Aggregates And Obama’s Plan: JP Morgan Says Tread Lightly

Vancouver– U. S. President-elect Barack Obama’s talk of massive new infrastructure spending as one response to an expected recession has some investors excited about stronger demand for aggregates. Money for infrastructure means funding for highways, which leads to surging demand for sand and gravel, the theory goes.

But while these enthusiasts may place bets on aggregate and cement companies, analysts at JP Morgan are urging caution. The connection between Obama’s infrastructure package — the size of which is uncertain — to an uptick in the aggregates industry may not be as immediate nor as significant as some may think.

Although JP Morgan agrees an Obama administration will almost certainly spend at least US$150 billion on an economic stimulus package, the investment firm warns that potential projects may not get up and running as quickly as assumed and that, at least in 2009, a decline of construction activity in the U. S. will largely temper benefits of any stimulus.

In a note to investors on Dec. 15, JP Morgan analysts put it bluntly:

“We anticipate a decline of around seven per cent in total investment in structures in 2009. This represents a decline in investment outlays on the order of US$90 billion,” they write. “Even under the most optimistic assumptions, the proposed infrastructure program seems unlikely to offset fully the decline in other construction investments during 2009.”

The firm also believes the incoming Obama administration “faces an array of conflicting objectives that are likely to slow the distribution of funds and hold down construction spending in the short term.”

Chief among these conflicts is how the infrastructure package affects state-level spending on projects already in the works.

JP Morgan estimates that there are more than 5,000 highway projects with a combined price tag of about US$66 billion throughout the U. S. that are “ready to go.” These are ones that state governors say could break ground within a few months of receiving funding.

However, JP Morgan is skeptical about optimistic construction start dates, and argues that many of these projects are in fact “ready to go” because governors are already willing to pay for them.

In this context, JP Morgan wonders if the consequence of Obama’s plan will merely be to shift the level of government shouldering the financial weight of highway projects.

“The National Governors Association. . . has called for temporary elimination of the required non-federal match for US$43 billion of transport, wastewater, and drinking- water projects,” JP Morgan notes.

If this policy were enacted, the benefit of the stimulus package on infrastructure spending would shrink substantially, JP Morgan says. Instead of spurring more construction, it might only support projects likely to have gone ahead anyway.

Leaving aside these concerns, analysts at JP Morgan nonetheless predict there could be a near-term winner under Obama’s plan.

“We think the aggregates sector will be among the first parts of the construction industry to benefit from an infrastructure program,” they write.

But JP Morgan questions the speed and degree to which federal spending will spur that demand. It notes that, according to the Congressional Budget Office, only 27% of federal road funds typically reach projects within a year. During the second year, that increases to 42% of promised funds.

So assuming US$64 billion of Obama’s infrastructure package goes toward spending on highways, JP Morgan estimates that the federal government would spend about US$9 billion in 2009 and US$22 billion in 2010 on highway improvement.

Translating those figures into increased demand for aggregates, and allowing for some work on schools as part of Obama’s plan, it estimates that the infrastructure package might lead to additional spending on sand and gravel of about US$1 billion in 2009 and US$2.4 billion in 2010.

At an average price of US$8 per tonne for aggregates, JP Morgan forecasts that the stimulus package would increase demand for aggregates by 5% in 2009 and 12% in 2010. The scenario also predicts concrete demand rising in 2009 and 2010 by the same amounts.

This is not, JP Morgan admits, a bad outlook for these and other aggregate and cement companies. But therein lies the problem. JP Morgan believes Obama’s plan has boosted interest in the aggregate sector too much.

“The near doubling in the share prices of (some) U. S. aggregate companies since their recent trough levels is. . . in our view an excessive reaction.”

Vulcan Materials (VMC-N) gets the biggest boost of the aggregate companies JP Morgan covers. In 2009, its earnings are forecast to get a 15% boost, a number that rises to 28% in 2010. Likewise, JP Morgan predicts cement giant Cemex (CX-N) will see its earnings rise 7% in 2009 and 19% in 2010.

But recent share price increases have far outstripped those potential increased earnings.

Vulcan’s share price, for instance, hovered around US$50 during October and November. But since Obama’s election and his announcement of the stimulus package, Vulcan has already gained more than US$20, trading either side of US$70.

For Cemex, the change has been even more dramatic. In October and November, its share price played above and below US$6. But news of Obama’s recession-busting plan has catapulted it to over US$10 in recent weeks.

That leads JP Morgan to conclude: “We think the benefits of the likely infrastructure programs are more than priced into the stocks.”

No quarrel from the quarry

Marco Romero, the president and CEO of Polaris Minerals (PLS-T, POLMF-O), an aggregate company operating in B. C. that ships more than three quarters of its materials to the U. S., in large part agrees with this conservative outlook.

“There’s a lot of smoke, a lot of talk about the effects of infrastructure spending,” he says. “We’ll believe it when we see it.”

Although Romero says Polaris is well placed to take advantage of increasing demand, the company isn’t placing its bets on a quick upswing in the industry.

From the point of view of a quarry operator, he warns that even if demand surges, it will take time to get shovels in the ground, mobilize a bigger workforce and arrange shipping.

Although Polaris has an agreement with its shipping company allowing it to increase capacity by as much as 35% if need be, he says “it’s not like you could call them up and ask them to transport one million more tonnes next month.”

So he says while Polaris is cautiously optimistic about the second half of 2009, he echoes the message underpinning JP Morgan’s analysis.

“We don’t imagine the impact will be immediate,” he says.