Knife River Corporation

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Knife River Corporation is a leading aggregates and construction materials company in the U.S. with a vertically integrated business model, operating quarries and producing construction materials across 14 states.

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

Knife River Corporation (KNF) is a geographically diversified aggregates and construction materials company operating primarily in the U.S., primarily in the states of the Pacific Northwest, Mountain, Central, South, and Southwest regions. The company’s operations are structured into five main segments: Pacific, Northwest, Mountain, Central and Energy Services, each with varying growth prospects, economics and returns. They produce and sell aggregates, ready-mixed concrete, asphalt, cement, and other related products. In addition, they provide contracting services.

Revenue Distribution:

  • Aggregates: These are construction materials such as sand, gravel, and crushed stone. This segment constitutes the largest portion of their revenue, accounting for 47% in 2022.
  • Ready-Mixed Concrete: This business segment produces concrete mixes for construction projects and had 25% of revenue in 2022
  • Asphalt: This includes the production and distribution of asphalt mixes, used in road construction and maintenance and provides 17% of revenue in 2022.
  • Cement: This segment is involved in the production of cement, a key component of concrete. It contributed 4% to revenue in 2022.
  • Contracting Services: This segment involves constructing infrastructure projects and represented about 7% of revenue in 2022.
  • Highly Fragmented Industry: The construction materials and services industry is generally fragmented, with many regional players. Competitive pricing and local relationships are essential.
  • Infrastructure Investment: Government spending on infrastructure is a crucial demand driver for KNF and the industry is expected to benefit from infrastructure bill tailwinds.
  • Commodity Nature of Materials: While products like cement and asphalt are essentially commodities, KNF strives to build moats through a vertically integrated model.

What Makes Knife River Different?

  • Vertically Integrated Model: KNF’s vertically integrated business model from extraction to delivery enables the company to maintain better control over costs, quality, and supply chain operations, and to potentially achieve economies of scale by streamlining operations, and capturing the full profit margin.
  • Geographic Diversity: Having operations across different regions provides some insulation against downturns in specific areas. As a regional player, they tend to have less competition and they have built relationships over several decades which is very difficult to replicate by potential competitors.
  • Proven Track Record: Knife River has a history of growth and a strong management team with a proven record in operating profitably in this industry for years, along with a strategy for value creation.

Financials: In-Depth Analysis:

Income Statement:

The company has seen consistent top-line growth. Here are a few notes, using the data from the latest 10-Q:

  • Revenues: Knife River generated significant revenue in recent periods, with $1.25 billion in revenue in Q3 2023 alone compared to $1.09 in the same period last year.
  • Gross Profit: The gross profit increased to $325.2 million in the current quarter, compared to $277.1 million in the previous year. The gross margin did decline slightly to 23.9% from 25.4% previously, though.
  • EBITDA: The EBITDA margin has slightly declined over the recent quarters. The company reported $118.6 million of EBITDA, a 14.6% margin, versus $132.1 million with 16.2% in the same period the last year.
  • Operating Income: Operating income is $101.1 million for the three months ended September 30, 2023, which is an increase of about $11 million versus 2022.
  • Net Income: Despite the growth in profits and revenues, net income saw a small dip to 82.8 Million.
  • Revenue Segment Analysis: Aggregates and Cement contributed over 57% of the total revenue. The rest is divided amongst ready mix, asphalt and contracting.
Balance Sheet:

Knife River’s balance sheet is generally strong. Here is an analysis of its current data:

  • Assets: Total assets as of September 30, 2023 were $2.8 billion. Notable line items include total property, plant, and equipment of $1.4 billion and goodwill & other intangible assets of approximately $274 million.
  • Liabilities: Total liabilities were $1.1 billion. The most significant components of total liabilities are accounts payable of $370 million and long-term debt of $456.6 million.
  • Equity: Total stockholders’ equity was reported to be $1.7 billion.
  • Capital Expenditures: Capex stands at $115.1 million for the 9 months ended September 2023.
  • Debt Level: Debt levels have been elevated to increase the company’s capabilities, and to help grow the company by acquisitions.
  • Book Value: The book value per share is 29.81$
Recent Concerns / Controversies:
  • Pricing Pressure in 2023: During the earnings calls for Q2 and Q3 2023, the company indicated that pricing across some markets has become volatile. This, together with increasing costs led to lowered margins.
  • Weather: The company’s revenue and margins are significantly impacted by weather, and a rainy season affects production and sales. For example, heavy rains in the Pacific Northwest decreased revenues for that region.
  • Labor: Despite most areas showing stability, lack of labor has become an issue for the south region. The company is working on ways to attract more people.
  • Impact of Spinoff: As an independent company (separated from MDU Resources), Knife River is undergoing a structural change, and must deal with the complexities that entails like the cost of separation and an increased interest cost.
Management Commentary

The management has spoken about its plan to improve profits through several different initiatives.

  • Pricing and Margins: Management will implement pricing initiatives where market dynamics allow and that they are working to improve and maintain margins.
  • Acquisitions: The company plans to expand by finding suitable acquisitions, and has already acquired 3 companies for $110 million in the latest 10-Q filing. These acquisitions will be of regional or strategic companies, and the company believes it is still undervalued.
  • Improving Production Efficiencies: KNF management is always looking to streamline operations and to increase production efficiencies.
  • Focus on Higher Margin Product Mix: the company is increasing focus on higher margin products, which are more profitable.

Moat Analysis

  • Source of Moat: While Knife River possesses some sources of moat, they are relatively narrow. As a commodity producer, the company struggles to create a wide economic moat. Their moat mainly comes from the geographic density of their operations, providing local mini-monopolies. Some of the company’s products like cement and asphalt are commodities which make it difficult to extract a premium from customers.
  • Moat Rating: The moat rating is a 2/5, mainly because of a narrow geographical moat, and an adequate vertical integration moat that may provide them some advantage in pricing. Although these moats are durable, they don’t give enough power to have a large pricing power or consistent large earnings margins.
  • Legitimate Risks:
    • Pricing Power Erosion: Due to the commodity nature of products like aggregates, the company can face pricing pressure from competitors which could shrink margins.
    • Macroeconomic Slowdown: Downturns in the construction industry could reduce demand, leading to revenue declines.
    • Regulatory Changes: Shifts in environmental and safety regulations could raise compliance costs.
    • Geographical Limitations: The local nature of their operations can constrain expansion, while also limiting pricing power if other low-cost alternatives are available in the area.
  • Business Resilience: The company’s ability to quickly adapt to fluctuations in demand has made it a fairly resilient business. They have a vertically integrated business model which may make them more agile. Their management team has great experience in this industry which could help them survive any coming downturns.

Understandability:

  • Rating: The understandability is 3/5.
  • Justification: While the core operations of Knife River, like producing construction materials, are fairly straightforward, valuing the business accurately requires an understanding of industry dynamics, regional markets, commodity pricing, and accounting practices. The financial statements need a good understanding of how to remove non-operational costs and to isolate the operational performance. It is not particularly difficult, but it is more complex than typical businesses.

Balance Sheet Health:

  • Rating: The balance sheet health is a 4/5
  • Justification: While KNF is using debt to expand operations, they are not extremely leveraged. KNF has a decent cash position, and current assets are double of current liabilities. This signals a generally healthy financial state. However, a recent increase in debt and liabilities to support their acquisitions requires careful attention by investors. Debt levels should be monitored in the future.