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Morningstar | Summit Looks Undervalued as It Should See Healthy EBITDA Growth Following a Tough 2018. See Updated Analyst Note from 06 Feb 2019

Summit Materials' operational and financial struggles continued during the fourth quarter, as unfavorable weather conditions weighed on deliveries throughout 2018. The impact was particularly noticeable in the company’s cement business, which saw full-year volume fall nearly 9% and prices rise an underwhelming 0.6%. Delivery problems were exacerbated by cost inflation that outpaced price increases, driving a 3.6% adjusted EBITDA margin contraction to $406 million.

Despite a tough 2018, we think of much of Summit’s struggle was temporary. Barring bad weather, 2019 should be much better. End-market demand remains strong; housing starts remain well below our forecast of 1.6 million in 2022 (which has a latent positive impact on nonresidential construction), and infrastructure funding and thus activity continue to grow. A planned 8%-10% increase for Summit’s cement prices in April is indicative of the strength of demand.

We’ve updated our model and lowered our fair value estimate to $23.50 per share from $24.50, which primarily reflects near-term margin contraction that we think will eventually be recovered through price increases. Our narrow moat rating, which is based on the company's aggregates and cement operations, is intact.

Summit’s share price declined 16% during the fourth quarter, underperforming Vulcan Materials, Martin Marietta, and U.S. Concrete, which declined 5%, 2.5%, and 14%, respectively. However, through the first several weeks of 2019, Summit shares have risen nearly 27%, outperforming peers that have gained 5%-16%, as we think the market has recognized it had overly soured on the outlook for construction activity.

Despite the meaningful recovery so far, we continue to see significant upside left in the shares as nonresidential construction and infrastructure remain positioned for further growth. Our fair value estimate is based on mid- to high-single-digit top-line growth and relatively mild margin expansion--a little over 200 basis points from 2016 and 2017, years in which Summit saw fewer wet days. As a result, we think the market is holding a relatively low bar for Summit to see significant share price gains in the coming years.

For more details on why we think today’s political environment is favorable for improved infrastructure funding, please see our report "U.S. Infrastructure Spending Outlook Boosted by Midterm Elections."