Arcosa, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Arcosa, Inc. is a provider of infrastructure-related products and solutions, with leading positions in construction, engineered structures, and transportation markets in North America.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Arcosa’s business is primarily a materials provider to the construction, infrastructure, and transportation industries.

Let’s dive deeper into Arcosa and its current standing:

Business Overview

Arcosa operates through three main business segments:

  1. Construction Products: This segment produces and sells natural and recycled aggregates, specialty materials, and construction site support equipment. They are a large producer of aggregate materials in North America. Key products include crushed stone, sand, gravel, and concrete products.

  2. Engineered Structures: This segment primarily manufactures and sells steel and concrete structures for infrastructure applications, including utility structures, wind towers, and other related products. It’s often seen as a more specialty manufacturing segment of Arcosa. They supply these structures for transmission, distribution, and telecommunications.

  3. Transportation Products: This segment manufactures and sells inland barges, fiberglass barge covers, and related products to the transportation industry, which are mostly used for the transportation of aggregates and other commodities.

Arcusa primarily focuses on providing the materials needed for various types of infrastructure.

Competitive Landscape

The competitive landscape is different across these segments.

  • Construction Products: This segment is highly fragmented, with numerous local and regional players. Pricing and supply are driven mostly by geographic and local factors, with limited competition from large national players. The moat is related to having a resource base close to customers and efficient local distribution.
  • Engineered Structures: This industry is characterized by a few larger players due to the high capital intensity and specialized production capabilities. The demand is linked to government infrastructure spending and long-term projects. This is an industry where relationship, track record and reliability are significant.
  • Transportation Products: This segment has fewer, larger players, requiring significant capital for production, including steel. Here, relationships and established track records, with the ability to produce large volumes are key competitive factors.

Economic Moat Assessment: 2/5

Arcosa possesses a narrow moat. Here’s why:

  • Intangible Assets:
    • While Arcosa has several brands (e.g. In-land Barge), their influence is somewhat limited, especially within the commodity-driven aggregates and the Engineered Structures segment.
    • Their manufacturing processes for some products are also difficult to replicate.
    • The scale and location advantages are very specific to certain regions and market niches. The regulatory approval they have for quarries and other mining operations, however, is limited as they can be transferred with sale of the land to another company in most situations.
  • Switching Costs: Switching costs in most of Arcosa’s businesses are generally low. Customers can easily buy aggregates, components, or transportation solutions from a different supplier with little pain. Some clients, particularly for its Engineered Structures, might be somewhat sticky due to the long-term nature of the projects. Overall switching costs are low to moderate.
  • Network Effects: Network effects are not a significant source of competitive advantage for Arcosa. While having more branches and a greater geographical footprint can help reduce transportation costs and make the company more accessible to customers, this doesn’t create a strong network effect in this case.
  • Cost Advantages:
    • Arcosa benefits from location and scale advantages in the aggregate business. The cost of transporting aggregates is very high and therefore local providers that are close to projects have an advantage. But those advantages, although strong, are very geographically limited.
    • Their Engineered Structures and Transport businesses are dependent on raw materials (including steel and other commodities) costs as well as on shipping and transportation costs. They don’t have any control over those.

While Arcosa exhibits characteristics that could lead to a sustainable advantage in certain regions or niche businesses, its overall moat is not particularly strong or wide.

Financial Analysis

Here’s a breakdown of Arcosa’s recent financial performance, focusing on what’s really important:

  • Revenue Trends: Arcosa has seen its revenues fluctuate. 2022 revenues were $2.3B, up 18% from 2021. 2023 saw revenues decline to $2.2B. Recent quarters (the latest ones until September 30th, 2024) show an increase in revenues vs 2023 but with a slow down in growth in Engineered Structures and Transportation Segments, where they are seeing reduced volumes of projects.
  • Margins: Operating margins across the segments varies substantially. Construction Products often has the highest and most reliable margins at around 18%. Engineered Structure and Transportation margins tend to fluctuate a lot more, with a trend of declining profits for both of them in the last 12 months. On a full year basis for 2023, operating margins stood at 11% compared to 12.7% in 2022.
  • Profitability: In 2023 Net income fell from $109.2 to $64.6 million.
  • Return on Capital: Return on capital was roughly 9% for 2023 and is projected to be in that range in the foreseeable future. This is not a high ROC and is in line with a company without a wide moat.
  • Cash Flow: Operating cash flows in the company are improving. They were $640 million in the last 12 months until September 30, 2024. This provides ample liquidity for Arcosa.
  • Debt: The total debt is currently around $1.2B (net debt is closer to $900 million). They just increased their credit limit, which is a positive for further growth. Given the level of free cash flow, and its debt being mostly long-term, Arcosa’s debt profile doesn’t represent any major issues for its current financial position and health. Their target Debt-to-EBITDA multiple remains at 3.5x or lower, which it is.

Arcosa’s revenues have shown fluctuations, with improving trends, but recent slowdowns in some areas of the company. Profitability is decent with lower margins in specific segments. Their Return on Capital is not amazing, but cash flows look strong and debt is managed well.

Understandability: 3/5

Arcosa is not a complicated business to understand, but it does have nuances. Here’s why the rating is a 3:

  • The Business Model is Straightforward: They are ultimately a materials manufacturer for infrastructure. What they do is not rocket science, but there are some specificities about how this translates in different types of revenues for different business segments.
  • Multiple Segments with Different Dynamics: A lot of companies operate in different areas, all under one umbrella, and Arcosa is no different. They have three separate divisions with their own economics and competitive structures. While they are related to infrastructure, each has its own characteristics that you need to understand.
  • Some Complexity in the Financials: While ROIC is fairly easy to calculate, some of the accounting regarding different types of leases and tax treatments is less straightforward for a casual investor to understand.

The company requires some effort to understand, but it’s not that challenging.

Balance Sheet Health: 4/5

Arcosa has a reasonably healthy balance sheet. Here’s why I’d give it a 4 out of 5:

  • Reasonable Debt Level: Long-term debt is well-covered by operating cash flows. The Net Debt/EBITDA multiple is at a manageable level, and debt maturities are not concerning in the near term.
  • Solid Cash Flow: Recent numbers show a significant improvement in cash flow from operations, demonstrating the company’s ability to generate cash to support operations and potentially fund growth.
  • Good Current Asset Ratio: Current assets are well above current liabilities for the last few quarters. While there are no hard rules for an acceptable current asset ratio, a ratio of 2 or more is usually seen as a sign of decent financial management. This translates to a business with the ability to comfortably pay off short-term debt obligations.

Arcosa’s balance sheet is reasonably healthy. Their levels of debt, which are mostly long-term, combined with positive trends in cash flow, gives the company ample financial flexibility.

Recent Concerns, Controversies, and Management Perspective

  • Lower Margins and Profits: Lower profits have been a point of concern lately. Arcosa management has commented that they are working to improve margins in the segments that have seen lower profitability, especially in the Transportation and Engineered Structures divisions.
  • M&A Activity: Arcosa has been acquiring companies in the sector, often with high multiples. Management states they will try to optimize performance through synergies and cost savings, but there is always a risk in integrating acquired businesses, and the prices paid might have been on the high side.
  • Geopolitical risks: Arcosa has a concentration of manufacturing and operations in Mexico and South America. Political, economic or regulatory risks in these locations can greatly affect the company’s operations and margins.
  • Interest rate risk: Arcosa’s credit facilities are variable rate. Increasing interest rates will impact the business’s net interest expense. However, management has taken some steps to mitigate that, which will result in a small increase in expenses related to interest rates in 2024.
  • Inflation: While inflation has been lowering, Arcosa remains susceptible to higher prices on the raw materials side, and this might have a negative impact on costs.
  • Slow Growth in Some Sectors: Arcosa is also facing a slowdown in construction. This sector has been a driver of growth, especially for the Natural Aggregates part of the business. This can impact future revenue growth for the company.
  • Slowdown in Steel: Given the recent price increases and oversupply in the steel market, Arcosa has been seeing lower prices for its products. Management is working to mitigate these negative trends by increasing prices to customers or reduce costs in manufacturing.

While Arcosa is taking steps to address the current issues, those might take time to materialize. The company’s dependence on a few particular markets and raw materials creates a susceptibility to those market swings.

Summary

Arcosa Inc. is a company with a narrow moat, driven mostly by location and scale advantages in its aggregates business. The company’s financial metrics are fine, but there is risk in the fluctuating profitability and some overreliance on certain markets. The company’s business, although not particularly complicated, requires some understanding of specific industry drivers.

For a long-term hold, some concerns may be considered. The reliance on government spending, as well as sensitivity to raw material costs are worth keeping an eye on. The company has a manageable debt, but interest costs can increase which is important to watch. Growth initiatives with acquisitions are also a risk- and these should be evaluated in the future, based on execution and whether management achieves stated synergies. Overall the valuation of the business needs to be done carefully with these risks in mind.