Material Strengths

In this edition of the Smart Investor newsletter, we examine one of the leading materials suppliers in the U.S. But first, let us delve into the latest Portfolio news and updates.

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Portfolio Updates

❖ Merck’s (MRK) animal health division completed a $1.3 billion acquisition of the aqua business of Elanco Animal Health. The buyout is expected to boost the position of Merck’s animal health business in the fisheries and aquaculture industry. Additionally, the pharma giant completed a $3 billion acquisition of EyeBio, which will strengthen Merck’s ophthalmology pipeline.

❖ Broadcom (AVGO) remained a top pick for Bank of America analysts, who see a major upside potential for the stock. BofA analysts expect that the semiconductor bull run will likely persist through the middle of 2026 as chip stocks will benefit from the spending on AI and cloud computing, as well as from the race for autonomous cars. In addition, the chip and software giant received a Street-high price target of $240, implying over 30% upside in the next 12 months.

❖ PayPal Holdings (PYPL): Mizuho Securities analysts reiterated their “Buy” rating, with an upgraded price target implying an upside of over 45% in the next 12 months. The upgrade follows the news that Apple has agreed to open its near-field communication technology (tap-to-pay) payments system to third-party payment providers for free. According to Mizuho and analysts from other Wall Street firms, this could enhance PayPal’s market position, particularly in Europe where the firm gets ~20% of its revenues, by providing access to Apple’s extensive user base. In addition, integrating PYPL payments with iPhone NFC technology should lead to growth in transaction volumes, boosting  revenue growth.

❖ Super Micro Computer (SMCI) will join the Nasdaq-100 index before the markets open on Monday, July 22, replacing the pharmacy chain Walgreens Boots Alliance. The index represents 100 of the largest companies (by market cap) listed on the Nasdaq. SMCI has skyrocketed by more than 200% year-to-date, drawing increased investor and analyst attention. While analysts from Susquehanna and Nomura are skeptical regarding the stock’s further upside, at least in the near term, others – including Barclays, Northland Securities, Bank of America Securities, and Loop Capital Markets – remain optimistic.

❖ Interactive Brokers (IBKR) published its FQ2 2024 results after markets closed on Tuesday, which featured strong growth on all important metrics. The broker’s revenues and EPS surpassed analyst estimates and displayed robust year-over-year growth. Importantly, customer accounts and customer equity jumped from the previous year, while commission revenue strongly increased on higher trading volumes. Total daily average revenue trades, or DARTs, surged by 28% from a year ago.

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Portfolio Earnings and Dividend Calendar

❖ The Q2 2024 earnings season is in full swing, with Taiwan Semiconductor Manufacturing (TSM), GE Aerospace (GE), Visa (V), and Pentair (PNR) scheduled to report in the next week.

❖ The ex-dividend date for Pentair (PNR) is July 19th, while for Dell Technologies (DELL) it is July 23rd.

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New Buy: Martin Marietta Materials (MLM)

Martin Marietta Materials is North America’s leading resource-based building materials supplier, providing aggregates and heavy-side building materials to the construction, infrastructure, agricultural, utility, and environmental industries in the United States and internationally.

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Becoming the Construction Materials Leader

Martin Marietta was established in 1939 as an aggregates company. Over the years, the company has undergone multiple changes, including a brief period as a founding partner of the Lockheed Martin Corporation in the 1990s.

In the past few decades, MLM has experienced a substantial surge in growth, expanding its product lines, production volumes, and geographical presence. The company’s expansion was fueled by internal investment in new production facilities, as well as multiple acquisitions of whole companies or their operations. Its latest such acquisition was completed in April this year when Martin Marietta finalized the buyout of 20 active aggregate mining operations from BWI Southeast for $2.05 billion in cash.

Since 2010, Martin Marietta has been implementing a strategy blueprint it calls “SOAR” (strategic operating analysis and review). SOAR calls for the company to constantly perform end-market analysis with its findings to be applied in a timely manner to update MLM’s business development, pricing, acquisitions, and other strategic actions. This agile strategy has been working outstandingly well, with the company’s market capitalization growing tenfold since its inception, and its share of the U.S. Construction Materials market reaching over 25%.

As a most recent example, within the SOAR strategy, the company divested its Texas cement business in February 2024 as the import share of the supply began rising, using the proceeds to buy 20 aggregate mines in the Southeast. The Southeast projects are benefiting from government tax and investment initiatives aimed at supporting U.S. industry.

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Building Blocks for the Industrial Renaissance

Headquartered in Raleigh, North Carolina, MLM operates in 28 U.S. states. Martin Marietta Materials supplies both commercial and government projects and plays a key role in the supply chain for construction projects across the U.S.

Geographically, Martin Marietta’s most important markets include Texas, Colorado, North Carolina, Georgia, and Florida, accounting for most of its sales, with a notable presence in Arizona, California, and Minnesota. Importantly, Martin Marietta’s purposefully built coast-to-coast network of approximately 360 quarries, mines, and distribution yards ensures efficient supply chain management, reduces logistics costs, reduces dependency on any single market, and increases MLM’s competitive advantages.

Since the 1990s, the company has been a major contractor for the American space station, Texas rail networks, and numerous other government projects. As one of the leading suppliers of materials for the construction of everything from bridges to data centers, MLM is capitalizing on the federal government’s subsidies and funding initiatives, including the Infrastructure Investment and Jobs Act, the Chips and Science Act, the “Investing in America” initiatives, among others.

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Diversification Focused on Margins and Revenue Stability

MLM offers crushed stone, sand, gravel, cement, ready-mixed concrete, and asphalt, as well as magnesia-based chemical products, dolomitic lime, and cement-treated materials. The company derives over 95% of its revenues from its Building Materials business, with the rest coming from its Magnesia Specialties business.

Within the Building Materials division, the largest part of revenues is provided by its aggregate business, responsible for ~65% of total annual revenues. The company’s remarkable 199 million tons of aggregate sales in 2023 demonstrated its significant market presence. The aggregate business provides better pricing power, higher margins, and more revenue stability than other end markets. In addition, its aggregate business demonstrates much higher barriers to entry, limiting competition.

MLM’s offerings are relatively diversified beyond aggregates, with the second-largest source of revenue – Concrete – providing ~15%, Asphalt and Paving adding ~10%, and the rest coming from its Cement business. Notably, Martin Marietta has been performing gradual divestitures of the cement plants over the past three years, as this business is far more susceptible to increased competition from imports, which can pressure pricing power and margins.

This end-market diversification helps mitigate risks stemming from individual product market fluctuations. Coupled with aggregates’ long history of secular pricing growth and flexible cost structure, the variety of MLM’s offerings underpin its ability to grow earnings through macroeconomic cycles.

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Robust Fundamentals, Strong Business Outlook

Martin Marietta boasts a strong balance sheet with very little net liabilities, as its net debt-to-equity ratio stands at a modest 19%, with the debt load significantly reduced over the past five years. The company has successfully performed multiple buyouts while cutting its debt, thanks to its very disciplined and pragmatic acquisition activity, aimed at accumulating resources at reasonable prices.

The company’s financial resilience is recognized by the credit rating agencies and is reflected by its investment-grade ratings: “BBB” at Fitch, “Baa2” at Moody’s, and “BBB+” at Standard & Poor’s. In May 2024, Fitch raised the outlook on MLM’s debt from stable to positive, applauding its “leading market positions, geographically diverse quarry network, high barriers to entry, strong credit metrics, consistent free cash flows, and solid liquidity.” The credit rating agency also noted in positive light the company’s diverse revenue sources, which are balanced between residential, nonresidential, and public construction end markets, and said it expects MLM to profit from high exposure to the regions expected to continue displaying relatively high construction growth, such as Texas, Colorado, California, and the Southeast.

Considerable diversification across end markets supports MLM’s optimistic outlook. The company’s management expects continued growth in demand for aggregates for infrastructure, large-scale energy, and domestic manufacturing projects. While residential construction demand remains soft, Martin Marietta expects to see a significant boost after interest rates decline, allowing residential construction to recover.

In addition, the company’s leading market position and competitive advantages support MLM’s ability to raise prices, further enhancing profitability growth. Overall, over the next several quarters, the company foresees significant tailwinds from reshoring of U.S.-based manufacturing of critical products (e.g., semiconductors, batteries, and EVs), industrial construction strength along the Gulf Coast, renewable energy projects supported by IRA credits, and continued proliferation of data centers.

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Strong and Stable Earnings Growth

Martin Marietta boasts industry-high profitability and capital efficiency metrics. Its ROA, ROE, and ROIC ratios are in the top 10% of the U.S. Construction Materials industry. While MLM’s free cash flow (FCF) margin comes “only” in the top 20% of its industry, its operating and net profit margins are in the top 5%.

The company’s revenues have increased at a CAGR of 14.4% in the past three years (post-pandemic), while its adjusted earnings-per-share surged at a CAGR of 41%. Despite the cyclical nature of its business, which is dependent on the domestic macroeconomic conditions, Martin Marietta’s earnings grew at an annualized rate of 19.3% in the past decade, demonstrating a significant amount of stability amid growth rates that are on the higher end of its industry.

Last year was record-breaking for MLM on many metrics, despite restrictive monetary policy, a housing slowdown, and rising geopolitical tensions. The company’s revenues grew by 10%, net earnings from continuing operations surged by 40%, and Adjusted EBITDA jumped by 33%. Meanwhile, gross profit per ton in aggregate business expanded by 46% from the previous year.

In Q1 2024, the company extended 2023’s successful performance. Despite a decline in sales caused by a slowdown in residential and warehouse construction, as well as significant weather challenges, the company confirmed its positive outlook for the rest of the year, raising its sales, EBITDA, and EPS guidance. This update reflected continued pricing momentum, as well as the rising demand arriving from record federal- and state-level infrastructure investments, large-scale heavy industrial activity, data centers, and energy projects.

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Total Return in Focus

MLM stock began trading on the NYSE in 1994; today, the stock is a member of the S&P 500 index. The stock has returned ~25% over the past year, slightly outperforming the benchmark index. MLM reached an all-time high in April this year, after which it gave back a part of the gains. The decline from a record high has decreased MLM’s valuations, providing an attractive entry opportunity. However, the stock seems to be back on investors’ radar lately, staging a strong comeback over the past two weeks, meaning that this opportunity may not last much longer.

Meanwhile, Martin Marietta is attractively valued, with its current P/E ratio of 16.4 reflecting a ~25% discount to the Materials sector’s average; it is about 40% below MLM’s long-term average. The company’s valuation comes at the bottom of the price range for its peers in the industry. In addition, based on the projected cash flows, the company seems to be ~15% undervalued.

According to analysts, the stock is now trading near the best valuation in a decade. As the company is increasing earnings faster than most S&P 500 members outside of the IT sphere, it could continue to outperform the S&P 500 over the next several years.

In addition to the stock price appreciation potential, MLM rewards its shareholders with dividends, which it has consistently paid over the last 29 years, raising them annually over the past eight years. MLM has been increasing the dividend amount by an average of 6.3% per year over the last decade. While Martin Marietta’s current dividend yield is low at 0.53%, its stellar finances and robust earnings growth prospects support the outlook for further dividend growth in the years to come.

In addition, Martin Marietta has a long-term share repurchase authorization, under which the company performs opportunistic buybacks. Throughout 2023, MLM repurchased its shares for the amount of $150 million, with another $150 million added during the first quarter alone.

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Investing Takeaway

In our view, Martin Marietta Materials is one of the best plays in the Materials sector, supported by its winning business strategy, financial strength, robust delivery, and optimistic prospects. Despite what looks like the beginning of a strong rebound, the company’s stock is still trading near its cheapest level in a decade, providing long-term investors with an attractive entry point. Considering all these factors, we believe that the stock can be a valuable addition to the Smart Investor portfolio.

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New Sell: McKesson (MCK)

McKesson distributes pharmaceuticals and provides health information technology, medical supplies, and care management tools in the U.S. and internationally. The company is the nation’s largest drug distributor, delivering a third of all pharmaceuticals used in North America.  The U.S. pharmaceutical business comprises 90% of MCK’s total revenues and has been a significant contributor to sales growth.

Over the years, McKesson’s revenues have been growing at an impressive average rate of 7.1% per year. However, the past three years have seen a worrying trend of negative EPS growth, which has declined at a CAGR of 7.5%. Moreover, while the company’s sales continue to get a boost from the sale of GLP-1 weight-loss drugs, it expects that the demand will slow down in FY25.

Despite the company’s growing revenues, its adjusted operating margin has also been shrinking – from 1.4% in the fourth quarter of FY23 to 1.3% in Q4 FY24. Notably, the fiscal fourth quarter was particularly challenging as the company’s revenues and adjusted earnings fell short of Wall Street estimates, leading to a weaker earnings outlook. Higher operating expenses are weighing on the company, highlighted by a bad debt provision of $725 million related to the bankruptcy of RiteAid, which was a major customer of McKesson.

Wall Street analysts still rate MCK as a “Buy”, but their average price target for the next 12 months implies a very modest upside of 7.6%. This is based on a shaky earnings growth track record in the recent quarters, as well as the fact that the stock is currently trading near its all-time high, indicating limited room for growth. Furthermore, some insiders have been selling the stock over the past three months, indicating weaker confidence in the company’s near-term prospects.

While the stock has outperformed some of its peers and the S&P 500 year-to-date, MCK may encounter downward pressure in the next several months. Therefore, we believe that it’s prudent to sell the stock, locking in the gains.

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Portfolio Stocks Under Review

❖ PayPal (PYPL) remains under review despite the dissipation of concerns regarding the potential impact of Apple’s features simplifying money transfers and expanding BNPL options. Although we believe that PayPal’s new management is capable of dynamizing the payments giant once more—and we have welcomed the news regarding its AI-powered advertising business plans—we have yet to see a strategic turnaround that would help it increase FCFs and maintain (much less grow) its market share. Analysts from Susquehanna have recently raised their rating on PayPal from “Hold” to “Buy”, saying that the company is now focused on profitable growth, which they believe will expand margins. Although this process could take some time, we are awaiting the company’s Q2 earnings report on July 30th for some signs that PYPL is indeed back on the growth path.

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Smart Investor’s Winners Club

*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.

Despite the volatility in large-cap tech shares, the last few days were very positive for the Portfolio overall. As a result, the list of Winners has expanded to 15 stocks: SMCI, GE, AVGO, ANET, TSM, EME, AMAT, ORCL, APH, ITT, GD, PH, TPL, VRTX, and CHKP.

The next in line to enter the lucrative club is AIT with a gain of 27.9% since purchase. Will it close this minute gap, or will someone else outrun it to the finish line?

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Smart Investor Portfolio

 Portfolio YTD Return
Portfolio Volatility (Beta) Portfolio Dividend Yield
25.48% 1.15 0.64%

 

New Portfolio Additions

Ticker Date Added Current Price
MLM Jul 17, 24 $577.46

New Portfolio Deletions

Ticker Date Added Current Price % Change
MCK Dec 13, 23 $583.95 +26.36%

Current Portfolio Holdings

Ticker Date Added Current Price % Change
SMCI Nov 8, 23 $876.96 +243.37%
GE Jul 27, 22 $162.85 +191.43%
AVGO Mar 22, 23 $169.38 +168.47%
ANET Jun 21, 23 $358.23 +136.44%
TSM Aug 23, 23 $186.04 +98.36%
EME Nov 1, 23 $390.88 +89.41%
AMAT May 31, 23 $245.84 +84.43%
ORCL Dec 21, 22 $142.61 +74.98%
APH Aug 9, 23 $70.41 +59.23%
ITT Oct 18, 23 $142.72 +49.43%
GD Dec 22, 21 $291.59 +43.10%
PH Oct 11, 23 $568.68 +42.95%
TPL Jun 5, 24 $824.07 +40.99%
VRTX Aug 2, 23 $488.98 +40.62%
CHKP Jul 19, 23 $174.70 +37.21%
AIT Dec 6, 23 $210.71 +27.90%
HWM Apr 10, 24 $81.38 +23.58%
ADBE May 29, 24 $566.54 +18.42%
DELL Mar 27, 24 $134.26 +17.10%
REGN Feb 7, 24 $1094.99 +16.76%
PNR Jun 26, 24 $83.28 +12.07%
KKR Jun 12, 24 $116.67 +5.86%
DOV May 8, 24 $191.49 +5.31%
EMR May 22, 24 $118.87 +4.55%
AIG May 1, 24 $78.29 +3.96%
IBKR Jun 19, 24 $123.66 +3.27%
MRK Jul 10, 24 $125.44 -0.48%
ABNB Jul 3, 24 $151.26 -2.00%
PYPL Apr 17, 24 $61.81 -2.55%
V May 15, 24 $269.25 -3.06%

 

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Disclaimer

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