Bull And Bear: Long Aceto, Short Vulcan

In this report I select a pair of stocks, one I recommend investors go long on and the other that they should short.

The Long: Aceto Corp. (ACET) Current price: $21.30 12-month target price: $27 Aceto Corp. is a global leader in marketing and distribution of pharmaceutical intermediates and active ingredients; finished dosage form generics; nutraceutical products; agricultural protection products and specialty chemicals. With operations in ten countries, it distributes more than 1,100 chemical compounds used as finished products or raw materials. Talk about being misunderstood, Aceto Corp. was previously classified as a lower multiple chemicals company but was recently reclassified as a pharmaceutical company. About 69% of the business is pharmaceutical related. About 52% of sales are in the U.S., and 44% of sales are in Europe, with the company sourcing 64% of its products from China and India. The company has strategically been emphasizing Health Sciences and Agricultural Protection products relative to traditional specialty chemicals. These product lines have strong growth prospects and higher margins. Given its strong global presence, Aceto Corp is in a unique position to capitalize from low cost sourcing and favorable emerging market growth.According to IMS Health, global spending for medicines will reach nearly $1.1 trillion by 2018 as aging populations continue to drive incremental spending. Strong demand in emerging markets will contrast against lower levels of spending growth for medicines in the U.S. Globally, market share for branded medicines, which fell from 70% in 2005 to 64% in 2010, is expected to decline further to 53% through 2015. The U.S. will experience the largest expansion of generic spending, boosted by significant policy incentives for generics. Aceto Corp. should trade at 25x EPS, in-line with peers, in our opinion. With our 2015 EPS estimate of $1.08, this implies a target of $27. The stock trades at 19x cash flow versus 24x for comparable companies. The company does have significant currency risk, as nearly all of the company’s assets are in the US, with 48% of sales outside of the US. As the dollar is increasing, this makes the company’s products incrementally more expensive in overseas markets. This effect may be most evident in the Pharmaceutical Intermediates business. The Short: Vulcan Materials (VMC) Current price: $82.38 12-month target price: $44 Vulcan Materials Company produces and sells construction aggregates, asphalt mix, ready-mixed concrete, and cement primarily in the United States. The company’s aggregates segment offers crushed stone, sand and gravel, and other aggregates. The company’s aggregates are used in public- and private-sector construction projects, including highways, airports, water and sewer systems, industrial manufacturing facilities, and residential and nonresidential buildings, as well as railroad track ballast.While the company delivered a strong quarter with revenue and earnings upside, the current valuation is discounting a robust industry recovery this year with significant pricing leverage, which is far from certain. Transportation work is dependent on the Federal Highway Trust Fund that continues to have long-term funding problems. The main issue affecting the solvency of the trust fund is that money is raised through a tax on fuel, and the rate has not been increased since 1993 despite the increasing age of U.S. transportation infrastructure. Additionally, the adoption of more fuel efficient cars has reduced the growth of gasoline consumption. In May of last year, Congress passed legislation that transfers $10.8 billion into the trust fund and reauthorizes it through the end of May, 2015. The long-term solution is clearly for Congress to pass a multi-year highway bill that raises taxes, but that will be difficult to accomplish given the existing acrimony in D.C. States need that certainty in order to be able to plan multi-year projects with the confidence that funding will be in place. Strained budgets of federal, state, and local governments will continue to present risks to future highway construction funding. Vulcan Materials has a fairly high level of debt.At the end of Q4:14, Vulcan Materials had more than $2 billion in debt, $141 million in cash, and a long-term debt-to-equity ratio of more than 44%. For all of 2014, the company had operating cash flow of just over $260 million and capex of almost $225 million, for modest free cash flow of around $35 million, or $0.27 per share. Management expects to spend roughly $250 million on capex in 2015. Traditionally, Vulcan Materials has grown mainly through mergers and acquisitions. The company made more than $284 million worth of acquisitions in 2014, and intends to continue to make acquisitions in order to grow. Future financial results could be negatively impacted if the company has issues either financing these acquisitions or integrating them with existing business operations. We believe it is doubtful that the next cyclical EPS peak will be higher than the last one, given the easy money, financial innovation, and mania that drove construction markets to unprecedented levels in 2007. In 2016, assuming a continued pay down of debt as well as sales and operating margin levels comparable to the late 2000’s peak, $3.6 billion and 19.7%, respectively, would generate EPS of about $2.90. Before the bubble, in the 2002 to 2006 timeframe, the stock traded for around 15x forward earnings. Applying a 15x PE multiple to this 2016 EPS estimate results in a price target of $44. Disclosure: Robert Maltbie’s firm is long Aceto Corp., and short Vulcan Materials Company. Source: Forbes.com

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