The Thesis
Construction Partners (NASDAQ:ROAD) continued to deliver double-digit topline growth as it exited the first half of FY24, as project activity remains robust due to a significant amount of public and government funding. This growth should continue further as the project pipeline remains strong due to public and government investments, which along with healthy demand in the commercial end market and strong backlog levels should drive the company topline growth in the quarters ahead. Strong volume growth should also support the company’s margin along with operation improvements, in 2024. The company’s long-term prospects also look promising as the company continues to invest in growing its market presence organically and through strategic acquisition. While the company’s growth prospect is good, its stock is trading a significant premium to its historical averages and its peers, making me avoid this stock at the current levels.
Business Overview
Construction Partners is a prominent company in civil infrastructure that is primarily involved in the construction and maintenance of roadways across the Southeastern United States including Alabama, Florida, Georgia, Tennessee, North Carolina, and South Carolina. The company provides its products and services to public and private infrastructure projects like roads, bridges, highways, airports as well as commercial and residential developments. The company also manufactures and distributes hot mix asphalt (HMA) for internal use and sales to third parties that are associated with construction projects and paving activities.
Last Quarter Performance
After delivering strong double-digit growth in FY 2023 and a decent start to 2024, the company reported another strong quarter as the company’s top line grew 14.3% year-on-year to $371.4 million during the second quarter of 2024. This growth was primarily a result of healthy project activity and a significant contribution of approximately $25.1 million from the recent acquisitions completed during 2023. The organic growth year-on-year during the quarter, on the other hand, was 6.6% driven by contract work and sales of aggregates to third parties.
The company’s gross margin also expanded significantly by approximately 230 bps year-on-year to 10.1% during the quarter, thanks to strong revenue growth and operational execution. General and administrative expenses, as a percentage of revenue, were flat versus the prior year’s same period. Adjusted EBITDA, on the other hand, saw an improvement of 130 bps year-on-year to 7.9% during the second quarter of 2024. While the company’s EBITDA expanded notably during the quarter, the company’s bottom line was negative as the company reported a loss per share of $0.02 during the quarter. However, when compared to the same quarter in the previous year, this marks an improvement from a loss per share of $0.11, as the company had been reporting a net loss in the first half of the fiscal year primarily due to decreased profitability during that period, which was impacted by unfavorable weather conditions.
Outlook
While the growth rate has moderated in 2024 as compared to the prior year, I expect this growth to continue further as the project demand remains robust, primarily due to elevated federal and state infrastructure funding. The demand environment in the commercial market also remains healthy across the region, which along with a strong backlog level of $1.79 billion and contribution from acquisitions should continue to drive top-line growth in the rest of FY2024.
Talking about the company’s end markets, the market conditions remain favorable for the company in both the infrastructure and the commercial side. In my opinion, the company should continue to benefit from significant public investment for repair and new construction across various types of infrastructure projects ranging from highways and bridges to airports, railroads, and military bases. A significant amount of funding from the Infrastructure and Jobs Act (IIJA) should also act as a key factor for the company’s demand in the quarters ahead as the investment is being converted into actual work done in the field. These sustained public and government investments are providing a strong pipeline of projects and providing a stable flow of projects for the company in the future, which should support the company’s topline growth for the company beyond 2024.
Moving to the commercial market, this end market is also showing strength with a steady flow of projects and letting opportunities in most of the private markets across various states. However, the specific areas with particular strength were Manufacturing, corporate site development, residential, and large economic development projects, indicating a diverse range of opportunities in these areas of the commercial market particularly, which should further help the company in its revenue growth in the coming years.
Apart from tailwinds from public and government investments, the company’s primary focus remains on expanding its market share organically in current and adjacent markets. For this, the company also invested significantly in its fleet equipment and paving crews to address anticipated strong demand growth in the quarters ahead. The other part of the company’s strategic growth model is acquisitions. The company has completed five acquisitions so far in fiscal year 2024 enabling the company to enter into new areas, expanding its market share, and adding capacity.
Going forward, the company has announced another acquisition of Sunbelt asphalt surfaces in North Georgia and will operate as a new branded division of the Georgia platform company, the Scruggs company. In my view, this acquisition, along with many other potential M&As in the highly fragmented market that the company operates in, should further help the company in growing its market presence across the region. The company is financially sound as well, with a debt-to-EBITDA ratio of just 1.81, within the target range of 1.5 to 2.5 times, which should continue to support the company in its future acquisition, driving the topline growth further in the longer term.
Talking about the ROAD’s upcoming quarterly results, the company is expected to report its Q3 FY2024 on August 9. As we just discussed above, the demand environment remains favorable for the company, which along with backlog should drive revenue growth in the next quarter as well. I am optimistic about the company’s upcoming results and expecting that the company should deliver topline growth in high teens, with an adjusted EBITDA in high single digits in the third quarter of FY 2024.
Valuation
In the past year, the company’s stock has significantly outperformed the market, nearly doubling in value during this period. This was primarily a result of strong top and bottom-line growth in the recent quarters. Currently, the company’s stock is trading at a Non-GAAP P/E ratio of 40.51, based on FY24 consensus EPS estimates of $1.14. When compared to the company’s five-year average P/E of 37.29, the stock appears to be at a slight premium. On the other hand, when compared with its sector median of 19.65, the stock looks significantly overvalued. While the company stock is trading at a premium to its peers which include companies like Granite Construction (GVA), Primoris Services Corporation (PRIM), and Sterling Infrastructure (STRL), ROAD has also delivered above-average growth during the last few quarters versus its peers as we can see in the table below.
This growth is also expected to continue further as the demand outlook remains favorable for the company, followed by significant public and government investment. Backlog is also strong, further driving volume growth for the company. The benefit from volume growth and operation improvement should help the company in margin expansion in the coming quarter, leading to bottom-line growth and an improvement in the stock valuation. However, considering the company’s forward growth versus its peers, ROAD’s current stock valuation, which is almost double that of its peers, looks unreasonable to me at the moment.
Conclusion
As we discussed above, the company’s stock is trading at a significant premium to its peers. The company has outperformed its peers in the past year and is anticipated to continue this growth further in the quarters ahead as the demand environment remains good for the company and margins are also expected to expand going forward. While the company’s growth prospects look favorable, its peers are also anticipated to deliver EBITDA growth in double digits in the coming years, as we can see in the table in the Valuation section. Considering the company’s overextended valuation, its growth prospects versus its peers don’t justify its premium valuation, making the stock valuation unreasonable to me. Hence, I would wait for the company’s valuation to cool down, and would give this stock a “Hold” rating at the current levels.
Read the full article here