Valuation Trends in the Aggregates Industry: which financial factors affect the value of an aggregates business? Understanding key value drivers for your company and prioritizing accordingly is the key to maximizing that value

Pit & Quarry, Jan, 2005 by Eric Z. Stephens

Productivity has been a hot topic in recent years. Productivity gains continue to be made, but the pace is beginning to slow. In the United States, for all industries, productivity growth in the second quarter of 2004 was up 4.6 percent compared to 4.1 percent in the same period last year. However, productivity growth has declined since the third quarter of 2003.

Still, corporate profits have grown faster than revenue in nine of the last 10 years (the exception being 2002). For the past decade, productivity gains have resulted from cost-cutting measures, rather than revenue growth. One indicator of productivity is the measure of sales per employee. An analysis of the data shows that the aggregates industry has done a good job of leveraging the efforts of its employees.

Today, the aggregates industry is generating revenue of more than $300,000 per employee per year. Figure 1 demonstrates the gains the industry has made over the years as well as the difference between the best and the worst companies in this area (the median growth rate was 7.5 percent per year over the past 11 years).

[FIGURE 1 OMITTED]

Recent unemployment figures show that companies are not hiring, so what are companies doing with their profits? They are either accumulating cash or paying higher dividends. In the aggregates industry, all but one of the eight public companies listed in this publication's "Stock Watch" have higher cash balances than they did in 2000.

With respect to dividends, even Microsoft is paying them. The software giant had always reinvested its earnings, so it was big news when the company declared its first dividend less than two years ago. It has since paid dividends four more times. For the aggregates industry, the median dividend payout ratio has increased every year since 1998 (at an average rate of 15 percent per year).

These figures demonstrate that companies have not been reinvesting their profits. Thus, our economic recovery has been termed a "jobless" recovery. It takes approximately 150,000 new jobs per month to keep pace with population growth, and we have not been keeping up. Indeed, we're still a million jobs short of where we were in March 2001. However, now that productivity growth is slowing, hiring may begin to pick up. In fact, according to economic theory, hiring will occur when real GDP growth exceeds productivity growth.

Valuation trends

The equity markets have been very soft this year. Through the middle of October 2004, the Dow Jones Industrial Average (DJIA), which reflects 30 of the largest companies in the market, lost 5.2 percent; the S&P 500 Index, which contains 500 large cap stocks, lost 0.9 percent; and the NASDAQ Composite Index, considered a small cap index, lost 4.7 percent.

In stark contrast, the aggregates industry, represented by the eight companies listed in the "Stock Watch," gained 16.7 percent. Why has 2004 been such a good year for companies in the aggregates industry? Of course the industry is tied, in part, to construction. But don't forget about the war or, more specifically, the rebuilding efforts. Rebuilding efforts have resulted in shortages of building materials such as plywood and cement, which have triggered higher prices.

As Figure 2 illustrates, the aggregates industry has generally outperformed compared to the S&P 500 Index and the S&P 500 Materials Index over the past several years.

[FIGURE 2 OMITTED]

The median price to earnings (P/E) ratio for the industry is currently 18.44. The S&P 500 has a P/E ratio of 19.28 and the DJIA has a P/E ratio of 17.14. The NASDAQ Composite Index has a P/E ratio of 45.30, but this figure is not directly comparable to the aggregates industry because it is reflective of many development stage companies with very low earnings.

The P/E ratio is a widely recognized valuation multiple, but valuation professionals rely on other multiples as well. Figure 3 displays some of the popular valuation multiples for the group of aggregates companies listed in the "Stock Watch."

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A key valuation

At the beginning of this article, we discussed productivity and its effect on employment. If the economists are right and productivity growth continues to wane, companies will start hiring again. With an improved job market, companies will have to pay close attention to attracting and retaining key employees, which leads us to another hot topic: employee stock options (ESOs).

By now you've heard about the controversy over expensing stock options, but you may not have heard that you have a choice in the how your stock options are valued.

Governed by Statement of Financial Accounting Standard No. 123 (SFAS 123), companies are given two ways to report ESOs: 1.) the fair-value-based method and 2.) the intrinsic-value method.

* Fair-value-based method. Under the Financial Accounting Standards Board's (FASB) newer, preferred fair-value-based method, an ESO's fair value as of its grant date is used to estimate compensation expense, which is subsequently recognized over the requisite service period (typically the vesting period).