PSB Monthly Issue February 2012

It’s no secret that the housing market has been in the dumps since the real estate bubble burst in 2006.

According to the Case-Shiller Home Price Index, home prices are down about 33% from their peak in July of 2006.

And new home construction has fallen even harder…

At the peak of the bubble in 2005, home builders were on pace to sell 1.4 million new homes per year.  Today, new home sales are down nearly 80% to a paltry annual rate of 307,000 per year.

Clearly, the residential construction industry has been knocked down a peg or two. And for good reason…

The industry is facing strong headwinds from a high number of foreclosures and tougher mortgage lending standards.

Here’s the thing… Most investors think a recovery in residential construction is still years away.

However, I think the recovery could be a lot closer than most people think.  In fact,construction spending is already on the upturn.

Get this…

Construction spending has increased in eight out of the last nine months.  And it now has the biggest year over year Increase since before the bubble burst.

At this point it’s clear, construction spending has already hit rock bottom.  And more importantly, it’s steadily increasing.

Not surprisingly, the housing industry’s sudden turnaround has caught many investors off guard.  But the reason for the uptick is simple… new household formations.

You see, it all boils down to some basic math.  As the population grows, new households are formed.  And in order to keep pace with population growth, the US needs to build around 1.5 million new homes per year.

However, over the last three years, housing starts have averaged less than 550,000.

That means construction needs to increase by nearly 1 million single or multi-family homes per year just to keep pace with new household formations.

And here’s the kicker…

Even when you take into account the overbuilding during the boom years, we’ve reached a point where the US would be in a housing shortage in a normal environment.

The only reason we’re not seeing the effects of the housing shortage is because of the slow pace of new household formations.  Following the 2008 credit crisis and the ensuing recession, new household formations have fallen to a paltry 500,000 formations per year.  That’s a far cry from the 1.2 million new households that were being formed in the last decade prior to the credit crisis.

But the population didn’t stop growing… These people didn’t disappear.  No, they’ve simply delayed forming new households.  But as the economy improves, household formations will, as statisticians like to say, revert to the mean.

In other words, after years of below average household formations, the US is overdue for a few years over faster than expected household formations.

In fact, new housing starts need to double from their current levels just to keep pace. When that happens, look out… the construction and building materials companies who have weathered the storm will reap huge rewards as construction picks up steam.

One company that’s dirt cheap and leveraged to a housing recovery is US Concrete(NASDAQ: USCR).

THE CONCRETE BUSINESS

USCR is a top ten producer of ready-mixed concrete and pre-cast concrete products in the US.  They operate primarily in Texas, New York, New Jersey, and California.

The ready-mixed concrete and concrete-related products segment formulates, prepares, and delivers ready-mixed concrete to customers’ job sites.  They sell crushed stone aggregates, sand, and gravel, as well as things like rebar, concrete block, wire mesh, color additives, curing compounds, grouts, wooden forms, concrete masonry, and tools.

The precast concrete products segment makes concrete blocks for use in free-standing walls, soundproofing and security walls, panels used to clad a building façade, and storm water drainages.  They also make finished products like utility vaults, manholes, catch basins, highway barriers, curb inlets, pre-stressed bridge girders, concrete piles, and custom-designed architectural products.

In other words, if something’s made out of concrete, USCR probably makes it.  But make no mistake, USCR’s bread and butter is residential housing.

As a result, the company fell on hard times as residential construction slowed to a snail’s pace.  But on the flip side, the company is also leveraged to a rebound in residential construction.

Now that construction spending is accelerating, USCR’s uniquely positioned to profit from the rapidly improving business conditions.

Let’s take a closer look at the company’s financials.

THE NUMBERS

USCR’s books have undergone a major facelift over the last few years.

Back when the construction industry was booming, USCR took on debt to fund the expansion of their business.  And business was great until sales fell off a cliff in 2008.
Sales dropped from $804 million in 2007 to $684 million in 2008, and then to $485 and $456 million in 2009 and 2010.  And the main driver was lower revenue resulting from a drop off in residential construction.

In 2005, more than half of USCR’s revenue came from residential construction.  Today, less than 20% of revenue comes from residential construction.

As expected, the company fell on hard times when their primary source of revenue dried up.  And once the financial crisis hit in 2008… it was game over for USCR.

The company simply couldn’t support the payments on their $300 million debt.  And they were forced into bankruptcy in 2010.

USCR emerged from bankruptcy in August of 2011.  Now the company’s lean and mean. And management is chomping at the bit to start growing again.

And here’s my favorite part… USCR’s backlog is growing.

The company has seen their backlog steadily increase over the last year.  That’s a great sign that demand for their products is increasing.  In fact, USCR should return to profitability by mid-2012.

Here’s the bottom line…

The post-bankruptcy version of USCR has a much healthier balance sheet.  They have around $77 million in debt (down from around $300 million).  They also have nearly $5 million in cash and an addition $15 million in credit available.

What’s more, they sport a solid 1.59 current ratio, so they should have no trouble meeting their short term liquidity needs.

USCR is clearly a great turnaround story.  As the stock continues to recover from these bargain basement prices, the shares should continue to rally sharply higher.

INVESTMENT RISKS

As with any investment, US Concrete has a few risks.

If the US economy slows, demand for USCR’s products would be hurt.  An economic slowdown would hurt consumers’ ability to buy homes and impair sales growth.

Another risk is the availability of funds for public or infrastructure projects.  Cuts to federal, state, and local government budgets could hurt sales.

Finally, a change in bank lending standards could impair consumers’ ability to obtain a mortgage.  This would likely hurt demand for residential construction and slow sales growth.

POTENTIAL RETURN OF 135% OR MORE

USCR is a great turnaround story.  And the stock is leveraged to a rebound in residential construction.

Some savvy investors have already taken notice of the rebound in construction spending.  They’ve begun to pour large amounts of money into construction and building material stocks like USCR.  At a recent price of $4.24, the stock has already doubled from the 52-week low of $1.90.

Despite the surging share price, USCR’s still trading at a nice discount.

Assuming housing starts increase from the current rate of 500,000 per year to a more sustainable rate of 1 million starts per year, USCR has tremendous upside.

Even under very conservative estimates for profit margins of 6% and a multiple of 6x EBITDA, USCR could easily soar to $15 per share.

Clearly, there’s still plenty of upside for USCR.

Based on our analysis, we see the stock trading up to at least $10.00.  Grab your shares of USCR now for potential gains of 135%!

ACTION RECOMMENDATION

BUY US Concrete (NASDAQ: USCR) up to $5.00 per share.