Business Breakdowns
· Matt Reustle, Rob Hansen
[00:00:00] S0: When you think about that cash gross profit per ton, that number trending upwards, how much of that actually trickles down through the earnings, through the income statement all the way down to the earnings line and potentially bringing it all the way into free cash flow? Is there anything unique about the business and how it's able to convert revenue and gross earnings into actual cash flow? [00:00:00] S1: They convert about 75% to 100% of net income into free cash flow. It's a very good business in that respect. In terms of the cash flowing down through the income statement, too, incremental EBITDA margins when things are normal, absent a big M&A transaction, et cetera, they're really around 60% on each incremental ton of volume. So it falls down very fast. The problem is sometimes you end up doing M&A transactions or little deals. And so all of a sudden, you'll see in their income statement, there are years where you're like, "Why did gross margins just go down by 4%?" But it's really because maybe they did a big transaction, a bunch of costs they have to maneuver. And we can talk more about M&A later, but it's just one of those things where there's a lot of different factors involved. [00:00:00] S0: And that 60% EBITDA incremental is absolutely wild. What's the baseline EBITDA margin for the business?
· Matt Reustle, Rob Hansen
[00:00:00] S0: And that 60% EBITDA incremental is absolutely wild. What's the baseline EBITDA margin for the business? [00:00:00] S1: Yes. So baseline is about 30%. As I mentioned earlier, it's about a 30% gross margin and then you have 10% sales, you have a 20% EBIT margin. And then you have a depreciation, depletion and amortization, which is another, call it, 10%. So that's how you get your 30% EBITDA margin, which is why they use that cash gross profit per ton metric because it's very similar to your gross profit. [00:00:00] S0: Yes, absolutely. I think with some of these businesses, especially anything that there's a production of, whether we call it a commodity or not something like that, it's tricky, but something along those lines helps you understand at the base level what it's costing and what they're profiting for production of each incremental thing. I want to get into capital allocation a little bit before we jump to M&A, just on that earnings conversion into cash flow. I assume that's the CapEx line that's swinging it. Are there large capital outlays related to new quarries? When you think about capital expenses, what do those typically look like? And how much is their volatility, just in terms of spending and big spending programs, anything along those lines?
· Rob Hansen
[00:00:00] S1: CapEx in general, let's call it, high single digits, maybe 10% of sales. So it is a little bit capital intensive. Now when you break that down even further, the most important piece of that is actually investing back into your business, updating your crushers, investing in the technology that they have. There's a very big piece of that, just the operational CapEx. And that's probably about 60% of that. So if it's 10%, that's 6%. Now the other 4% is actually for growth. And that's that very long-term investing in future quarries. And that's just so hugely important because it's very expensive. It's very long term. It's a little bit risky because you have to think about a market and say, "Where is our next leg of growth going to be in 20 years? Because -- where is Atlanta going to grow? Which quarter?" That other 4% is really spent on that, and that's land acquisition, environmental costs, remediation. It can be pretty expensive to take that through the whole entire process, and it just lasts a long time. And they obviously have many of these projects going on. They don't tell you how many exactly, but it's got to be a lot because if you look at their slide deck, and when I was going back through it, from 2016 to, I think it was, 2022, it looked like there was maybe about almost 20 new locations and some of those are just drop areas, but it's a super important part of the business.
· Matt Reustle
[00:00:00] S0: And in terms of what determines a good outcome from that capital spend opening up a new quarry, is it the demand that's ultimately attached to that? Obviously, expenses can get out of control based on what you mentioned. But are there risks that when they start mining the rock, it's not high-quality rock? Just thinking about the variability and outcomes when it comes to new quarries.
· Rob Hansen
[00:00:00] S1: That's definitely a small risk, but they do spend a lot of money looking into this, doing these geological surveys and studies to really make sure there's x feet that we can go and get out of this thing and maybe we can try to extend it into the future over this other area, but we have to buy that land. Making sure you have access to all the mineral rights and all that stuff. So the risk, though -- I mean, you could spend a lot of that money and then the town just says, "No, sorry, that's it. We don't want that. We don't want your big trucks running around and kicking up dust everywhere and ruining our air quality. And also, your big pit is really ugly, so we don't want it." There is a wide variety of risks, and that's why you have to have a bunch of different irons in the fire all throughout it. And look, the other big risk, too, is maybe you choose an area for your leg of growth that's going to happen in 20 years, and what if the population doesn't actually fill in there? That could be a material risk. You spend all this money, now you got this quarry, and there's no construction to fill this in, so that is definitely a risk. It's just such long-lived assets that -- it's just funny, I mean, you could be wrong and then eventually be proven right maybe in year 40 instead. And you're like, "Oh, wait, I did have this quarry still."
· Matt Reustle
[00:00:00] S0: I will say, going into this, I completely failed to appreciate the importance of geographical proximity to the end construction and how much of a role that plays when it comes to the transportation cost. So very interesting to see how important that is. Shifting to M&A, you mentioned sometimes that can throw off the numbers. Is that a key part of the DNA with this business, acquiring other businesses and consolidating the industry?