Grading Three Infrastructure Rebuilding Players
Spring has arrived in the U.S., meaning construction projects will begin in earnest nationwide. This week, we use AAII’s A+ Investor Stock Grades to provide insight into three infrastructure stocks. With the U.S. Department of Transportation (DOT) requesting a $145.3 billion budget in 2024, should you consider these three construction materials and heavy machinery companies of Caterpillar Inc. (CAT), Cleveland-Cliffs Inc. (CLF) and Nucor Corp. (NUE)?
Recent Infrastructure News
With the collapse of the Francis Scott Key Bridge in Baltimore, Maryland — as well as the entire East Coast — will see major disruptions that have the potential to be detrimental to the U.S. economy. Rebuilding the bridge is expected to be a long and expensive process; however, it is still too early to calculate the exact economic cost that may be involved. Maryland has received some emergency funding from the Federal Highway Administration and the Bipartisan Infrastructure Law but may still need more government help in the short term. The bridge had an insurance policy in place, which is likely substantial enough to cover the cost of reconstruction.
While this tragedy was an accident, it brought to light some issues with aging infrastructure in the U.S. Newer bridges have more comprehensive safety measures in place to prevent direct strikes from vessels. Improving infrastructure has been a large talking point of the Biden administration, and the $1.2 trillion Infrastructure Investment and Jobs Act was passed in 2021. Spending more to rebuild roads and bridges, as well as building out high-tech infrastructure such as 5G networks, will help provide jobs and give a lift to the broader economy.
Companies that produce building materials such as cement, concrete, sand and gravel could benefit from any increased spending on transportation infrastructure. Steel companies also benefit from rebuilding infrastructure, especially those that manufacture structural steel.
What the A+ Stock Grades Reveal
When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is why AAII created the A+ Stock Grades, which evaluate companies across five factors that research and real-world investment results indicate to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality.
Using AAII’s A+ Stock Grades, the following table summarizes the attractiveness of three infrastructure stocks — Caterpillar, Cleveland-Cliffs and Nucor — based on their fundamentals.
AAII’s A+ Stock Grade Summary for Three Infrastructure Stocks
Caterpillar Inc. (CAT) is a manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company operates through three main segments: construction industries, which supports customers using machinery in infrastructure, forestry and building construction; resource industries, which supports customers using machinery in mining, quarry, waste and material handling applications; and energy and transportation, which supports customers in oil and gas, power generation, marine, rail and industrial applications.
Caterpillar has a Momentum Grade of A, based on its Momentum Score of 86, which is very strong. This means that it ranks in the top tier of all stocks in terms of its weighted relative strength over the last four quarters. This rank is derived from high relative price strengths of 16.1% in the most recent quarter, 9.9% in the third-most-recent quarter and 8.5% in the fourth-most recent quarter, slightly offset by a low relative price strength of –1.8% in the second-most-recent quarter. The ranks are 86, 54, 83 and 77, sequentially from the most recent quarter. The weighted four-quarter relative price strength is 9.8%, which translates to a rank of 86. The weighted four-quarter relative strength rank is the relative price change for each of the past four quarters, with the most recent quarterly price change given a weight of 40% and each of the three previous quarters given a weight of 20%.
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher Quality Grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals to assets, Z double prime bankruptcy risk (Z) score and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
Caterpillar has a Quality Grade of A, based on a score of 93, which is very strong. The company ranks strongly in terms of its return on assets and buyback yield. Caterpillar’s return on assets of 12.0% is over three times that of the sector median. The return on assets indicates how profitable a company is in relation to total assets. The higher the return on assets, the more efficient and productive a company is at managing its balance sheet to generate profits. The company’s 2.7% buyback yield is also well above the sector median of –0.4%. Buyback yield is the repurchase of outstanding shares divided by a company’s existing market capitalization.
Caterpillar has a Value Grade of D, based on its Value Score of 37, which is expensive. The Value Grade is the percentile rank of the average of the percentile ranks of the price-to-sales (P/S) ratio, price-earnings (P/E) ratio, price-to-book-value (P/B) ratio, price-to-free-cash-flow ratio (P/FCF), shareholder yield and the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA). Caterpillar’s Value Score is based on a high price-to-book ratio of 9.60 and a high price-to-sales ratio of 2.79.
The components of the Growth Composite Score consider a company’s success in growing sales on a year-over-year and long-term annualized basis and its ability to consistently generate positive cash from its core operations. The company has a Growth Grade of B, with a score of 62, which is strong. The company has a five-year sales growth rate of 4.2% and has seen its sales increase year over year for three out of the past five years. Cash from operations has been positive in the past five years.
Cleveland-Cliffs Inc. (CLF) is a vertically integrated producer of iron ore and steel products. It has upstream and downstream operations and supplies both customized iron ore pellets and steel solutions. Its two segments are steel and manufacturing and mining and pelletizing. Its steel and manufacturing segment is a producer of flat-rolled carbon, stainless and electrical steel products, primarily for the automotive, infrastructure and manufacturing and distributors and converters markets. Subsidiaries of this segment provide customer solutions with carbon and stainless-steel tubing products, engineered solutions, tool design and build, hot- and cold-stamped steel components and complex assemblies. The mining and pelletizing segment supplies iron ore pellets to the North American steel industry from its mines and pellet plants located in Michigan and Minnesota.
Cleveland-Cliffs has a Value Grade of B, based on its Value Score of 74, which is good value. The company has a rank of 30 for shareholder yield, 16 for the price-to-free-cash-flow ratio and 19 for the price-to-sales ratio (lower ranks indicate a more attractive valuation). The company has a price-to-sales ratio of 0.50 and a price-to-free-cash-flow ratio of 6.9. Lower price-to-sales and price-to-free-cash-flow ratios are considered better. Cleveland-Cliffs’ price-to-sales ratio is well below the sector median of 1.26, and its price-to-free-cash-flow ratio is well below the sector median of 17.7.
Earnings estimate revisions indicate how analysts view a firm’s short-term prospects. The company has an Earnings Estimate Revisions Grade of F, based on a score of 15, which is very negative. The grade is based on the statistical significance of its latest two quarterly earnings surprises and the percentage change in its consensus estimate for the current fiscal year over the past month and past three months.
Cleveland-Cliffs had a positive earnings surprise of 19.4% for fourth-quarter 2023, even though it reported a loss of $0.50 per share. Over the last three months, the consensus earnings estimate for the first quarter of 2024 has remained unchanged at $0.405 per share.
The company has a Quality Grade of B, based on a score of 80, which is strong. It has a high F-Score of 7, compared to the sector median of 4. The F-Score is a number between zero and nine that assesses the strength of a company’s financial position based on its profitability, leverage, liquidity and operating efficiency. Cleveland-Cliffs also has a strong change in total liabilities to assets, with a rank of 82, decreasing its liabilities by 7.5%.
The Momentum Grade of B is based on a score of 70, which is strong.
Nucor Corp. (NUE) manufactures steel and steel products that produce direct reduced iron (DRI) for use in its steel mills. Its three segments are steel mills, steel products and raw materials. The steel mills segment produces sheet steel (hot-rolled, cold-rolled and galvanized), plate steel, structural steel (wide-flange beams, beam blanks, H-piling and sheet piling) and bar steel (blooms, billets, concrete reinforcing bar, merchant bar and engineered special bar quality). The steel products segment produces steel joists and joist girders, steel deck, hollow structural section steel tubing, electrical conduit, fabricated concrete reinforcing steel, cold finished steel, steel fasteners, steel grating and expanded metal, wire and wire mesh, metal building systems and others. The raw materials segment produces DRI; brokers ferrous and nonferrous metals, pig iron, hot briquetted iron and DRI; supplies ferro-alloys; and processes ferrous and nonferrous scrap metal.
Nucor has a Quality Grade of A, with a score of 95, which is very strong. It ranks highly in terms of its return on assets and F-Score. It has a return on assets of 13.3% and an F-Score of 7. Nucor’s return on assets exceeds the sector median of 0.9% by a significant margin. However, it ranks poorly in terms of its change in total liabilities to assets, in the 50th percentile.
Nucor has a Value Grade of B, with a score of 75, which is good value. It has a Momentum Grade of B, based on a score of 76, which is strong. Its weighted four-quarter relative price strength is 3.4%, well above the sector median of –3.1%.
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The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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