Martin Marietta Materials Inc (MLM) 2006 Q2 法說會逐字稿

Good day, everyone and welcome to this Martin Marietta Materials Incorporated conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the conference over to the President and Chief Executive Officer, Mr. Stephen Zelnak. Please go ahead, Mr. Zelnak.

Thanks for joining us this afternoon. I have with me Anne Lloyd, our Chief Financial Officer.

We had a very good second quarter in spite of lower than expected volume in our Aggregates business. Net sales of $518 million increased 9% over the prior year period while net income of $76 million was up 23%. Consolidated operating margin of 23.1% increased 220 basis points. Earnings per diluted share of $1.63 increased 25% as we repurchased 500,000 shares of common stock at an average price of $86.37 per share during the quarter. In our Aggregates business, we experienced decline in volume of 2% versus the prior year period which was below our expectations. Extremely wet weather in eastern North Carolina and the mid Atlantic states, particularly in June, had a negative impact on our shipments. We also experienced significant rail transport shortages into Houston during the quarter. Pricing was positive with a 12% rate of increase reflecting strong demand in the southeast and southwest. The Aggregates product line gross margin increased 220 basis points as we continued to do a good job of managing our business in a difficult cost environment. Our Magnesia Specialties business had another outstanding quarter with both our line and Magnesia chemicals product lines performing extremely well. Net sales of $36 million increased 21% over the prior year period while earnings from operations of $10 million increased 56%. Our magnesium hydroxide slurry products for water treatment and for the pulp and paper industry continue to show excellent growth. Our structural composites business had a reduced loss of $3 million versus $4.7 million in the prior year with the difference being related to lower inventory write-downs. Although we get high marks from existing and potential customers with our products, we continue to struggle to convert favorable customer reviews into a steady flow of revenue. We will review this business at the end of the year to determine how to approach it in the future.

Year-to-date, net sales for the corporation of $943 million is up 16% while earnings from operations of $171 million is up 43%. Earnings per diluted share of $2.29 is a 59% increase over the prior-year period. Operating margin 18.1% is up 350 basis points. Both our Aggregates and Magnesia Specialties units have posted record revenue, operating earnings, and operating margin.

In July we brought online our new 500 million ton per year facility at North Troy in southern Oklahoma and our new Three Rivers plant near Paducah, Kentucky, which has 8 million plus tons of annual capacity. These two plants represent almost $90 million in capital investment. The North Troy location will rail material primarily to Dallas, but also to Houston. Three Rivers is our major barge location serving 14 states, including Louisiana. During the second quarter, we had more start-up costs than expected with these locations along with our new sand plant in Des Moines. We will continue to fine tune the plants in the third quarter with steady state operation expected in the fourth quarter. The new tonnage at North Troy and the expected cost reduction at Three Rivers should contribute positively to earnings in 2007.

Given the turmoil in the stock market since May and the federal reserve's continued push on interest rates, we have taken a hard look at the economic environment and outlook for our Aggregates business. On residential, we had probably been the most negative in our sector on the overall market. Unfortunately, our view looks about right. Housing should be down 10% or more this year followed by a further decline in 2007. In our principal markets in the southeast and southwest, it looks like the decline will be about half the national rate or less. Nonresidential construction appears to be solid at this point. Infrastructure is generally positive with strong programs in Texas, Oklahoma, Florida, Georgia, and Indiana. Both North Carolina and South Carolina are struggling with cash flow issues, which is reducing the amount of work left to contract. North Carolina is set to transfer $170 million from its general funds surplus to highways to fund maintenance. The state also has $900 million in Garvey Bond authority which they should begin to use later this year. At the federal level, both the house and the Senate have locked on to $3 billion increase in funding in fiscal year 2007 which should be helpful. We continue to see many local initiatives to fund both roads and schools in high-growth areas.

With respect to pricing, we were a bit more successful with midyear increases than we expected. The most notable increase was in the Dallas-Fort Worth area, which ranged from a $1.00 to $1.50 a ton, depending on location. This is particularly noteworthy given our 5 million tons of new capacity at North Troy aimed at serving this high-growth area. We also put in place some significant increases in North Carolina and have indicated to our customers in that state that they should expect an increase of about 15% in January 2007.

Overall, we believe housing construction will continue to be negative while non residential and infrastructure construction should be positive going forward through 2007. With less than 20% of our volume used in residential construction, our downside risk to large volume declines tends to be limited. The end result of the current environment should be a little less volume and a bit more price than our earlier expectations. On the positive side, new capacity plus cost reduction at the major new locations should give us earnings momentum going into 2007. Also, we will begin to receive the first shipments of some 50 new barges we have ordered in early 2007, which will be targeted toward Louisiana opportunities. The major risk in our view continues to be the actions of the fed both in tone and absolute terms with respect to interest rates. Based on our current view, we expect the third quarter earnings to fall in a range of $1.70 to $1.90 per diluted share versus earnings of $1.62 last year which included a one-time positive tax adjustment of $0.15 per share. For the full-year 2006, we expect earnings to fall in a range of $5.30 to $5.60 per diluted share.

At this time, I'd be pleased to take any questions you may have.

[OPERATOR INSTRUCTIONS] Our first question will come from Jack Kelly with Goldman Sachs.

Good afternoon, Steve. Just looking at the volume shortfall which you alluded to, can you give us some idea what the Houston bottleneck cost you and maybe just a progress report, where are we now on kind of de- bottle-necking that? And secondly, the weather impact, particularly in North Carolina?

Yes. Houston volume was troubling. We were about 500,000 tons short in Houston for the quarter, all based on UP's inability to move it. And I'm not going to tell you what the margins are there, but let's just say that was a substantial detriment to where we expected to be, certainly in that market. Eastern North Carolina and mid-Atlantic, as you know, North Carolina is a very good spot for us and anytime we -- you get hit there, that's costly to us. We tried to do some estimation of what the impact of that was, and if you recall in the first quarter, we had a clear upper on weather. And we had characterized that somewhere between $0.06 and $0.10 a share. I will tell you, in the second quarter, we reversed that out. It's somewhere in that neighborhood based on our calculations. So I think as we hit the midpoint of the year, we're basically right where we ought to be if you even the weather out.

Okay, great. Then in terms of the North Carolina specifically, you mentioned some things going on with regard to funding. The highway contracts awarded there for the first six months were down about 47%, but June was up 15%. Is June reflecting kind of some of these -- this money getting moved into the transportation fund or can we expect a turnaround in that business in the next couple of months?

Actually June really does not reflect the appropriated money moving in yet. That will come later. North Carolina has been in a letting lull based on cash flow difficulties. In fact, quite honestly, they just misestimated their cash-in and their cash-out and they had to balance it out. The legislature attempted to address that in this latest session and the $170 million that goes towards maintenance is the best money we ever see because it's very heavily weighted toward Aggregate. So we would expect in the third quarter to see that begin to be let and pushed out. That will carry over into '07. Likewise with the Garvey Bond funding, that authority is there. It's a matter of them just picking their timing when they want to begin to roll it out. We're told second half that they're going to roll it out.

Just a final question on pricing. You had mentioned that 15% number in I guess just North Carolina. Is that what's going to be -- you're going to try to implement in January '07, Steve, or is that going to be the collective price increase year-over-year based on what you did this year plus what you do in in January where it's going to be effectively 15% to the customer?

That will be the effective increase. We won't implement increases that are very substantial, one-one. What we have done is talk to the majority of the customer base, certainly all of the larger customers, and given them an early head's up on that. What we would like to do is cut down on carryover jobs, any protection on jobs they've already quoted. We're trying to minimize the carryover. We expect we're going see an effective price increase in North Carolina next year something on the order of about 15%.

So that would include the carryover of '06 whatever you implement next year?

Yes.

And did you think as you look through the rest of your markets without giving us specific numbers, do you think the rate of increase you're going to implement in January of '07 will be greater than what was implemented in January of '06?

The answer to that is no. Certainly the Midwestern markets in the automotive areas of north central has weakened somewhat. You're not going to see large-scale increases there. I would expect that increases will continue to be strong in the high-growth markets in the southeast and southwest.

Okay. Thanks.

Moving on to Arnie Ursaner with CJS Securities.

Good afternoon. Couple of questions. You indicated in your release you were successful getting midyear price increases better than you had expected. What did you end up getting at mid-year on average?

Not something that -- not a number that we're going to give you, unfortunately. I'll keep that one to myself. But there were two places where we were able to implement increases that were notably better than we had expected. One was Dallas, which I highlighted for you and gave you the magnitude at $1.00 to $1.50 a ton there. That's very significant because that's a relatively low price market. And the other was North Carolina where we got some mid-year increases. Not across the board, but for the majority of the customer base we were able to implement some mid-year increases we did not anticipate. Those are the two areas of significant impact of above what we had planned.

And just remind me again in Texas, the $1.00 to $1.50 is on a basis of somewhere in the range of $5.00 to $6.00?

That's correct.

Okay. And then following-up on --

Let me qualify that, Arnie, it's that at the quarry level. If you're coming on rail from a distribution yard, that number will basically be doubled because of the freight. So some of the supplies from distribution yards, some of it applies to FOB sources.

Okay. And obviously you've been using free cash flow when you have it to buy back shares. Can you remind us what your expenditures are like to be? What they are year-to-date, what you expect them to be in the back half of the year?

Second quarter was likely our peak CapEx quarter for the year, primarily because we had those two big projects I cited that we're finishing up. And I think we're about $158 million through the first six months. Estimate for the year is that we're probably going to spend another $90 to $100 million.

My final question is related to Magnesia Specialties. Your margins there continue to improve very impressively. What is the utilization you're running at now? Can you comment on price increases and where you think margins may be heading in that business over the next 18 months or so?

The interesting thing about the capacity utilization is as we continue to make adjustments in our product mix at Manistee Chemicals Plant, we continue to create more capacity opportunity. We're running probably somewhere in the neighborhood of about 85% to 87% or 88% and we've got some incremental projects that will probably expand the capacity a little bit. We've got some room to push more product through. It's turned into a growth business, and it's a growth business where the pricing opportunity for most of the products has been double digit. We think we're going to have another strong pricing year next year. We think we're going to have another strong volume year next year and certainly we're getting some pretty attractive margins in both the chemical side and the lime side. We're quite pleased with what we've been able to do with that business. As I've said, the chemical side is truly a growth business. We see a lot of opportunity there.

Okay. Thank you very much.

Jack Kasprzak with BB&T Capital Markets has the next question.

Thanks. Good afternoon, Steve. I was wondering if you could break down the sales of Magnesia Specialties and composites, if you have those numbers in the quarter?

Composites was basically de minimis, you can estimate it at less than $2 million. We had indicated in the release at the end of the first quarter that we were going to have very small sales in composites in the second quarter. That's exactly the way it worked out.

Okay. My second question is just on the pricing dynamic in Aggregates, certainly if you look over a long period of time it's been stable, generally up every year. But over the last year or 18 to 24 months it's been above historical trend. I think there might be some concern that, like everything else, reversion to the mean could occur and certainly there's a big element of demand here that's at play. I was wondering if you could give us your view on whether you think that Aggregates pricing, the environment is -- what's changed and what's more permanent or secular versus what's more cyclical?

Well, certainly what's changed is gradually over time you continue to grow the business. We talked about it being a relatively slow-growth business, but it grows. And what's happening is that the supply, particularly the ability to put reserves into play at the right locations where you can supply markets effectively has not grown. It's back to that math that we show a lot that shows where the reserves are that feed the southeast and southwest. And all that Coastal plain area where people are moving where there isn't any Aggregate available. So you've really gotten to the point based on a lot of reserves being depleted, reserves being taken out of play with zoning and permitting and also specifications have taken reserves out of play. In Florida in particular, some of the material that used to be used in Florida and even Coastal South Carolina and North Carolina can no longer be used because it really wasn't very good material to start with, they were just faking it, they were using it. And it turned out that finally it was recognized it was inferior material and what you built with it was falling apart prematurely. So as you up the specs, you take a lot of substandard material out and it puts the emphasis of high-quality deposits well located. Those are pretty expensive to put together. Ourselves and other players have spent a lot of time and effort assembling positions and those positions are very powerful. I think back -- too much schooling -- but I actually took, I think, nine economics courses. I'm beginning to believe theydidn't lie to me. Supply and demand do matter.

That's great; that's eight more than I took.

You're a better man than me. You're better off for it.

Just real quick, the 500,000 tons that you think you didn't get in Q2 going into Houston, is that something that you could get in Q3, or you just don't know given the bottleneck problems? It's just pushed out a little farther?

Jack, we just don't know. The rail service has been very erratic and as you know and others, the railroads have more business coming up than they can reasonably handle. And they're having to allocate tracks, they're having to allocate power, and in some cases, cars. We made a big move late last year and with buildout early this year to bring in 780 new cars and significantly increase our car fleet. So we don't have the big issue with cars. It comes down to the railroad being able to supply timely power and trains. That's where the issue is. I can't predict it. We just don't know.

Okay, fair enough. Thanks very much.

We'll now hear from Mike Betts with J.P. Morgan.

Hi, Steve. Two or three questions if I could. The first one, and I'm sure it's a relatively low number, but could you quantify the costs involved, the cost of expectations in getting these two new major capital investments up and running? How much of that hit Q2 earnings?

It wasn't a huge number. It was something on the order of $1.5 to $1.75 million.

Okay. My second question was on share buyback. As you're probably aware, one of your major competitors was much more active in the second quarter than you were, but obviously has less debt on the balance sheet. I suppose two questions. Was there any reason for you not being more active and what kind of debt to cap ratio are you targeting in the medium term?

If you go back over time, Mike, we've been very active purchasing shares now for the last couple of years as opposed to just doing it last quarter. We've been busy with that and it's been a regular part of our program. We determined a couple of years back that we weren't going to let our leverage go down, that we were going to keep our leverage up. We think 30% to 35% is an ideal leverage ratio for a business like ours, 30% to 35% debt to cap. So we've been targeting that way for the last 2.5 years or so. And what we're doing is using free cash flow as opposed to going out and borrowing money because we've kept the leverage up. So to the extent we have free cash flow available, we've prioritized, we're going to fund the business first, all good capital opportunities where we can grow it. And certainly we're at record CapEx, we have plenty of those. And I've mentioned a couple, but we've got quite a few more out there that are in the works. We'll do that. We'll look at any pension needs we have, which will be minimal. And then it comes down to share buyback and dividend increase. I'll say it again, we plan to return the free cash flow that we don't have need for to the shareholder. It's that simple. That's not a new program.

Okay. My next question was if you could just give us some idea of the volumes by region that you often do, the broad regions, how the volume trends were in the second quarter, please?

Yes. Hang on just a second and I'll pull that out. If you take a look at the southeastern area, that was the area that really went very, very well. In the second quarter, volume in the southeast was up about 7%. Demand was just extremely strong as a function of being able to get it to where it was needed, a lot of that being long haul distribution. The shipments in the what we call our Mideast division, which is dominated by North Carolina runs up through the mid-Atlantic and Ohio to Indiana, that was down 7% and that's a reflection of the weather in mid-Atlantic and eastern North Carolina. It's also a reflection of a weaker environment in Indiana and Ohio with the automotive problems. And the northwest, which is dominated for us by the farm belt, some weakness there. Particular weakness in the Kansas City area. We were down about 5%. And you're certainly seeing pullback in housing in that area. It's not a particularly robust area most of the time anyway. It tends to be dominated by infrastructure. And in the southwest, a lot of this related to shipping difficulties. We were off about 5%. The market would have supported significant growth in the southwest. We just had trouble getting it to market. Is that helpful?

That's very helpful, Stephen. Just on that last question. With the rail situation, is there any sign of this improving? The situation seems to go on quarter after quarter. Is there any reason why it should be better looking forward?

Well, it seems to bounce around by carrier. What I would tell you right now is that service on the CSX is improved. They seem to be functioning better, moving traffic more regularly and we've seen some pickup in terms of filling orders there, which we're pleased with. We've seen deterioration in the Norfolk Southern, which is unusual because typically they're pretty effective as a carrier, but in the second quarter they were not as effective as their norm. The UP, as I mentioned, really struggling. The BN performing reasonably well, but we're going to put a much bigger burden on the BN going forward because that new quarry at North Troy with the 5 million tons of new capacity, virtually all of that tonnage is going to go out on the BN, so we're really going to test BN. As far as some quick fix, wave-your-magic-wand, I don't really think it's there. All the carriers are working really hard trying to improve their flows and that's really the key.

Okay. That's great. Thank you very much.

Clyde Lewis with Citigroup has the next question.

Good morning, Stephen and Anne. A couple of questions if I may. Firstly on acquisitions, I know it's not a key part of what you want to do at the moment, but are you being tempted at all to maybe pick up a quarry or two that are maybe coming up for sale?

Well, I would change the phrasing on what you said. You said, it's not a key part of what we would like to do. Don't ever think we wouldn't like to do them. We've done 62 of them going back to becoming a public Company. We like to do them when the opportunity is right. We continue to struggle finding things that create value as opposed to the internal CapEx. And we weigh that out. We have looked at many and we continue to look at many, so there's no lack of looking. But when we get down to it with some of the EBITDA multiples that people want for these properties, you start running the internal rates of return and you run those and you look at single digit numbers and then you look at your internal CapEx projects and you're looking at 25% plus numbers and then you look at share buyback based on what we think our Company is doing and set up to do, it's pretty tough to want to invest in single digit IRR acquisitions. And a lot of the pricing, certainly as we have looked at it, that's what you get. So we'll continue to look. At some point that will change, it always does. And when it does, don't be surprised if we're not back in there as an active buyer.

Okay. Second question I had was on the flow through of prices. I think back in May with all your Q1 numbers, you indicated you would expect 2007 prices to be benefiting by 4% to 7% because of the sort of momentum you've had in this year's price rises. Have you changed at all from 4% to 7% at all?

4% to 7% is probably your number, what I said is probably mid to single digits, I'll let you frame that however you want to. The reality is we did get more than expected which I've highlighted. Does it change mid-single digits? No. But it certainly does give us good momentum and some nice tail wind going into 2007.

The last one from me was on the shipping capacity that you're bringing onstream. Has the timing changed for when you expect that to come on stream at all?

You're talking about deport ships?

Yes.

No. We're looking at getting some additional capacity flowing in August and at that point in time, we're going to be balanced out very nicely with long-term agreements on our shipping out of both Nova Scotia and the Bahamas. And the next thing we'll be focused on -- we've just completed a docking project at Nova Scotia, which gives us more stockpile space and a better docking facility. We'll be focusing next on higher speed load out and probably enlarging the capacity of that quarry to go with it.

Okay. Thanks very much.

We'll now hear from David Macgregor with Longbow Research.

Good afternoon, Stephen. I was wondering if you could help me sort through the puts and takes on 2007 volume growth. You've got new capacity, ramping, but you've got shipping capacity issues you're struggling through, market conditions, there's competitive issues. Put it all together for us, if you could and just give us a sense of what we should expect in terms of 2007 volume growth?

Too early for that. We won't give you those kinds of numbers until we get late in the year. We've just tried to be directional and directional is housing down again. Certainly, you can read the home builder's releases and that would lead you to that conclusion pretty quickly. Fortunately, the markets we're in seem to be holding up quite well.

Don't have a lot of housing exposure?

Yes, we're pretty pleased with that. And infrastructure and non-res continue to look pretty good.

What is the -- in terms of 2007 from the new capacity, what is that going to give you in terms of total -- if you covered this earlier, I'm sorry, I got on late -- what will that give you in terms of incremental capacity year-over-year?

The big change is going to be the North Troy capacity in Oklahoma that we bring in.

That's 5 million tons?

5 million tons.

And you've got Three Rivers, how much is that?

Well, 3 million tons -- excuse me. Three Rivers. We'll take a facility that's been doing between 5 and 5.5 million tons and ramp it up to 8 plus. What we ramp it to depends on what the market demands, what it can bear; we're permitted to 12 million tons.

To 2.5 to 3 there?

Yes. But I need to qualify that for you so you understand what we're doing. We'll be coming out of a facility and consolidating to Three Rivers. And the big play at Three Rivers initially is not going to be on the volume, it's going to be on significant cost reduction. We're going to be running this -- at Three Rivers by itself, we've run three plants. And then we run an additional plant in Illinois. And we'll be consolidating all of that into one facility, running 8+ million tons with one big operation with dual high-speed load outs, so highly automated facility.

Can you quantify the potential cost savings for us?

I won't now. Certainly we know what the target is. I may later in the year after we shake this plant down and know exactly where we are.

And the Des Moines sand plant, what's that going to give you in terms of incremental volume?

It's not big volume, it's about a half million tons, but that's a market where sand is short. Have some very attractive margins associated with it.

Can you get into the west Chicago market from there?

No.

Okay. Long haul.

Not unless we've got a dirigeable to try to lift the capacity.

[OPERATOR INSTRUCTIONS] We'll now hear from John Fox with Fenimore Asset Management.

Hi, everybody. I just had two questions left. One is, I seem to remember a period of time in the second quarter, Houston had some flooding, a lot of rain, I just wondered if that impacted your shipments at all?

They did have two major rain events down there and certainly at the time, those impacted shipments. But the key issue down there was just very simply we couldn't get the material down there we had to market for.

And that was transportation related?

Yes.

Okay. And Steve, I had a question, if housing is down 10% this year and some number next year continuing to decline, why wouldn't that pressure Aggregate prices as that demand comes out of the system?

Well, it depends on where you are and who your customers are.

Right.

The place where -- if you look at the housing sector, you've got a couple of component that goes into it. Ready-mix concrete is a big factor there, and then you have a fair amount of material that is back fill materials for pipelines, possibly septic if it's on septic, just a fair amount of miscellaneous material. With respect to the ready-mix, it tends to be customer alignments as much as anything because there are certain customers, ready-mix customers, who cater to the res market. Others that cater more upscale to non-res, bigger projects, high rise, where you need much more equipment investment. You can't just flip from one to the other. It becomes a question of how people's individual quarries are positioned, who their customers are market by market. It's not like you wake up on a Thursday and say, jeez, I'm going to go grab a piece of somebody's market share. It does come back to positioning physically and geographically and the customer base you serve.

When you get down into Florida, it's a little different issue. The concrete business in Florida is limestone business. Our predominant material going into Florida is in fact granite coming out of Nova Scotia, out of Georgia, and out of South Carolina. And that goes predominantly in the infrastructure. So it's pretty tough to impact us in a big way. We've got a special niche down there that seems to work very well and there are some advantages to our product. Low absorption of asphalt with asphalt at today's price is $400 plus. That can be big numbers quick just on absorption. And also on drying costs with fuel for the drying, limestone tends to be porous and absorb a lot of water. It's really very market specific as opposed to some generality where you can just intuit.

Okay. Thank you.

[OPERATOR INSTRUCTIONS]. Greg Pools with Metropolitan Advisers.

My question was answered.

Mr. Zelnak, it appears we have no further questions. I'll turn the conference back to you for closing or any additional remarks.

Thanks for joining us. Obviously an interesting marketplace. We've tried to define it for you as we see it. A lot of capacity expansion going on in our Company. A lot of effort targeted at driving out costs, particularly with plant innovation. We've indicated what we're going to do with excess cash. We've been doing it for a long time and we intend to keep doing it. I think you understand our marketplace, the lay of the land, and our game plan probably pretty thoroughly. Look forward to getting with you again at the end of the next quarter. Thanks.

Thank you, Mr. Zelnak. Ladies and gentlemen, that does conclude our conference for today. On behalf of Martin Marietta Materials, I would like to thank you for your participation. Enjoy the rest of your day.