May 17, 2012

Einhorn and StarMine models agree on Martin Marietta Minerals’ Outlook

by Sridharan Raman

As soon as the final syllables of the stock symbol “MLM”, the symbol under which shares of Martin Marietta Minerals Inc. (MLM.N) trade on the New York Stock Exchange, left hedge fund manager David Einhorn’s lips at the 2012 Ira Sohn Investment Conference yesterday, the frenzied selling began. Within minutes, word that Einhorn had established a short position in the stock had erased $300 million or more of market value from the stock, which fell as much as 11%, before ending up with a loss of about 8% for the day.

At the heart of Einhorn’s bearish view of the stock is his contention that it’s tremendously overvalued. Whereas once the company – which sells construction materials, including sand and gravel products that can be used in road building – benefitted from some of the stimulus programs announced in the aftermath of the crisis and during the recession, that benefit has faded. It has been trying to acquire rival Vulcan Materials Co. in a $5 billion hostile takeover, only to have the Delaware courts respond favorably to Vulcan’s contention that the bid was illegal, and force Martin Marietta to shelve its efforts for another four months. The CEO is a megalomaniac, Einhorn argued in a characteristically outspoken presentation, and trading at 35 times its earnings, the company’s shares are too pricey to do anything but sell short.

The instantaneous reaction to Einhorn’s presentation of Martin Marietta Minerals as his first “best idea” at the annual gathering of top investment managers (other who spoke included Bill Ackman, Jeff Gundlach and John Paulson) said more about Einhorn’s ability to move markets and the fear of being caught on the wrong side of a play made by a heavyweight investor than fundamentals. Nonetheless, StarMine models show that those fundamentals support Einhorn’s views on the company’s valuation. (Neither StarMine nor AlphaNow can weigh in on his characterization of the company’s CEO.)

With a trailing 12-month price/earnings ratio of about 36, as seen in the chart below, the company commands 27 times forecast earnings for the next 12 months – significantly above the average levels of about 15 for the S&P 500. That’s also higher than it’s 10-year median of 18.2, and well above the industry average, represented by the red line in the chart below. That’s a very generous multiple to ascribe to a company whose revenues in 2011 grew only 4% from 2010 levels to $1.714 billion, after a horrendous year for the company in 2009 when they plunged 26%, But although sales are once again approaching the $1.72 billion recorded in 2004, the company has struggled far more to rebuild its profitability, thanks to declining profit margins and rising interest expenses. In 2011, the company recorded net income of $82 million, the lowest level it has reported in the last decade and well below the $129 million it announced in 2004.

The company clearly is carrying a hefty debt load, and the StarMine SmartRatios Credit Risk (SRCR) model score of only 6 (at the bottom end of the 1-100 range) signals that the risk profile of its balance sheet isn’t yet fully reflected in the company’s stock price. Translating this score into an equivalent agency rating gives a Market Implied Rating that is into “junk” territory [B-]. This model combines financial ratios and metrics that are predictive of credit risk into five components: profitability, leverage, debt coverage, liquidity, and growth; such a low score signals that Martin Marietta Minerals has a greater-than-average risk of default thanks to its high leverage, poor balance sheet liquidity and inconsistent pattern of growth in revenue and earnings. Before Einhorn’s brutal critique of the company drove Martin Marietta Minerals’ stock price down so rapidly and dramatically, the company’s valuation was out of step with that share price. The StarMine Intrinsic Valuation model calculates that fair value of the company’s stock lies at around $55.88 a share. That still leaves a valuation gap, given that by after-hours trading, the shares had recovered some ground, trading at around $68.84 a share. So, any trader or investor who responded to Einhorn’s comment based on panic, opportunism or in hopes of profiting from the momentum, can take comfort in knowing that according to at least some of these long-term gauges of value and risk are sending out the same warning signs that concern Einhorn.

Some of Einhorn’s other investment calls also reflect recent research calls made by StarMine. For instance, the hedge fund manager says he remains upbeat on Apple (AAPL.O); AlphaNow has repeatedly noted the extent to which the company appears undervalued relative to earnings growth forecasts. While Einhorn didn’t announce that he had shorted the stock of (AMZN.O), he did make some bearish comments about the company’s business model and prospects that reflect concerns that AlphaNow has written about in recent weeks.

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