$ROAD an infrastructure serial acquirer
Construction Partners Inc.
Key points
ROAD 0.00%↑ is a platform serial acquirer in the hot mix asphalt HMA industry.
The company operates in a large growing market of potential acquisition targets.
Recent infrastructure spending has given them a tailwind.
Their earnings guidance suggest they could more than double in size over the next few years.
Key company Information
Market cap: $2.2 billion
Sales: $1.5 billion
Earnings: $50 million
P/E: 45
5 year sales CAGR: 15-20%
Construction Partners, Inc. is a civil infrastructure company that operates in the asphalt materials and service industry in the south east portion of the united states. Another name for the industry is the “hot mix asphalt” (HMA) industry. The engage in the following
Manufacturing and distribution of HMA
Paving activities, particularly roadway base layers and the application of HMA
Site development, installing utility drainage systems
Mining aggregates for the production of HMA
Distributing liquid asphalt cement for internal and external use and sales to third parties.
They have 6 platform companies in 5 different states that they use as a platform for their bolt on acquisitions.
They were founded in 2001 and formed Construction Partners as a holding company in 2007 to facilitate their acquisition growth strategy. Since their founding they’ve made 36 acquisitions, 19 of which were between 2018-2022. They’ve also expanded their footprint into 6 states and at least 27 local markets.
Their basic strategy is to acquire their way into a new market or geographical area to establish a platform company then numerous bolt on acquisitions and increase efficiencies with their own integrated HMA plants.
Who are their customers?
Much of their growth over the past few years has come from government initiatives to fix the roads in America. 63% of their revenue comes from publicly funded projects and 37% come from private. In the public segment they serve the federal government, Department Of Transportation (D.O.T.), and various local municipalities. Their private customers include real estate developers, both commercial and residential.
There is a little concern over their customer concentration. Between the Florida and North Carolina Department Of Transportation , they make up about 20% of their revenue which certainly presents a risk if they lose that business.
Growth drivers
Their historical growth rate has been between 15-20%. Their future growth will come from 3 areas.
Organic growth - Investing in their current crews and services in existing markets to offer additional services. They also operate in a market with growing demand, which I’ll get to in a minute.
Invest in new HMA plants to increase efficiency or enter a new market. This is important in expanding their margins which are very small currently. They claim their margins will expand over the coming years and I assume this is how they’ll be doing it.
Acquisition - Both platform and bolt on acquisitions.
When thinking about demand and market growth drivers for this business two obvious things come to mind.
Demand to fix and maintain crumbling roads
Population migration to the south east United Staes where they operate
First lets talk about the state of American roads
If you’r anything like me, you pay a lot of taxes and find yourself wondering why you can’t drive down the street without plowing through a pot hole the size of a small bathtub. Shoot, there’s no need to drive down to the lake to go fishing anymore, you can catch yourself a nice lunker down the street!
Obviously thats an exaggeration but the point is US roads need some serious love and one can’t help but ask why the roads are in such poor condition in the first place.
The US government has dumped massive amounts of money into infrastructure over the last few hundred years. This is a good thing but it hasn’t always been a long term success. According to Richard White, professor of American history at Stanford University, we’ve over built and delayed maintenance for far too long.
“The real problems arose before anyone lifted a shovel of earth or raised a hammer. These problems stem from how hard it is to think ahead, and they are easy to ignore in the face of excitement about new spending, new construction and increased employment.”
“The money invested in roads, railroads, airports and dams cannot be repurposed, and what is built requires large future expenditures for upkeep.”
“People tend to disregard the long-term costs of the plans they make, particularly if they reap the benefits and others pay the costs.”
So the story of American infrastructure is both a success for the initial generations and a failure for future generations as the maintenance costs weren’t carefully considered and the maintenance was delayed.
94% of roads in American roads are made with asphalt and there are over 4 million miles of public roads and roughly 164,000 miles of federal highways connecting them. The American Society of Civil Engineers (ASCE) has given American infrastructure a C- partly because 43% of our roads are in either poor or mediocre condition which means there will be significant investment in fixing asphalt roads.
Migration to the south east
Census data suggest that some of the states with the largest inbound migration are some of Construction Partners biggest territories such as Florida, Georgia, South Carolina and North Carolina. This population growth inevitably creates a demand for new roads, both public and private, as governments and private developers build new infrastructure to support larger populations.
Who’s paying for it?
We all know the answer to this question, you and I are going to pay to fix and build the roads, well at least the public ones. According to the ASCE it there is a funding gap of about $2.6 trillion dollars this decade, and if it’s further neglected it could end up costing $10 trillion by 2039. Even though the largest chunk of these investments will need to go to transportation infrastructure like roads, bridges and airports, it’s hard to say exactly how much of that money will flow to the road systems and paving companies like Construction Partners.
Regardless, there have been various bills passed aimed at addressing the infrastructure issues. In 2021 the federal Infrastructure Investment and Jobs Act (the “IIJA”) passed, allocating an additional $548 billion for infrastructure spending through to 2026. The Inflation reduction act passed in 2022 which also provides additional funding for the industry. State transportation departments also continue to increase infrastructure spending in the regions they’re located in.
Nature of the business
One of the most difficult aspects of the construction industry is that the variables are often changing or difficult to predict. Whether it’s commodity prices, interest rates, cyclicality, changes to the construction plans and timelines or unforeseen complications on the job, theres always something changing. This means the best construction businesses are profitable, predictable and repeatable and they’re also skilled at managing contracts and different variables.
Construction Partners seems to have a predictable non cyclical business. Although there is some seasonality in this business its not cyclical like home building which is largely dependent on economic conditions and interest rates. Most of their projects are steady and necessary jobs.
They have a solid system for getting leads and generating bids, calculating the cost of the projects and making sure they know their subcontractors prices on fixed total price contracts before they submit their bids. This simply means they’re taking the time to give accurate prices to their customers so they wont have unexpected cost’s half way through a project.
The business of paving is also just less complex in general compared to other areas of construction such as building a large skyscraper so I think this is good business to be in.
Pricing and billing
Most of their customers, particularly their public (63%) ones are billed on a fixed unit price basis which means they bill according to some fixed unit such as “$10,000 per ton of asphalt” or “$1,000" per man hour”, and this is usually billed as the project progresses. They bill their private customers on a fixed total price basis, which means they will bid the entire cost of the project before hand then submit it to the customer.
Fixed unit price contracts are typically better and less risky because they don’t require a contractor to predetermine their revenue ahead of time and speculate on what their labor costs will be. Instead they just bill for their time and materials or total tons poured or however they measure it. So it’s good that most of their customers are government entities (63%) that are billed at a fixed unit cost. This means more consistent margins.
Acquisition opportunities
There are 300 potential asphalt company acquisition opportunities within the states they operate in and nearby states. They target companies with strong management and well funded D.O.T. programs operating in regions with growing populations.
Aside from that they estimate there are about 2,000 additional non-asphalt opportunities indicating they are open to expanding their total addressable market or integrating different businesses such as trucking, striping, barriers, and various others (found below)
Management
Smith
The current CEO is Fred Jule Smith. Smith was hired internally in 2021 and was previously CEO of one of their platform businesses in North Carolina, The Fred Smith Company.The Fred Smith company was purchased by his father purchased in 2009 and then subsequently sold to construction partners in 2011. Fred Jule Smith was previously COO at construction partners and held various management positions at Fred Smith company.
Ownership and compensation
Smith owns 131k shares of the stock valued between $5-6 million. They incentive their management based on EBITDA, Revenue growth, and ROCE. Smiths base salary was $615k in 2023 plus $280K plus about 20k shares in long term equity incentives (RSU’s and PSU’s based on ROCE and revenue CAGR). His total compensation was about $1.7 million. To put it into perspective, in 2023 his base salary was about one tenth the size of his equity ownership and his immediate cash awards were even smaller, the remaining 800K was share based compensation based on revenue growth and ROCE targets. His total compensation was about a third the size of his equity ownership.
Generally, I like to see CEO’s with salaries much smaller than the value of their equity ownership. Smiths compensation is reasonable relative to his ownership but could be better.
Owens and Fleming
The two founders of Construction Partners remain on the board and hold considerable ownership and voting power. Ned Fleming and Charles Owen, along with a few others founded both Construction partners in 2001 and SunTx, a private equity firm in Texas.
Potential nepotism and related parties
It’s obvious there is a connection between SunTx and Construction partners because they have the same founders, owners and have done a few small transactions between the two companies. Their experience in private equity is a good thing because they are probably experienced in M&A, but there’s also a lot of inter-family hiring between the companies which concerns me a bit because they may be choosing to hire family members rather than more qualified executives.
Financials
The first thing to understand about this business is that its a low margin business, their gross margins are around 12-15% because they have very high labor and material costs. However, their margins are expanding from their lows a few years ago and they expect them to keep expanding as they look for ways to become more efficient.
Aside from 2020 during the Covid lockdowns, their revenue growth has been in the 15% - 20% range since going public. They’ve seen huge growth since the Infrastructure and Jobs Act passed in 2021, clocking over 40% growth in 2022 and about 30% in 2023. I assume they will continue to experience tail winds will for at least a few years until the infrastructure money is completely allocated, although Im not convinced they will continue to have 30% growth like they’ve enjoyed the last few years.
They’ve had decent returns on invested capital historically (10% - 15%) but they’ve taken on more debt than usual over the last few years which has sort of bloated their invested capital base and bogged down returns on capital. Sometimes this happens with serial acquirers who take on a lot of debt to fuel acquisitions but it doesn’t seem to be an issue so long as they can service the debt.
Construction Partners total debt is somewhere around $375 million, while their operating cash flow is around $160 million, so if for some reason they had to pay off all their debt they could theoretically do it in just over 2 years.
Valuation
They’ve given future guidance on earnings for FY 2024 as well as guidance until 2027. In 2024 they believe they’ll be doing $1.75 - $1.82 billion in revenue and between $63-$70 million in earnings. By 2027 they believe they will be doing between $2.7 - $3.2 billion in revenue and between $145-$171 million in earnings on higher margins. I’m using these given variables and I’m assuming the multiple contracts from around 45x earnings today to between 20-30x earnings in 2027. This all implies a range of potential returns between 9%-32% annually over the next three years from the current market cap, which is great, but only if they can continue to do what they’ve been doing the last few years. Their projections are based on a “normal funding and economic environment”
Final thoughts
I like this business and think it has potential to compound over the next decade but I’ve also reserved a few small doubts in my mind concerning a some things. First, I can’t help but wonder what growth will be like once US roads have been largely repaired. How long would this take? These are questions I’ll have to think more about before committing any large meaningful of capital to this business.
Second, in the off chance that they don’t continue acquiring and growing at the same rate, what would the bear case look like in then? I lowered the growth rate down to 10% and gave it an end multiple of 15x earnings in 2027 and came up with an annual return of about -5%.
This is why the starting valuation can be important, especially in the short term. If I’m wrong, or they’re wrong about their projections, a low entry valuation softens the blow quite a bit sometimes. As it sits right now the market has priced ROAD 0.00%↑ as a compounding serial acquirer, which it is, but often times these serial acquirers get bid up to high multiples on the expectation that they will continue to perform at the same level, and if they don’t, look out below.
All in all I find this company interesting and I may take a tiny position just to track this company as I think about it more. If it were to drop down to $30 - $35 I would be much more excited. As for now I’m watching.
Anyways thats it for this week thanks for reading!
Nice review of the company. Seems like an interesting play on the infrastructure in the US. Thanks for sharing it!