gain an understanding of this specific business, why it has been a good investment, and why it may continue to be a good investment.
Second, it’s really a case study on value creation. As we figure out Vulcan’s success, there are tremendous lessons to be learned that relate to almost any potential stock market investment.
What is Vulcan Materials? |
| Headquartered in Birmingham, Alabama, the evolution of Vulcan Materials, like so many great American companies, is a lesson in American history.
Dubbed the “Magic City” because its population suddenly surged to 4,000 within two years of its founding in 1871, Birmingham prospered because of the geological uniqueness of the Jones Valley. The Jones Valley in Alabama is one of the only places in the world with an abundance of three naturally occurring raw materials that are needed to produce iron: coal, iron ore and limestone.
The city was founded by the Elyton Land Company, a group of investors that included cotton planters, bankers and railroad entrepreneurs. They named the city Birmingham hoping to achieve the same greatness as an industrial city as Birmingham, England. They created the city to take advantage of its natural resources and built railroad tracks in close proximity to the mines.
Metal, stone and coal are heavy. When it comes to heavy raw materials likes these, transportation is everything. This is why Birmingham, Alabama took off, decades before any of Vulcan’s predecessor companies were formed. The city was planned around the transportation problem.
The challenge of transporting heavy raw materials would ultimately become the most important element of Vulcan’s success as well. |
| |  | Birmingham iron mine circa 1906 |
| Vulcan traces its origins to the Birmingham Slag Company, which was founded by businessmen Solon Jacobs and Henry Badham in 1909. By this time, Birmingham had developed into a major steelmaking center.
With mass production of automobiles ramping up, Jacobs and Badham had an insight—all those cars needed roads. They would take slag, a waste product from steel production, and repurpose it as a construction aggregate.
By 1916, the founders, profitable from the start, were ready to sell their interests. The Ireland family entered the picture and took majority control of the business.
Charles Ireland would run Birmingham Slag through World War II. In addition to his sons, he was assisted by C.A. Barinowski, aka “the Baron,” aka “Mr. Slag,” who joined the company in 1917. Through an aggressive marketing program, Barinowski brought the company to the point where it was selling millions of tons of slag and crushed stone. |
| | The Baron may be a so-and-so, but thank God he’s our so-and-so! - Charles Ireland |
| | Other important executives in the growth of Birmingham Slag included G.C. McCullough, whom Charles Ireland met on a 1916 trip to the Panama Canal Zone in search of used construction equipment. He brought back McCullough, who would work at Birmingham Slag and accumulate substantial stock ownership until his retirement in 1945. |
| World War I presented challenges to Birmingham Slag and deprived the company of manpower and materials. The company faced additional pressure during the Great Depression. Things picked up in the late 1930s, however, as the company began to sell supplies to the Tennessee Valley Authority for the construction of dams and power generation plants (the original electrification wave).
World War II was another catalyst for demand as the industrialization of the United States accelerated. Among other contributions to the war effort, Birmingham Slag supplied construction materials that were used to build the Oak Ridge, Tennessee facility of the Manhattan Project.
After the war, Charles Ireland handed management of the company over to his sons, Glenn and Gene, and, later, his grandson Charles.
Vulcan is born |
| Just as mass production of the automobile gave rise to Birmingham Slag, it was the creation of the Interstate Highway System that took the business to the next level. In 1956, President Eisenhower signed the Federal Aid Highway Act that would supercharge highway and road construction all over the country. |
| | The nation badly needs new highways. The good of our people, of our economy, and of our defense, requires that construction of these highways be undertaken at once. - President Dwight Eisenhower, letter to Congress, 1955 |
|  | | Birmingham Slag changed its name to Vulcan Materials Company in September 1956. There is a large and well-known statue of the Roman god Vulcan that overlooks the city of Birmingham. Many people assumed this was the inspiration for the new name. They were wrong.
A few months later, on December 31, 1956, the renamed Vulcan Materials Company merged with Vulcan Detinning Company of Sewaren, New Jersey, which was already listed on the New York Stock Exchange. Vulcan Detinning was a cash-rich scrap metal business that lacked growth prospects.
Birmingham Slag adopted the name of this New Jersey-based company for purely pragmatic reasons. The new Vulcan Materials wanted access to the capital markets so it could ride the wave of Eisenhower’s highway buildout. Vulcan Detinning was a convenient way to go public.
On January 2, 1957, Vulcan Materials Company began trading under the ticker symbol VMC. In the decades that followed, VMC would see tremendous growth, driven in no small part by continuous acquisition activity, from other public companies to small “bolt-on” mom and pop quarry operations.
VMC would evolve into one of the most important building materials companies in the United States. The Ireland family became extraordinarily wealthy.
Charles Ireland, grandson of the original Charles Ireland, served as Chairman of the Board from 1959 to 1983. A portrait of him, painted by his friend Andy Warhol, hangs in the Birmingham Museum of Art. |
|  | Fast forward to February 19, 2007. VMC shares closed near $112, close to the all-time high. Over the preceding 10 years, VMC delivered more than a 400% total shareholder return.
Shareholders were undoubtedly happy. Management was brimming with confidence. Perhaps too much.
A catastrophic decision
With then CEO Don James at the helm, VMC announced that it intended to acquire Florida Rock in a cash/stock deal (predominantly cash) for $4.6 billion, a 45% premium.
At the time the deal was announced, the United States was already entering the late stages of a sub-prime mortgage fueled frenzy of homebuilding. There were already signs of trouble. Yet management was undeterred. |
| | [W]e are not afraid of the residential market. We recognize there is a correction going on. This is an opportune time for Vulcan to make a transaction. - Vulcan CEO Don James, The Wall Street Journal, 2/19/2007 |
| | Markets would stay complacent over the bursting housing bubble for a few more months, but by July, VMC shares would begin a four year descent. By late 2011, the share price would be in the $30s.
The Florida Rock transaction was flawed on multiple levels and destroyed shareholder value in a profound way. The deal was not only valued at a rich multiple for the sector (more than 11x EBITDA), but Florida Rock had been completely over-earning as a play on Florida residential real estate during the housing bubble.
Much of Florida Rock’s profitability was associated with downstream ready-mix concrete sales. This was low quality profitability, in contrast with VMC’s own business, which was much more geared to construction aggregates. Florida Rock was generating unsustainably high margins. In the years following the acquisition, these margins would collapse.
In short, VMC paid a very high price for an asset that was about to implode. The company took on a lot of debt just as its own business was about to see a significant decline in volumes and profitability. The housing bubble unwound in brutal fashion and demand for construction materials fell precipitously in the years that followed.
A hostile bid surfaces
As the dust settled on the housing collapse, shareholders were furious. These included members of the Ireland family. The company had effectively borrowed billions only to give them away in exchange for very little, while issuing a fair amount of stock as well.
In December 2011, Martin Marietta (MLM)—Vulcan’s closest peer company in construction aggregates—made an unsolicited bid for VMC. The deal never came to fruition, as the board (correctly) concluded MLM was bottom-feeding with the share price at extremely low levels.
Despite MLM’s best efforts, shareholder pressure was insufficient to get it done. There was also legitimate concern that antitrust authorities wouldn’t approve the deal anyway, or if they did, they would require such drastic divestitures that it would defeat the purpose. The antitrust risk gave the VMC board sufficient cover to reject the premium bid.
In retrospect, MLM was quite justified in its interest in VMC at the end of 2011. VMC shares would never again see such depressed levels.
Lessons from the Housing Bubble
Notwithstanding the fact that VMC nearly lost control of the business in the aftermath of the housing crisis, the entire experience—in an ironic way—demonstrated the strength of Vulcan’s assets and the resilience of the business model.
Prior management at VMC delivered a self-inflicted wound just before a cyclical downturn of epic proportions. While many companies connected with homebuilding went under, without necessarily having done any big stupid deals on the eve of the financial crisis, VMC survived and ultimately bounced back.
Pricing power
The key to understanding Vulcan, and really the construction aggregates market as a whole, is pricing power. In almost all commodity markets, when demand falls, unit pricing falls. This simply does not happen with aggregates.
The ultimate stress test was the housing bubble collapse. We recall, during the very worst of it, aggregates companies were reporting temporary 5% to 10% price cuts to certain long-term customers to help keep them in business. That was it.
We borrowed a chart from a VMC presentation from several years ago that illustrates this point. Even though aggregates volumes peaked in 2006, unit pricing continued to go up thereafter. Prices went up even as industry volumes collapsed some 40% peak to trough. |
|  | Source: Vulcan Materials Company |
| Skeptics have long argued that these pricing dynamics are unsustainable. Short-sellers like David Einhorn have even bet against aggregates stocks—in part because they lacked faith in their ability to hold the line on price. While aggregates stocks like all stocks are susceptible to volatility, betting against them has proven to be an exceptionally unprofitable trade.
It has been some 15 years since the housing bubble. We are now in a position, which is quite favorable for a stock like VMC, where the country is facing a housing shortage (along with an infrastructure deficit). We have also accumulated significantly more data with regard to the pricing question.
Aggregates pricing held up during the greatest demand collapse in the history of the industry, so it is perhaps unsurprising that pricing continued to advance as demand normalized. It should also come as no surprise that Vulcan has been able to deliver substantial unit price increases in recent years, as inflation swept the entire economy. |
| |  | Source: Vulcan Materials Company |
| Over the course of just two years, 2022 and 2023, VMC has been able to lift unit pricing nearly 30%. It’s important for investors to realize, there is not a more profitable way of generating revenue than raising prices. Price increases have 100% profit margins. |
| | The single-most important decision in evaluating a business is pricing power. If you've got the power to raise prices without losing business to a competitor, you've got a very good business. - Warren Buffett |
| | VMC’s earnings are susceptible to swings in volumes, but there is a tailwind on unit pricing that translates into a profound driver of long-term earnings growth. Over the past 5 years, VMC has increased its profits per ton of stone sold by approximately 50%. This is price driven. |
| |  | It’s only natural to express some skepticism at this juncture and ask the question, how do they get away with it? Surely, this is unsustainable and perhaps even an antitrust problem.
How do they do it?
First, it should be recognized, this is an industry that is heavily scrutinized by the antitrust agencies. VMC and peer companies have largely built their businesses through acquisition—often one quarry at a time. The industry is in fact highly fragmented. Vulcan is the national leader but only has about a 10% market share.
From an antitrust perspective, the key thing to understand is that the relevant market is defined very locally. Any given quarry can realistically only serve customers within an approximate 50 mile radius (unless there is absolutely no alternative). The industry is hyper-local.
Why such a small radius? We alluded earlier to the importance of transportation costs. Aggregates are usually delivered by truck. While aggregates unit pricing has grown steadily, and well above inflation rates, it is important to pause and reflect just how little is actually being charged for the stone.
As noted above, Vulcan’s reported average price per ton for crushed stone is now $19.
How many other items can you think of that cost $19 per ton? For perspective, at current prices of approximately $2,200 per troy ounce, a ton of gold is worth $64 million. A unit of gold is more than 3 million times more expensive than a unit of crushed stone.
Even copper is currently about $8,500 per ton. That is about 450 times more expensive than crushed stone.
Trucking arithmetic
A large dump truck can typically handle about 15 tons of stone. At $19 per ton, one shipment is only about $300. A dump truck can typically get around 5 miles per gallon of diesel. A gallon of diesel costs about $4. So fuel costs alone are about $200 for a truck to travel 50 miles.
The economic moat that protects aggregates producers is simply the prohibitive cost of shipping the product from a competitor that is more than a certain distance away from the job site. It’s not just fuel costs, but total cost of delivery.
In addition to acute truck driver shortages, trucks are becoming more expensive. Certainly, ESG-related regulations, restrictions and taxes on diesel trucks will only further drive up the cost of moving a ton of stone. (The same goes for any imagined long-term transition to electric trucks.) |
| | Marginal costs ballooned 21.3% last year over 2021 to $2.251 per mile, surpassing the $2 per mile mark for the first time in the history of ATRI’s operational cost report. Trucking's cost per mile has jumped 34% since 2021, and 2022's mark is 61 cents higher per mile than 2020. Costs per hour in 2022 totaled $90.78, also the highest in the report's history. - Commercial Carrier Journal |
| | Antitrust lawyers and economists understand that the only thing that matters is if an aggregates company is trying to acquire assets that overlap within their economic radius. These companies have been built through acquisition—carefully avoiding overlaps that would lead to antitrust interventions while obtaining the cost benefit of regional scale.
In addition to transportation costs, there are a number of other important factors underpinning the long-term pricing story: Not In My Backyard (NIMBY). While stone is generally abundant (more so in certain geographies than others), no one wants a new quarry in their town. The number of stone, sand and gravel quarries across the U.S. has been level for decades. Quarries can last for many decades but are eventually depleted. Quarry owners are disciplined. They realize reserves are finite and prices trend up. When demand subsides due to cyclical pressures, they are not keen to give away their reserves at lower prices. Pricing sophistication. The industry in recent years has become increasingly sophisticated about using data to understand customer alternatives and bid contracts accordingly. Stone is a small portion of total costs. Customers expect aggregates price hikes and absorb them. Aggregates are typically a single digit percentage of total construction costs. Customers are often contractors who pass through the higher costs.
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| Why VMC?
We like the aggregates industry generally and acknowledge there are a few different ways to get exposure. As mentioned, MLM is a similar peer. European companies CRH (CRH) and Heidelberg Materials (HDELY) are other interesting options, although not pure-play US aggregates companies.
VMC is especially interesting to us, particularly from a long-term perspective, because of its geographical footprint. VMC is strong across the sunbelt states, which have the most attractive outlook for population growth. |
|  | | More population growth means more homes, more jobs, more infrastructure—and ultimately more concrete and asphalt. As sunbelt states densify, the supply-demand imbalance only becomes more favorable for aggregates producers in those markets. |
|  | | As noted we have a high degree of confidence in the pricing story. Our conviction around price is the main reason VMC is held in both our American Resilience and Inflation Protection Model Portfolios. We do not anticipate any material changes to the industry structure which would challenge our confidence in pricing, but as with all of our investments, we are constantly looking for disconfirming evidence.
On the risk side, there are two areas investors should in VMC should focus on most.
Cyclicality
As a supplier to the construction industry, Vulcan is susceptible to a downturn in demand. Even if pricing is firm, lower volumes means lower profits.
However, approximately 50% of its business is tied to long-term infrastructure spending (whether state, federal or local), where the outlook at the moment is quite good. Additionally, VMC has historically been protected in recessions by a pick-up in infrastructure-related spending.
Despite higher interest rates, residential construction demand is supported by the national housing shortage and net migration to southern states. Commercial construction is tied to the overall state of the economy but seeing some benefit from investments in the electric grid, data centers and other pockets of demand.
On balance, in 2024, as the effects of higher interest rates course through the economy, VMC anticipates flat to slightly lower volumes, with non-residential private construction as the main source of weakness. This volume softness is expected to be more than offset by unit pricing growth of 10% to 12% for the full year.
Capital allocation
The good thing about bad mistakes is that they are usually remembered. The Florida Rock debacle of 2007 was a defining event for VMC. Depending on one’s assumptions, it’s conceivable the share price would be twice as high today if that deal never happened. It was totally unnecessary and an unforced error.
We are confident that VMC has learned from this mistake. Since CEO Tom Hill took over from Don James, he has been emphatic about being prudent when it comes to M&A and expansion. While VMC will continue to invest in growth opportunities, we expect these to be rational allocations that reinforce existing market positions and do not dilute the focus on construction aggregates. Tom Hill’s 10-year track record supports this interpretation.
Conclusion
Operating in states with the brightest long-term economic outlook, Vulcan Materials has an asset base that is literally foundational to the American economy. Concrete and asphalt remain essential components to the construction industry where, thanks to building codes and demanding safety specifications, change is measured in decades not years.
Vulcan is in fact more likely to benefit from technological change than to be disrupted by it. Decarbonization, electrification and AI are driving construction demand. ESG is making it even harder and more expensive to open new mines, which just makes Vulcan’s existing network of quarries more valuable. Electric vehicles weigh more, do more damage to the roads, and will only create more demand for road paving.
We have encountered few businesses, if any, that operate with such favorable economics around pricing and are able to benefit to such an extent from economy-wide inflationary pressures. The more expensive it becomes to ship stone, the more room VMC has to expect higher prices.
With America’s housing overbuild now a distant memory and the country facing a genuine infrastructure deficit, the long-term demand outlook appears quite favorable. Volumes should rise over time, price will take care of itself, and long-term investors in VMC should continue to reap the benefit of potentially high teens earnings growth.
(Editor’s note: Most of the historical content provided above was obtained from A History Written in Stone, a privately published book that was given to attendees at a Vulcan analyst event several years ago.) |
| | Well, as I’ve said, I think we’re in a very, very good place from a pricing perspective based on the fundamentals that we’re seeing. -Tom Hill, Chairman and CEO, Vulcan Materials
And then double-digit pricing, is that like the new norm going forward? - Analyst
I feel good about pricing. - Tom Hill
Vulcan Materials Q4 2023 Earnings Call, 2/16/2024 |
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