Vulcan Materials: Rock On - [Business Breakdowns, EP.151]  

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0:45This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. This is Matt Russell, and today we are breaking down Vulcan materials. Vulcan is America's largest producer of construction aggregates. Now that's all of the crushed rock, the sand, the gravel, which gets used for the foundation of pretty much everything around us. All of the buildings, the roads, the infrastructure that defines the physical footprint of America. To break down Vulcan, I was joined by Rob Hansen, Senior Analyst at Bontobel Asset Management. And Rob shared what makes this relatively simple business so successful.

1:25Let's begin into the dynamics of operating quarries, the logistics of moving rocks, and what's cyclical versus what is not. So please enjoy this breakdown of Vulcan Materials, one of my recent favorite episodes to record and to learn about. All right, Rob, I am excited to have you here to break down Vulcan Materials. It is a large business at the time of this recording, close to a $30 billion market cap. I don't think it's a household name, and I don't think it's necessarily a household product, an industry that's involved in. So I thought maybe we could start there with the simple introduction to Vulcan and the construction aggregates market.

2:10If you could just introduce us to what exactly is going on there, that'd be a great place to start. Yeah, Vulcan Materials, it's a pretty basic business. They make aggregates. And really what that is, is they take big rocks and crush them into small rocks. And then you use those rocks for different things. It's almost like the foundation of the United States in a way, because you need this underneath a highway. You have 21 inches of this. You use it in asphalt. You use it in concrete. It's a very, very important material. and it's really used everywhere and you walk on it every day, but you don't think about it at all.

2:48So it's a very important piece of the United States. I like the way that you simplify that, just taking rocks, crushing them down. In terms of Vulcan, are they actually owning quarries and then taking those rocks, breaking them down? Is there some type of contracted involvement there? Just a little bit about the industry structure and where they fit into it as well. Yeah, so Vulcan is the largest aggregates producer in the United States. They own quarries. They've got about 400 locations, and their quarries are located within 60 % of the United States population. So the way it works is that the TAM for this industry for aggregates is about, call it around $35 billion.

3:37It's used primarily in asphalt and concrete. Asphalt, 90 % of it by weight is aggregates. And concrete by weight, 80 % of it is aggregates. I mentioned the stat about the 21 inches too. If you think about a four -lane highway, if you're building a mile of four -lane highway there, you need about 38 ,000 tons of aggregates for that. And if you're building a home, you need about 400 tons. This stuff, it's not that expensive. It costs, depending on the market, maybe $10 a ton, maybe $25 if it's a very high cost market. In terms of the end markets, the companies try to look at it as just public and private.

4:21Public includes, the way we look at it is really infrastructure. And so that's all your road building and whatnot. But there's also some institutional because it depends on the funding. So the institutional side would be like a school, things like that, anything where it's publicly funded. Now, on the private side, that's the other, call it half of the industry, that comes from residential and then non -residential. And that's about around 25 % each. And non -residential is just think about data centers, warehouses, office buildings, retail, although those have become a much smaller piece of that in recent years just because we're not building many of those things.

4:57But the warehouses and data centers are huge in markets. And is there split between that, what I would just reference as government funded versus private market funded? Is that split evenly? Is there a big mismatch between the two? And just general trending over time? Has one been significantly better business than the other? So from the company's perspective, it almost doesn't matter who's paying for it because they all pay the same price. The government funded stuff is a lot more steady because you're constantly fixing roads, you're constantly building roads. An interesting piece of that is that 75 % of the spend on the government side actually comes from state and local government.

5:37Now, the other piece of it is on the non -res side, the privately funded side, all of that is coming from businesses and just general construction. So it does tend to be a little bit of a byproduct of economic activity. But you can have a situation like now where there's a lot of public money coming from the federal government that can help. So on the public side, it tends to be very steady eddy and grows and not as much security that the private side does have a little more security. Let's get into the history of this business just a little bit. You were telling me a fun story when we were talking before about their IPO and what that was tied to.

6:17So just some background on Vulcan, how it came to be a market leader. And from my research, it seems like only one of the major pure players and operators in this space. But what's the beginning and any key milestones that you would talk about in terms of what led to them being in that leadership role today? Yeah, so Vulcan is a very, very old business. 1909, this was started as Birmingham slag company. There were a few different iterations of itself, but business continued to operate and eventually seven families formed together to create this business. But the most important date was in June of 1956, President Eisenhower put funding for the federal highway, interstate highway system.

7:01So these families came together, merged themselves, and then went public on January 2nd of 1957 in order to take advantage of this government money that was going to be funding this interstate highway program. Fast forward to 1970, they had about 70 aggregate operations in eight states. And then you have today 400 aggregate operations in 22 states. They have about 16 billion tons of aggregate reserves, which is about a 60 -year supply. But what's interesting about these quarries is I was looking through one of their 10Ks at one point, and there's a Norcross quarry, for example, in Georgia. And this quarry has actually been in operation since 1970.

7:46So these quarries have 50 to 70 year lives, but this one has been in operation since 1970. And then if you look at today, what they have left, it's a 49 year supply based on today's volume. So these things really can last for a long, long, long, long time. Yeah. And I think I'm familiar with quarries thinking about some of the finished material you might see in a kitchen, like a granite or a quartz marble. And I'm not as familiar with the quarry market in the US. They started in Alabama. Am I right to think that there were a lot of quarry locations there? Is there anything geographically unique?

8:27Oil, you think of Texas and certain other areas. When you think of quarries, are there certain geographical spots that these are most dominated in? They're pretty much everywhere. The bigger governor is really the cities and towns because no one likes these things. But there is an important fault line. I think it's called the Brevard fault line that runs from DC down the mid Atlantic through Texas where you can't get as much rock. And then you have Florida where there really isn't any rock at all. So all of that has to be shipped in by boat. But everywhere else in the US, there are plenty of them.

9:03I think in the US in total, there's around 10 ,000 quarries. Another interesting set was back in 1976, the number of quarries in the United States peaked at 12 ,600 or something like that. So we don't tend to make a lot more of them. So that's why I mentioned the bigger governor is just cities and towns really not liking these big giant pits because Vulcan and there's a couple of other competitors like Martin Materials and Summit Materials and CRH. These companies are really mining companies. People don't really think about them that way, but they're above ground mining. They just dig a giant hole in the earth and then you have your quarry and you just keep mining it and mining it and mining it for as long as you can.

9:43It's an interesting, not in my backyard, NIMBY, barrier to entry, it seems like in terms of having the quarries today and restricting new folks from coming into the market. Is there a difference in quality between the different locations? You mentioned a little bit before in terms of the cost and the price you might pay and what that looks like. Is that coming down to the specific quality of what's actually being mined? Is there much difference there? There are some differences. And that's why it's crushed stone, sand, and gravel. So there are different types of rock that are used for different things.

10:18And some of them are more specific. There's the certain sands that are used in oil and gas. But for the most part, a lot of it can be very similar. It just depends on where you are. It's not a ton of differentiation, which is why when I look at this business, you're like, this is a commodity product in a pretty fragmented industry. And that's capital intensive. How could it be any good? But it's actually kind of the opposite. You can have a great business based on some of these characteristics that you'd otherwise think wouldn't be the case. Yeah. No, it's quite interesting. I think you referenced one of the reasons why it could be a good business with the regulatory barriers to entry.

10:53The other I wanted to ask about is just the actual mining operations. That's typically capital intensive. There's usually a lot of different costs that go into it up front, but then logistically. how does the business think about the cost profile of what they're doing? And what are they actually required to do in terms of, okay, they're mining that, are they required for the transportation as well? How much of that is integrated into the business versus outsourced? And anything that you could talk about just in terms of the cost profile of what they're doing and operational excellence, if that is a thing in this space.

11:29Opening a new quarry is very time intensive and it's very capital intensive. You need to have maybe $50 million if you want one that's close in and it's going to take you 10 to 20 years to get this permitted through the environmental piece. It's very, very complex and one of the major barriers to entry. It's a scarce resource too. I know I call it the commodity, but it is scarce. It's got to be close to a population center because this is 10 to call it 20 bucks a ton. So it doesn't travel very far. Every 40 miles you travel by truck, the cost doubles because it's about 25 cents per ton mile. So you've got to have the logistics and the trucking there.

12:14And then you have to have relationships with some of these downstream contractors too, because you need to have people to use your product. So it's a very hard industry to get into. And greenfielding, Vulcan, they do greenfields every maybe one maybe two a year, but some of those are just really distribution sites where they mine it, and then they put some rail tracks down. What's interesting, though, is the logistics piece is just so important. And part of that is because if you're going to transport this stuff, I mentioned by truck, it's 25 cents per ton mile. If you do it by barge, if you can have a quarry located close to an ocean, it's only one cent per ton mile.

12:54Whereas then rail, I believe, is about eight to 10 cents per ton mile. So transportation of this material is hugely important. I think it's an overlooked piece of the business that is just hugely important. In terms of who pays for that transportation, generally the way they price it, they price it on a per ton basis and the transportation is included in the price. But quite often the customer's paying for that and quite often they'll pick it up as well. But in general, the stats around it are that 80 % is shipped by truck. And then the other 25 % is shipped via barge or rail first, and then use a truck.

13:34You always have to use that truck and it's highly expensive, which is why in certain markets, you want to have multiple quarries. And that's why you have this platform approach. There's a lot of different ways Vulcan adds value in terms of the operational piece to really get the price down as much as they can for their customer. It really is interesting to hear about how important it is from a logistical standpoint. When the price is so impacted by the transportation cost, I can think about coal in the US. That was such a massive driver. I think it was 35 % of the overall cost of coal at one point.

14:11And rails refused to move on pricing. And that killed a lot of the coal mines. Here, it just would seem like the geographical focus is really important. And has that essentially led to local geographic monopolies where certain players are just dominant in the areas that they have the quarries? These local oligopolies are hugely important. And you want to be number one or number two in a market. So I mentioned they have 10 % share overall. And the number two player, Martin Materials, probably has a 9%, 10 % share as well. But really, that doesn't matter for the whole entire United States because it's really what you can do in that local market.

14:46So I was reading a Harvard Business School case because they looked at the IPO of Summit Materials. And one of the factoids in there was pretty interesting. Markets where you have one to four players, the margins tend to be 25 to 40 percent for aggregates. Markets where you have five or greater players, the margins are 10 to 25 percent. So these local oligopolies are really hugely important. And that's a big contributor to the value of the business. And in Vulcan's case, in 90 plus percentage of the markets, they're in their number one or number two. It's a natural point to ask, what is their margin profile today?

15:25Where do they come out on that scale? The gross margins in the aggregates business are around 38 to 40 percent. They've also got concrete and asphalt. And those businesses are more like 10 to 15 percent gross margin businesses. but part of that just happens to be, and we can talk more about vertical integration later in the conversation, but it really depends on where the market is and certain factors. And from a sales perspective, what percentage of the business is the aggregates and what percentage is that asphalt and concrete and other? Aggregates are 60 % of sales, but 90 % of gross profits.

16:04So it's really an aggregates dominated business and you're gonna lead with your aggregates and fill in on asphalt and concrete in the markets where you need to be. And one important question too is where are you gonna be vertically integrated? First of all, you wanna ask yourself, am I aggregate led? Okay, yes. And the second piece is for asphalt, are my contractor customers, do they do asphalt? And if the answer is yes, then you don't wanna be in the asphalt business because you don't wanna compete with your customers. So there are gonna be markets where it's value accretive to be in aggregates And it's return on capital accretive because those businesses are very capital light, lower barriers to entry.

16:44But if you can supply your own self with your aggregates, they can work very well. In a similar vein on the concrete side, what's more important there is are the cement guys, do they have their own ready mix? Ready mix is just those big concrete trucks that you see on the roads. They're constantly just mixing these things up. It's an easier business to get into, but it's hard to run because you can only have these trucks going for a certain amount of time before the concrete just fills up the truck and you're ruined and it's done. You really don't want to be in the ready mix business when you're competing against cement player because they control the cement and they can whip you around on price and you're just the lonely aggregates guy.

17:24But there are certain markets where they do that. They have some good markets in Northern California where they can compete quite well there. Yeah. Really interesting when it comes to thinking about that in terms of the vertical integration, where it makes sense, especially when you have that big of a disparity in the margin profile. If we just focus on the top line a little bit, and we can dissect it both on the volume side and on the price side, start with volume. You referenced before, the government side of things is a bit more steady. The private side of things, you can see a bit more cyclicality.

17:56how has that trended over time? Is it generally in line with GDP? Is it outpacing GDP? Is there anything from a volume perspective that is unique? When I would think of this, I would just think of very tied to construction. But is that oversimplifying? Is there anything else you had mentioned there? No, I mean, that makes sense. There's actually data in this industry from the USGS, the US Geological Survey that goes back to 1900. The long term volume trend is about 3 % going all the way back. And then if you look at the last 10 years, it's a little more like 2%. And then they actually have price data as well.

18:35And the long term for that is around 2 % to 3%. But if you look in the last 10 years, it's actually accelerated more to around 4%. So the industry in general, you should think about growing up 5%, 6 % just in general for the entire United States. Now, if you're in a good market where there's population growth, growth, employment growth, household formation, then you should be getting a higher growth profile than that. Because if you're building a new residential community, then you're going to have to build in some strip malls. I don't think you're building regular malls anymore, but maybe you need an Amazon warehouse.

19:09So it tends to follow. And they're very generally long cycles. It is cyclical. During the last, the GFC volumes were down 55 % for these guys. But I think that's not really a normal downturn. If you look back in the early 90s was the last time volumes for this industry really came down and it took about two to three years and it was maybe 15 to 20%. Again, that was the ROTC crisis. So it was another crisis. But what's more normal in terms of that is what's happening today where you have non -residential declining, residentials improving, and then you have the government piece slowly, steadily rising.

19:48So for example, this year, I think the aggregates players have been talking about flat to down volumes for the industry. And I'm sure 2024 is going to be something similar because it's very similar dynamics. When you think about something like the 15 -16 timeframe, industrial recession, but it didn't really feel like a massive recession in the economy, did that put pressure on the business? Just thinking about that more recent example. During 15, 16, they actually did okay. Volumes continued to rise slowly. They get price every single year without fail. And what's great about too, about this industry is when they're raising prices, 40 % of the business is project -based business.

20:31So they know what's going to happen with price for at least 40 % of the market next year. So that's why we're looking at another year of high single digit, low double digit prices this year. But at that part of the business, it's nice. There's some visibility into it. in terms of the big project business. The pricing charts are absolutely incredible. So in going back over time, what is the driver there? I think you laid it out just in terms of an industry that has fewer players and you have your geographical locations, but is there anything else that's allowing them truly to capture those price increases and seemingly pass on inflation while they're doing it from year to year?

21:09If you think about it, it's a very fragmented customer base. And then the other thing is that supply is lasting. You can turn off the aggregate facility in 15 minutes if you need to. So it's not a factory where you just have to keep pumping out things. That's one key difference between cement and this business. Cement, you've got to keep that kiln fired up. You've got to keep it operating. And whether it's a recession or not, you're just going to keep pumping out cement. And if need be, you're going to ship it by barge to wherever you can to unload it anywhere in the world. And it's a much higher because it's a much higher price.

21:46I mean, that goes for 100 bucks a ton at least. So it's really just the fragmented customer base, the fact that you can turn on and off the factory, so to speak. And then, like I mentioned, too, another factor is just the being number one or number two in a market where there's maybe three to four players. It's just a little more rational in general. And is there anything else that they can offer to a customer that maybe a smaller player wouldn't be able to offer? Is there anything just being a large player, having this business that spans wide geographical? Is there anything they can offer just at a local level that differentiates them?

22:22Yes, for sure. These guys have done a really good job at incorporating technology into their business. I mean, this business is super old. The way it was done before is you have your paper ticket, you get the weight, you tell them what you want, where to deliver it, whatever. And it's very slow. And then you end up delivering it maybe at the wrong address and it costs you money. These truckers get upset. These guys have been able to incorporate this technology right down to the customer level and into their plant. And one interesting example of their ability to monitor their inventory position at their customers is they actually have technology where they go and they dump the rock at the customer's site, and the customer will take it and do what they want with it when they need it.

23:07But they can monitor that, for example, and see when they need to deliver more. So it's kind of like when you have your printer, and it automatically orders more ink when your ink gets low. That's exactly what this is, except a giant truck of rock shows up at your facility when you need it, so they can keep replenishing their rock for their customers. But even beyond that, simple things like giving an accurate coordinate of where you're going to deliver the rock. Because if you think about it, sometimes there is no road there yet. You're building the road. So there was no ability to say, go on core and main and it's right there.

23:43It just didn't exist. So being able to have a coordinate and deliver it exactly where it needs to be, when it needs to be on the exact time. They have this app that they use on an iPad or an iPhone, and it shows all the stats with that and helping the truckers with utilization too because it costs them fuel. Those guys are paid differently in that respect. That's probably on the selling side where they've really helped their customers, but they've also used technology in their operations as well. That's fascinating too because basically they've created almost like a digital twin of all of their rock crushing machines.

24:18And they can analyze it. If you open your fact set and you look at it like green and red and it's blinking and flashing, that's what they have for their plants. And they can see, okay, there's an issue at this specific spoke of the crusher. We need to fix this or else our plant's going to have less throughput. So they've been able to basically run the plants less hours, generate more tons. And so you have better throughput. And it's this enterprise -wide performance tracking where you can pull this up. or if there's an issue, instead of having to call somebody, an expert, and have them come on a plane and a week later and fix it, and so there's all this downtime, they can actually just do it over the phone and tell the person, go into this location, find that, fix this, whatever.

25:05And they like to talk about how the number of Sundays they worked has gone down from 20 till two or something like that. Working on a Sunday is expensive because it's all over time. So if you can reduce that and incorporate technology into there. It's super important. Very interesting to see dashboards and other industries outside of finance. Finance, it's usually just the green and red, like you mentioned. You have refineries, seeing where their oil is coming from, Nigeria, North Dakota here, and crack spreads. The example you just described, which is excellent, it seems like it actually has a meaningful impact on cost.

25:39I love that where technology is really coming into play and impacting the operations. when they talk about actual profitability of the business, it's profit on a per ton basis. We explained a little bit just in terms of what's driving the revenue. When you split out cost per ton, you talked a lot about the transportation side of things. What other big buckets are there? And how have you thought about that trend line over time, just in terms of the cost of what they're producing and whether that's inching upwards or downwards and how they control that? So I'm going to attack this from a little bit different of a perspective.