Granite Construction Incorporated

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Granite Construction Incorporated is one of the largest diversified construction and construction materials companies in the US, engaged in the infrastructure industry including construction of highways, roads, bridges, tunnels, rail lines, etc., as well as mining of aggregates.

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.

Business Overview: Granite Construction Incorporated is a leading infrastructure and construction materials company in the United States. The company operates in two primary segments: Construction and Materials. The Construction segment focuses on a variety of civil infrastructure projects, such as highways, roads, bridges, tunnels, mass transit systems, aviation facilities, and airports. The Materials segment is engaged in the production and sale of a broad range of construction materials including crushed stone, sand and gravel, recycled concrete, asphalt, and concrete-related products. They are primarily a heavy-civil contractor and materials supplier for public agencies.

Revenue Distribution

Construction: Forms the majority of revenue through contracts and various projects.
Materials: Significant and complimentary as it supplies the materials for the construction segment. Also directly sells to other companies.

Industry Trends

Infrastructure Investment: Increasing government spending on infrastructure projects and the need for improvements in existing infrastructure.
Inflation: Prices for building materials and fuel can fluctuate and impact margins.
Labor: Competition for skilled labor within the sector.
Project Complexity: Projects are becoming increasingly complex and require sophisticated processes and technology

Competitive Landscape: Granite operates in a highly competitive environment, marked by numerous national and local players. Companies such as Fluor, AECOM, Tutor Perini, Martin Marietta and Vulcan Materials directly compete for similar business. The industry is fairly fragmented, so it makes it hard for any single company to dominate. Competition for projects is usually fierce, with many companies vying for contracts.

Differentiation: What is often used as a competitive advantage, such as good relationships with clients, skilled personnel, and large geographic scale can be easily replicated, but hard to maintain.
Client Power: A large proportion of customers are government agencies, which means that those customers have buying power and may seek low prices

What Makes the Company Different Granite operates in a vertically integrated fashion, being involved in both the construction and the materials sector. It has a long history of operating in California and other areas of the US. The company has also developed strong relationships in many places.

Financials Overview: Granite’s financial performance is a mixed bag. Looking at the financials, we can see that the company’s revenue in recent periods were $913.6M, $1.01B, $1.09B for their respective last three quarter ends (Sep 2022, Jun 2023, and Sep 2023) showing slight growth.

Gross Profit: Is quite volatile with 10.2%, 6.6%, 8.5% for 2021, 2022 and TTM respectively.
Net Income: It has fluctuated significantly with a net loss of $10.8 million in 2023 vs a profit of $14.9 in 2022. Net profit margin was very low during these periods
Cash Flow: Free cash flow is highly cyclical, and the company has had large cash outflows during their acquisitions and investments in CAPEX.
Debt: Company has total debt of $1.11B as of the latest period, and a debt-to-equity of over 1x.
Operating Margin: has varied between 12% and 5%, but is on a downtrend.
Backlog: The backlog of contracted projects have been declining, from 6.2 billion in March 2022 to 3.3 billion by December 2022

Recent Controversies and Problems: There has been concerns of the business’s profits being unstable, and have also experienced significant loss in sales and backlog. For example, there was a revenue shortfall in the Q3 2022 earnings as they recognized that their materials revenue was lower than anticipated due to lower volumes. While they were able to win a huge amount of projects, margins had been an ongoing issue. Furthermore, debt levels have also been a concern, with concerns around the large amount of acquisitions the company has undertaken. The stock price has been highly volatile due to this uncertainty.

Management Comments: The management has talked a lot about improving their margins by working more efficiently, and they expect revenue to increase due to government spending. There was also a commitment to managing costs and leverage while maintaining market share.

Moat Assessment: Based on the analysis, Granite Construction has a weak economic moat, deserving a rating of 2 out of 5. There are some aspects that might offer a moat, but these sources are easily replicable.

Scale Economies: Granite’s large size and presence in several markets do not necessarily translate into significant competitive advantages as the industry isn’t a winner-take-all market.
Switching costs: Switching costs are not very high for their customers, as there are many other competitors, and bidding is based on pricing and expertise which means its easy for customers to switch.
Network effects: It does not benefit from any strong network effects as most projects are on specific areas and the network does not benefit as it grows.
Intangible assets It does have a brand name that is well established, but its impact on pricing power is not significant.

Moat Risks:

Increased competition: If competition rises this will reduce returns.
Rising Input Costs: Higher costs of materials and fuels could make the company less profitable.
Project execution risk: Failure to execute a project properly can severely harm profitability and company reputation.
Cyclical demand: The industry is heavily reliant on macroeconomic conditions.

Business Resilience: While the company may be affected in a recession, they tend to be able to survive due to their ability to win government projects. The high fixed costs and their highly leveraged balance sheet makes the company not that resilient.

Understandability: The business earns a rating of 3 out of 5 for understandability. The business and its business model are relatively straightforward to understand. However, there are a few intricacies due to the large number of operations, the project lifecycles and their various contracts. Furthermore, the accounting aspects can be quite complex due to accounting changes and acquisitions.

Balance Sheet Health: Granite’s balance sheet health is rated 3 out of 5. Debt levels have been high and have recently been increasing. However, their asset value is still decent, and they can pay off most obligations. While not terrible, they should focus on deleveraging more.

In conclusion, Granite is a leading construction company with a weak moat. The industry has increasing competition and volatility, and the company has not managed its finances well. While a turnaround seems possible, it’s far from a certainty.