Construction Partners, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

A civil infrastructure company that specializes in the construction and maintenance of highways, roads, bridges, and other infrastructure projects, primarily in the Southeastern United 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: Construction Partners, Inc. (ROAD) is a civil infrastructure company operating primarily in the Southeastern United States. It focuses on the construction and maintenance of highways, roads, bridges, and related infrastructure projects. Their operations are heavily reliant on state and local government funding for transportation projects. They work with construction materials including asphalt and aggregates.

Revenue Distribution and Business Segments

The company’s operations can be broadly classified into two segments:

  • Construction: This segment involves projects that include new road and highway construction, resurfacing, bridge building, intersection improvements, and more. This segment accounts for the majority of their revenues.
  • Maintenance: The company is also involved in maintenance of existing roads, highways and other infrastructure projects. This segment is a smaller revenue contributor than the construction side, but is crucial for their long term stability.

ROAD’s revenue is primarily derived from publicly funded contracts and their revenue is significantly driven by government spending on infrastructure projects, particularly at the state and local level. Due to the seasonality of construction, the first quarter usually has lower revenue due to lower activity in colder weather.

The industry in which ROAD operates is influenced by several key trends:

  • Government Spending on Infrastructure: As a civil infrastructure company, their growth is directly connected to government spending and infrastructure projects. The implementation of the Infrastructure Investment and Jobs Act (IIJA) is expected to provide a substantial tailwind for the business.
  • Demand for Construction and Maintenance Services: There is increasing demand for construction and maintenance of infrastructure due to the aging of existing infrastructure.
  • Material Costs: Fluctuating prices of materials like asphalt, cement, and steel can significantly affect project profitability.
  • Labor Availability: Like many companies in this industry, they are facing a constrained labor pool and that impacts their labor costs.
  • Technological Advancements: Although it is an old industry, it’s starting to see a slow adoption of new technologies which include the usage of drones and data analytics.

The construction and infrastructure industry is cyclical and heavily reliant on government spending. This has a large impact on the revenue they receive.

Competitive Landscape

ROAD operates in a competitive environment with several key players:

  • Large regional players: There are multiple regional players that are similar in size to ROAD. These companies are capable of taking on similar projects.
  • National players: They also have to compete with major construction companies, but the scale advantage of national players means they are limited by their reach.
  • Small local players: There are also many smaller local players that target more specific niches that compete with the company.

ROAD’s main advantage is the ability to be vertically integrated since they produce their own asphalt, aggregates, and other materials which helps them lower cost and control over the supply chain. They are also focused on growth through a geographically concentrated portfolio and strong relationships.

Financials Analysis

Revenue:

  • ROAD’s revenue is primarily generated through construction contracts, and the growth has been solid with revenue of $1.35 Billion in 2022, which is a 13% increase over 2021.
  • The Company has a revenue backlog of 2.4 billion in 2022 which shows how much business they have lined up in the future.
  • They have seen revenue growth from existing as well as newer markets.

They had a record quarterly revenue of 362 million, which increased by almost 15% from previous year. However, organic revenue grew only 8.6% which indicates that much of the revenue growth came from acquired companies. Profitability:

  • The Gross Profit for 2022 was 10.7%, which was roughly the same as the gross margin of 2021, as inflation increased the material costs.
  • They have seen increases in selling expenses as well, increasing to 7.7% in 2022, compared to 7.0% in 2021.
  • The net income also increased in 2022, which indicates their financial health remains good.
  • Their 2023 first quarter profit fell due to higher input costs and weather impact, but this should improve in the next quarter.

Financial Health:

  • Their balance sheet is solid, with manageable debt and decent liquidity to manage fluctuations and invest in organic and inorganic expansion.
  • They have maintained a positive cash flow during 2022.

They have good liquidity and financial flexibility and their acquisitions have been adding significant amounts to their income. Their revenues are increasing, and they have good access to the credit market, which enables future growth. ### Moat Analysis and Rating ROAD has a narrow moat, with a rating of 2/5. This is due to the following:

  • Scale-based cost advantages: ROAD operates in a capital intensive industry and their scale does provide an advantage in lowering cost, however, they are not much more effective than their competitors in that area.
  • Integration of the supply chain: They are a vertically integrated company since they produce some of their own raw materials. This allows them to control costs, but this is not a very big advantage as they still need to compete on price.
  • Network effects: They have an established presence in the southeastern United States, however there is limited switching cost for customers, so this does not count as a moat.

The long term durability of this moat is not strong due to the nature of the business as it can be easily attacked by similar sized regional and national players, as well as small local players with very targeted operations.

Risks That Could Harm the Moat

Several factors could affect ROAD’s moat and business:

  • Decreased Government Funding: A reduction in public spending or changes in government infrastructure priorities would adversely affect the company’s revenue.
  • Material Cost Inflation: Increases in asphalt, cement, and fuel prices can erode margins, as these raw materials are essential for their products. They can hedge some of this but it does add more risk.
  • Increased Competition: Intensified competition from larger and smaller players alike, can lead to lower pricing power and reduced market share.
  • Economic Downturns: A potential economic downturn can impact the company negatively as local governments start cutting spending on infrastructure projects.
  • Labor Costs: Any significant increases in labor costs due to the tight labor market can harm margins.
  • Regulatory changes: Changes in legislation and policies surrounding infrastructure can put them at a disadvantage.
  • Technological disruption: The industry does face a low risk of disruption due to its reliance on old tech but any technological disruption can impact the moat in the long term.
  • Acquisition integration risks: With a strategy relying on acquisitions to grow their company, they are prone to overpaying for these acquisitions or have issues in combining the new companies with their existing operations.

Business Resilience

Despite the challenges listed above, the business has multiple areas of resilience.

  • Recurring revenue: The maintenance sector brings stability to the revenues.
  • Infrastructure growth: Federal and state governments spending more than usual on infrastructure should provide a tailwind.
  • Vertical Integration: Their control over the supply chain will help maintain costs.
  • Backlog: A healthy backlog should ensure the company’s future revenues.

Understandability Rating

The company has an understandability rating of 2/5.

  • The company’s main operation of road construction and maintenance is pretty straight forward to understand
  • However, understanding the financial statements and accounting is moderately difficult, especially for an amateur investor. The high amounts of goodwill and intangibles from their acquisitions can be tough to interpret.
  • The business model is simple but it has complexities due to government funding, seasonality and the way they book revenues and expenses.
  • The company’s reporting, although detailed, is complicated and it might be difficult for a beginner to understand all the items, especially when they are accounting related.

Balance Sheet Health

The company has a balance sheet health rating of 4/5.

  • The debt level is well within manageable limits, which demonstrates a sound financial footing.
  • They have a history of consistent growth in income and profits.
  • They have also maintained a good cash flow from operation during recent fiscal years, allowing them to weather any financial hardships.
  • They have been increasing their capital expenditures to expand their operations and revenues.

Recent Concerns / Controversies and Management Comments

  • Some analysts are concerned that their margins are low and they are not utilizing the full benefits from the government spending.
  • During their recent earnings calls the company has admitted to some challenges in finding skilled labor and in a tight supply market that is increasing cost for materials, but they say these trends are likely temporary.
  • There is a concern that the rising debt levels from acquisitions can lead to financial problems, however, the management says they are targeting profitable acquisitions that can increase value.
  • They have also talked about how the company would maintain its positive trajectory through cost management, and effective integration of acquisitions, while also seeking opportunities to grow in their core competencies.

In conclusion, Construction Partners Inc. (ROAD) has a narrow economic moat with a solid financial health, and operates in an industry that will likely see consistent growth going forward. It is moderately easy to understand the core operations, but more thought and experience are needed to understand their financials. This rating was determined taking into account all past and current performance along with recent management comments and guidance.