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Postelection Optimism Boosts U.S. Building Materials Firms

But it’s uncertain whether Trump’s infrastructure spending plan will be executed in its proposed form.

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U.S. aggregates and concrete companies rallied sharply following the election of Donald Trump as America’s next president. On one hand, we think this makes sense. Unlike globally fungible commodities like steel or copper, cement, aggregates, and concrete are almost entirely consumed near their production sites because of their low value/weight ratios. As a result, increases in infrastructure spending would benefit the financial performance of  Vulcan Materials (VMC),  Martin Marietta Materials (MLM),  Summit Materials (SUM), and  U.S. Concrete (USCR). On the other hand, we’re skeptical that the touted $1 trillion infrastructure spending plan will be executed in its proposed form. We think the shares of these companies are now pricing in significant growth, and we see little risk-adjusted upside at this time.

During his campaign, Trump proposed to spend $1 trillion over a 10-year period to repair roads, bridges, and other infrastructure. In part, he hopes to lean on private spending to achieve his goal, with $137 billion in tax credits for construction companies that would then borrow on the open market to fund projects with attached revenue streams--a toll road, for example. U.S. infrastructure construction (including transportation, highway and street, sewage and waste disposal, water supply, conservation, and development) is set to total about $180 billion in 2016. Tacking on an additional $100 billion would translate to a 55% increase in annual spending. However, we don’t think a full $100 billion increase is likely.

First, it’s unclear whether the $100 billion would be incremental or part of existing spending levels. Additionally, infrastructure funding has always been a category that both parties could theoretically agree on, yet, this did not stop it from succumbing to partisan politics, as evidenced by years of stop-gap measures for highway trust funding bills between 2012’s Moving Ahead for Progress in the 21st Century Act (itself just a two-year funding bill) and 2015’s Fixing America's Surface Transportation Act.

Second, Trump’s proposed plan requires an unprecedented level of public-private partnerships and infrastructure privatization. Given the controversy regarding the efficacy of past privatization of public assets, we think this would be a significant challenge to the proposed plan. In addition, not all infrastructure assets lend themselves to a revenue stream--how would you toll a local road?

Third, increasing infrastructure spending at the federal level is like trying to steer a massive ship. When it comes to roads, highway projects are planned and executed by state departments of transportation. Federal funding for these projects comes on a matching basis, in which the national government provides funding when the state and local governments provide funds as well. Adding even more complications, states often need to wait until the next fiscal budgeting process or election to find their funding source. In all, this translates into a very slow process from the announcement of a plan to a newly paved road. For example, even though it’s been nearly a year since the FAST Act has passed, there has yet to be a significant increase in actual road construction activity, as states are still working on boosting their own funding.

Even if infrastructure projects are put in the hands of the private sector, we don’t expect a much speedier process. We think states would need to spend meaningful time convincing citizens that privatization would be beneficial and possibly issuing voter referendums for approval, given the skepticism regarding public-private partnerships. As a result, we think it will be some time before construction growth could even be realized.

While the shares of Summit Materials and U.S. Concrete had stayed relatively flat year to date before the election, the shares of Vulcan Materials and Martin Marietta had gained 30%-40% as U.S. construction activity continued on a path to recovery and investor expectations for demand growth rose. The acceleration in share prices since the election reflects even higher expectations for demand growth. However, we caution that what gets said on the campaign trail doesn’t always come to fruition, presenting a meaningful risk to these construction names.

Kristoffer Inton does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.