How Eagle Materials Inc. Could Be Gearing Up For A Homebuilding Boom

With Quiver Quantitative’s recent institutional holdings data, we can see that many hedge funds and asset managers have increased their stake in Eagle Materials Inc. EXP. Firms such as ExodusPoint Capital Management, Alyeska Investment Group, and Vanguard Group have all added to their EXP positions recently. Most notably, Vanguard Group increased shares held by around 2% (as filed on 03/31), bringing their total EXP holdings to 4,072,799 shares worth nearly $774 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Eagle Materials.

Eagle Materials Inc. operates within the construction materials and building materials industries, meaning that it is levered to the US construction industry. While this industry is cyclical in nature, recent US homebuilding data shows that the US homebuilding industry may be heating up for a boom. After years of low inventory and rate hikes over the past year, existing home sales are down (due to limited inventory) and home prices have been pushed to their highest in a year. To add credence to this point, the June median sales price of all existing homes was $410,200, according to the National Association of Homebuilders, the second highest price of all time and only 0.9% off the all-time high set last year. With unsold inventory sitting at a very low figure of 3.1 months of supply, compared to 4.5 - 6 months supply often seen in balanced market conditions, it is becoming increasingly evident that there is a major need for more home construction.

This comes as new home sales jumped to their highest level since February of 2022 just this May, according to the National Association of Homebuilders. In May, sales of newly constructed single family homes increased 12.2% to a SAAR (seasonally adjusted annual rate) of 763,000. Like mentioned above, this boom in new home construction is largely because of extremely low inventory of existing single family homes, sitting near 3 months supply. Because of this, new home inventory made up over 30% of total inventory in May, compared to the historical average of 10-15%. Evidently, there is a large need for new home construction, and with improving macroeconomic conditions and a slowed pace of rate hikes from the Federal Reserve, a multitude of factors are combining nicely for a boom in new home construction, directly benefiting Eagle Materials and the rest of the building materials industry.

Eagle Materials Inc. is a leading manufacturer of light building materials and heavy construction materials in the United States. The company, headquartered in Dallas, Texas, was founded in 1963 as a subsidiary of Centex Corporation and was publicly traded under the name Centex Construction Products Inc. until 2004, when the company was renamed Eagle Materials Inc. The company's main products, Portland cement and gypsum wallboard, are essential in residential and commercial construction, public construction projects, and repair and remodel work. Like mentioned above, the demand for their products is cyclical and seasonal, largely depending on economic and geographic conditions. However, their products are distributed across many geographic regions and markets, giving them regional economic diversification.

Eagle Materials strives to be a low-cost producer in each of the markets that they operate in. The company sells construction materials that are basic necessities, meaning that the lowest-cost producers are able to maintain higher margins, better returns, and stronger free cash flow generation. Management understands that price is the main driver of competition in the markets that they operate in, therefore, they are regularly investing into their production processes to lower the raw materials and resources needed to produce their products. With a high ROIC and ROIC to WACC ratio, it seems that the business is able to efficiently invest into these ventures. 

The company also strives to maintain a decentralized operating structure and operate in regionally diverse and attractive markets. With a decentralized operating structure, operations and products are handled by separately managed companies. This allows the business to operate with higher brand recognition and lower transportation costs, a major factor that helps to further reinforce their low-cost producer competitive advantage. Additionally, Eagle Materials chooses to operate in attractive markets and diversify their regional footprint. 70% of their revenue is generated in 10 states (CO, IL, KS, KY, MO, NE, NV, OH, OK, TX). Furthermore, these states are chosen because of their strong population growth prospects. The population of these states is expected to grow 10% from 2020 to 2050, compared with an expected 7% population growth rate in the United States during that same timeframe. Population increases are an important metric to consider for construction product and building material demand, therefore, we can see why the company is strategically placing itself in high population growth states.

Through stringent return on investment objectives, reliable free cash flows, and a strong balance sheet, the company plans to consider acquisitions and organic growth opportunities. Since 2012, Eagle Materials has invested $2.2 billion dollars to expand within the heavy materials sector, doubling their U.S. cement capacity and making the company the largest independent U.S. producer of cement. Acquisitions help them increase their geographic footprint and capture growth opportunities.

Management’s capital allocation is superb, with priorities to enhance shareholder value. Management invests capital into acquisitions and growth opportunities that meet their stringent return standards, operating capital investments to strengthen their competitive advantage as a low-cost producer, and share repurchases and dividends to return excess cash to shareholders. Since 1994, shares outstanding have decreased 48%, and they have decreased 27% within the last decade. In the last 5 years, the company has spent $1.7 billion dollars on dividends and share repurchases, showing management’s strong commitment to returning shareholders value. 

Competitive advantages for Eagle Materials include a strategically located plant network, low-cost producer position (as mentioned above), production flexibility, substantial owned raw material reserves and resources, and a proven management team. Like mentioned above, Eagle Materials' strategically located plant network, largely located within high-growth U.S. markets and states, gives the business cost advantages. Their plant network is located close to customers and raw materials / resources, largely cutting down on transportation costs. Additionally, the diversified market reach allows them to avoid large demand fluctuations due to individual regional construction cycles. Their production lines allow them not only to maintain their low-cost producer position, but to maintain production flexibility. They are able to accordingly change production levels based on demand downturns and rebounds, allowing them to operate at a very efficient scale. Additionally, their substantial raw material reserve gives them a massive competitive advantage. With 25 - 50 years of primary raw material reserves for all of their facilities, they are able to control the cost of resources and stay protected from large swings in commodity prices. 

A strong management team is a large competitive advantage for Eagle Materials. Management has stringent return on investment objectives and prioritizes initiatives to return value to shareholders, spending billions in the last few years on dividends and share buybacks, not to mention over a billion dollars invested into acquisitions and organic capital expenditures to grow the business and indirectly return value to shareholders. Additionally, management and the board own around 1% of shares outstanding, worth a little over $60 million dollars in shares. CEO Michael Haack alone owns almost 20 million dollars worth of shares or 0.3% of shares outstanding. As we can see, management is not only excellent at capital allocation, but they are incentivized to return value to shareholders as they own a fairly large stake in the business as well.

Eagle Materials is a very efficient business. It operates at a ROIC of 23% and a ROE of nearly 40%. With a WACC (weighted average cost of capital) of 9.4%, Eagle Materials has a ROIC to WACC ratio of around 2.5x, a relatively high ratio that shows how the business is able to achieve returns significantly higher than its cost of capital. The business is able to efficiently reinvest capital back into the business, rapidly growing intrinsic value and rewarding shareholders handsomely.

Taking a look at Eagle Materials’ income statement, we can see some stellar growth in revenue, gross profit, EBITDA, and EPS. Since 2014, Eagle Materials has grown its revenue at a CAGR of around 10%, with gross profit growing at a CAGR of 15%. This relatively high gross profit CAGR can largely be explained by expanding gross margins. In 2014, Eagle Materials operated at a 20% gross margin, however, they now operate at a LTM gross margin of 30%. Additionally, Eagle Materials has been able to grow EPS at a CAGR of 20% since 2014, growing EBITDA at a CAGR of around 13% in that same time frame. As we can see, Eagle Materials has been able to handsomely grow their revenue, profit, and earnings over the last decade, indicating strength in their business model.

Looking at Eagle Materials' balance sheet, we can see that they are a highly leveraged business. With around $15 million dollars of cash and cash equivalents on hand, compared to around $1 billion dollars in long term debt, we can see that the business operates at a high cash to long-term debt ratio, however, this is normal for companies operating within the construction materials industry, where capital-intensive projects and investments are common. With an EBIT / Interest Expense (interest coverage ratio) of 17x, investors should feel safe knowing that Eagle Materials has plenty of runway to cover its interest expense on its outstanding debt.

Looking further on the balance sheet, we can see that shares outstanding have been slashed since 2014. In 2014, shares outstanding stood at 48.28 million shares, with current shares outstanding sitting at 35.39 million shares, a 13 million share or 27% decrease in shares outstanding in less than a decade. This shows how management handsomely rewards shareholders through stock buybacks.

Analyzing Eagle Materials’ cash flow statement, we can see further evidence of a strong business model, with stellar sustained growth in free cash flow and net income. Free cash flow has grown at a CAGR of around 16% since 2014, largely attributed to expanding free cash flow margins. In 2014, Eagle Materials operated at a free cash flow margin of 12% of revenue, compared to today where the business operates at a LTM free cash flow margin of 20% of revenue. On top of this, net income has grown at a CAGR of around 16% in the same time frame, further showing Eagle Materials strong business model and operational efficiency.

Looking at valuation metrics, you can argue that the company is currently trading at a reasonable price for the growth you are exposed to as a shareholder. Using Benjamin Graham’s 2G rule of thumb (he argued that you should not pay more than 2x the growth of a business), we can see that the business is trading at a fairly low valuation. Eagle Materials is currently trading at a NTM P/E ratio of 13.93x earnings, meaning that Eagle Materials would have to grow its earnings at a CAGR of around 7% over the next several years, however, that seems very attainable. Like mentioned above, Eagle Materials has grown its EBITDA at a CAGR of around 13% within the last decade. Additionally, with analysts projecting a LT growth rate of 14% (long term growth rate), we can see that the company may be trading at a low valuation relative to its future growth. With improving macroeconomic conditions and slower rate hikes from the Federal Reserve, we believe that margin expansion is a possibility as tailwinds from a booming U.S. homebuilding sector drive increased demand for construction and building materials.

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