Grading Three Infrastructure Rebuilding Players
Spring has arrived in the U.S., meaning construction projects will begin nationwide. This week, we analyze three stocks using AAII’s A+ Investor Stock Grades to show their position in their respective industries. With U.S. Congress approving a high budget for infrastructure in 2023, should you consider these three construction materials and heavy machinery companies: Caterpillar Inc. (CAT), Cleveland-Cliffs Inc. (CLF) and Nucor Corp. (NUE)?
Three Stocks That Could Help Rebuild America’s Infrastructure
There have been high hopes for a significant U.S. infrastructure spending bill for the last few years with very little to show for it. Some politicians are renewing calls for more infrastructure spending. Will this time be different?
President Biden hopes to win bipartisan support for his plan to spend $2 trillion on roads, bridges, airports, railways, sources of renewable energy, 5G wireless broadband networks, power grids and electric transport infrastructure. Every four years, the American Society of Civil Engineers (ASCE) grades America’s infrastructure based on its condition and need for reinvestment. In 2021, it graded the nation’s infrastructure as a C– and warned that its deterioration is harming the nation’s ability to compete in the global economy.
In late December 2022, Congress passed the Omnibus Appropriations spending bill for 2023, allocating $1.7 trillion to various agencies. As this relates to infrastructure, the U.S. Department of Transportation (DOT) received more funding than it ever has in one year, around $144 billion. Additionally, the U.S. Departments of Energy and Interior received around $55 billion and $39 billion, respectively.
Spending more to rebuild roads and bridges, as well as building out high-tech infrastructure such as 5G networks, could help provide jobs to those who need them and give a lift to the broader economy. Most of this spending maintains the government’s commitment to past bills such as the Infrastructure Investment and Jobs Act passed in 2021. Each of the aforementioned government agencies has received more funding this year than in 2022, potentially leading to economic stimulation for companies involved in construction and building materials.
Companies that produce building materials such as cement, concrete and 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.
Grading Infrastructure Stocks With AAII’s A+ Stock Grades
When analyzing a company, it is helpful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown 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
What the A+ Stock Grades Reveal
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 B, based on its Momentum Score of 63. This means that it ranks just above the middle tier of all stocks in terms of its weighted relative strength over the last four quarters. This rank is derived from a high relative price strengths of 8.3% and 24.8% in the second-most-recent and third-most-recent quarters, offset by low relative price strengths of –13.8% and –13.1% in the most recent and fourth-most-recent quarters, respectively. The ranks are 50, 68, 89 and 34 sequentially from the most recent quarter. The weighted four-quarter relative price strength is –1.5%, which translates to a rank of 63. 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 weighting of 40% and each of the three previous quarters given a weighting of 20%.
The company has a very strong Quality Grade of A based on a buyback yield rank of 88. Buyback yield is the repurchase of outstanding shares divided by the existing market capitalization of a company. Caterpillar has a 4.0% buyback yield, which is well above the sector median. It also has a strong return on assets (ROA) with a rank of 86. Its return on assets of 9.0% is over triple 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.
Caterpillar has a Value Grade of D, based on its Value Score of 38, which is considered expensive. This is based on a high price-to-book-value (P/B) ratio of 7.01 and a high price-to-free-cash-flow (P/FCF) ratio of 41.8. The company has a strong Growth Grade of B, with a score of 63. It currently has a shareholder yield of 6.2%. A stock’s shareholder yield is the sum of its buyback yield and dividend yield. It shows what percentage of total cash the company is paying out to shareholders, either in the form of a cash dividend or as expended cash to repurchase its shares in the open market.
Cleveland-Cliffs Inc. (CLF) is a vertically integrated producer of iron ore and steel products. It has upstream and downstream operations. It supplies both customized iron ore pellets and steel solutions. Its two segments 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. The company’s 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 75 (a higher score being more attractive).
Cleveland-Cliffs’ Value Score is based on several traditional valuation metrics. The company has a rank of 36 for shareholder yield, 31 for the price-to-free-cash-flow ratio and 15 for the price-to-sales (P/S) ratio (lower ranks indicate more attractive valuation). The company has a price-to-sales ratio of 0.35 and a price-to-free-cash-flow ratio of 8.4. A lower price-to-sales ratio is considered better, and Cleveland-Cliffs’ price-to-sales ratio is well below the sector median of 1.00. The ratio of price to free cash flow (the lower the better) is slightly better than the sector median of 11.9.
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-to-book ratio, the ratio of enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA) and the price-earnings (P/E) ratio.
Earnings estimate revisions offer an indication of how analysts are viewing the short-term prospects of a firm. The company has an Earnings Estimate Revisions Grade of B, which is considered positive. 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.
The company reported a positive earnings surprise for first-quarter 2023 of 43.3% but reported a negative earnings surprise of 36.2% in the prior quarter. Over the last three months, the consensus earnings estimate for the second quarter of 2023 has increased 6.3% to $0.739 per share due to three upward and three downward revisions.
The company has a strong Quality Grade of B based on an F-Score of 5, which is above 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 89, decreasing its liabilities by 12.5%. It has a Momentum Score of 33, which is considered weak.
Nucor Corp. (NUE) is focused on manufacturing 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 (SBQ). 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.
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.
Nucor has a Quality Grade of A with a score of 97. The A+ Quality Grade is the percentile rank of the average of the percentile ranks of return on assets, 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.
Nucor ranks strongly in terms of its return on assets and F-Score. It has a return on assets of 27.0% and an F-Score of 7. Nucor’s return on assets exceeds the sector median of 2.8% by a significant margin. However, it ranks poorly in terms of its change in total liabilities to assets, in the 30th percentile.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
If you want an edge throughout this market volatility, become an AAII member.