Summit Materials: Cementing Its Position

Shares of Summit Materials (NYSE:SUM) took a dive in the wake of the announcement of a significant deal, which comes in somewhere between an acquisition and merger.

The purchase of the North American business of Argos takes place at a substantial valuation in relation to its own business, in fact, the seller becomes a huge investor in the firm. Despite the potential for operating synergies, investors are not too upbeat as the paid multiples look quite reasonable.

While I am naturally inclined to such situations, it is still high earnings multiples and a non-impressive track record which prevent me from jumping onboard.

The Business - Standalone

Summit Materials supplies cement, aggregates and other products across the US to a diverse set of commercial, residential and public customers. This makes the company largely a play on increased economic activity and capital spending, notably the housing market, green energy, warehousing, datacenters, roads and others.

Founded in 2009, Summit has acquired a range of cements assets in the earlier 2010s, as it went public in 2015. Shares started trading around the $20 mark as the company continued to acquire assets, while its pre-IPO owner Blackstone divested its stake over time. The early 2020s were characterized by divestments of non-core assets, as the overall results have provided a mixed bag to investors.

Despite the acquisition strategy and exposure to long-term growth, investors have seen cyclical returns. A $30 stock, early in 2018, fell to $10 by the end of the year. Shares recovered to the $40 mark in 2021, but fell to the low twenties last summer, only to trade in the high-thirties again in recent weeks.

These returns were seen amidst no dividends being paid out, and while Summit has grown sales over time, it has failed to deliver on a steady earnings growth trajectory for investors.

In February of this year, Summit posted flattish sales for the year 2022, with revenues reported at $2.22 billion with strong pricing offsetting lower volumes and the impact of divestments.

Operating profits rose by 6% to $269 million, as adjusted earnings came in at $1.27 per share. Based on such minimal earnings power, it was hard to see why shares would trade near $40 per share. Net debt came in just below the billion mark for a 2 times leverage ratio, as adjusted EBITDA approached the half a billion mark.

With EBITDA seen at a midpoint of $500 million in 2023, suggesting rather flattish earnings trends, I failed to see how the business would see greater earnings. Moreover, cash flows are largely in line with earnings, absent of huge working capital swings, with capital spending of $220-$240 million actually exceeding depreciation charges.

Through the first half of 2023, the company grew total sales by 5% to $1.16 billion as operating profits of $114 million came in $37 million ahead of the results last year. Adjusted earnings were up twenty cents to $0.45 per share so far this year, although this is typically the softer part of the year. On the back of the stronger operating performance, the company hiked the EBITDA guidance to a midpoint of $560 million, pushing up leverage above 2 times with net debt up to $1.26 billion.

With 119 million shares trading at $39 in recent weeks, a $4.6 billion equity valuation works down to a $5.8 billion enterprise valuation.

A Massive Deal

Amidst the moving targets, and quite frankly demanding earnings multiples, Summit announced a $3.2 billion acquisition to acquire the US operations of Cementos Argos. The deal involves 4 cement plants, 140 ready-mix plants, 8 ports and grinding capacity of 9.6 million tons.

The deal is set to create the 4th largest cement producer in the US, having a nationwide footprint. Some 40% of the deal will be paid for in cash, about $1.2 billion, with the remainder being financed by the issuance of nearly 55 million shares. This valued the deal at $3.2 billion, based on a pre-deal share price of $36.

The deal is valued at 10 times EBITDA and an 8 times EBITDA multiple post synergies, suggesting that a $320 million EBITDA contribution has been paid, with $80 million synergies seen on top of that. The deal presentation even reveals an expectation of as much as $100 million in annual synergies. In comparison, Summit trades around 10 times EBITDA in the higher thirties, marking roughly similar multiples.

The company claims a pro forma $4 billion revenue base post-closing and about a billion in EBITDA (including synergies) which seems to add up. Pro forma net debt will jump to $2.4 billion, pushing up leverage ratios a bit, although still rather manageable.

The Market's Take

Despite the reasonable multiple and anticipation of synergies, the market took a beating in response to the deal. Shares are down some 9%, just over $3 per share, in response to the deal.

Including the to-be-issued shares, that implies that some half a billion in value has been lost. This seems like a small overreaction in isolation, although that the observation is that I failed to be very upbeat on the shares on a standalone basis in the first place.

Earnings power has not been sufficient nor stable enough to warrant a current high multiple, as the long term track record is quite mixed. The current deal looks quite fair, certainly if synergies are realised, but even after the latest pullback, I fail to have conviction here.

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