1. The product or service is economically agnostic, meaning that it can thrive in good times and bad; it is not overly dependent on the overall economic cycle to thrive.  One such example is auto parts retail.  When the economy is growing, there are more miles driven, which means more repairs and more replacement parts.  When the economy is in a downturn, new car sales lag, and drivers opt to maintain the cars they currently have, thus leading to more demand for replacement parts.  This resilience can be seen in the same store sales growth of industry bellwether O’Reilly Auto Parts, which has reported positive same store sales growth every year since going public in 1993.  Despite multiple economic downturns along the way, including the financial crisis of 2007 – 2009, same store sales growth continued:
2. The industry benefits from strong pricing power, meaning that the industry incumbents are price makers, not price takers, and, ideally, can raise prices faster than inflation.  An example of an industry with strong pricing power is tobacco, which has historically raised prices faster than overall inflation, thus resulting in outsized profit growth relative to consumer staples broadly; the opposite would be alcoholic beverages, which have failed to pass on costs at even the rate of inflation over the past few decades:
3. The product or service is mission-critical, but a small cost overall.  It is a good place to be when your product or service is mission-critical, but a small cost of the overall project, product, etc.  These niches tend to have a lot of pricing power because there is a high cost of failure and so substitute lower-priced competition is often not even considered.
4. The industry benefits from a high incidence of recurring revenue.  To see better the value of recurring revenue it may be instructive to look at an example of an industry with virtually none of it. One of the opportunities Wayne Huizenga identified when he started AutoNation in the 1990s was that ~75% of all auto dealership customers did not return for a second, let alone a third, purchase.  By consolidating several hundred dealerships and focusing on customer service as well as less discretionary customer spending on maintenance, he sought to alleviate the severe customer churn the dealerships faced.  It is no wonder that selling cars is a cutthroat business when three out of every four of your customers are turned over frequently.  Investors place a premium on businesses with more easily predictable revenue growth, and with good reason.
5. There are either barriers to entry or barriers to scale.  I have written in the past about several industries with barriers to entry that are more durable than others.  These would include tobacco, where government regulations regarding advertising and product enforcement make it very difficult for new players to enter the marketplace, or railroads, where long established players have already built out networks that cannot be duplicated on real estate that is not for sale.  Less discussed are barriers to scale in industries where new players may enter the market more or less at will, but struggle to achieve any semblance of economic scale.  An example of this would be trucking, an industry in which new drivers can offer their services with the proper licensing and a tractor-trailer at his or her disposal and gain business through freight brokers.  However, these small players face high hurdles when it comes to the capital requirements for acquiring more trucks, train and keep employees (some estimates show employee churn as high as 90%), and maintain facilities.  These are real barriers to scale that insulate the largest players in the market.
6. The industry is benefiting from strong secular tailwinds.  With all due respect to Peter Lynch’s famous preference for no growth industries, I believe strong growth is necessary to make an industry stand out.  By this I am not referring to strong but short-lived cycles but rather to those trends that play out over many decades.  One such megatrend is the migration of people to the South, which has been playing out for decades and still shows no signs of slowing down.  You can read more on that topic here.

A case study:  Pest control

An example of an industry that arguably ties all of these features together is pest control, which has grown without interruption for decades, and at a rate faster than GDP.  Because official industry data are hard to come by (the Federal Reserve database ends in 2022, sadly) we can look at the results of Rollins, Inc. owner of Orkin as well as several other leading pest control brands.  One can discern from the chart that revenues grew solidly through both the financial crisis and the COVID pandemic.  That satisfies our criterion for being economically agnostic.

The pest control industry is mission-critical, featuring strong pricing power and recurring revenue, which satisfies our second, third, and fourth criteria.  Rollins employs a CPI+ pricing model, meaning they consistently charge their customers a margin above inflation, which keeps their margins healthy.  Recurring revenues are a stated ~75% of the business, so revenue streams are very predictable and consistent.  Moreover, pest control is non-discretionary (your restaurant has to pass that health board exam, for instance), because the cost of it is very low compared to the cost of being closed for business due to an infestation.  This is highly supportive of pricing power.

While there are relatively low barriers to entry in pest control (there are estimates of anywhere from 15,000 to 20,000 pest control providers in the US alone, the vast majority of them with revenues less than $50,000,000), there are several barriers to scale.  Pest control is inherently a classic route-density business.  There are only so many locations a technician can reach in any one day, so schedulers will try to assign as many jobs as possible within a certain area so that technicians spend most of their time providing services as opposed to driving from job to job.  This means that larger players with more resources will have an advantage as they deploy more capital on route optimization software, as well as more trucks and technicians to provide services. Additionally, they should become acquirers of choice as smaller players seek to combine forces with the larger players rather than try to scale themselves.  This satisfies our fifth criterion.

Finally, pest control benefits from strong secular tailwinds such as the movement of people to the southern states (warmer weather means more bugs, especially termites), and that means more pest control demand.  Furthermore, the gradual rise in temperatures means winters with fewer deep freezes, which also means more bugs, and thus more eventual demand for pest control services.  When combining these things with overall increases in household formation and rising consumption at hotels, restaurants, etc., it seems like the industry has a very bright future ahead of it.

Disclosure:  At time of writing, both the author and clients of Fortune Financial Advisors, LLC maintained positions in O’Reilly Auto and Rollins, Inc.  The information provided in this article relating to stock examples should not be considered a recommendation to buy or sell any particular security.  Any examples discussed are given in the context of the theme being explored.

The post The Traits of an Ideal Industry appeared first on Fortune Financial Advisors.

As an investor, imagine if you could invest in an industry that enjoys the pricing power and regulatory barriers enjoyed by tobacco incumbents as well as the growth prospects of high tech?  That would be a kind of investment Nirvana, wouldn’t it?  Well, it just so happens that such an industry exists, and it is the multilayered aerospace industry.

In fact, while most investment historians are familiar with the fact that tobacco, in market-weighted terms, has been history’s best performer, on an equal-weighted basis (which means component suppliers are represented equally with airplane producers), it is actually the aerospace industry that has outperformed all others, and it has done so on a remarkably consistent basis:

Among the many reasons for this is that aviation has historically grown at a very high rate, by some estimates as high as twice that of GDP.  Thanks to rising incomes and innovations such as the Boeing 747, which Bill Gates referred to as the “first world wide web“, affordable air travel became a reality for the masses.  Increased globalization in the latter half of the 20th century meant a more interconnected world, and data paint a clear picture:  as GDP per capita increases, air travel increases:

Given this dynamic, and the rather surprising fact that an estimated 80% of the world’s population has never flown, the growth drivers for demand in aerospace seem solidly in place.

That being said, growth alone has never been enough to sustain outperformance in a given industry, so what makes aerospace so unique?

For starters, commercial airliners are extremely complex machines with tens of thousands of components.  They range from landing gear assemblies and heat shields to safety buckles and luggage compartment fasteners.  Because of the inherent risks of flying large jets around the world at 30,000 feet, these parts typically must be certified by regulatory authorities for use on aircraft.  Secondly, large passenger aircraft operate in very long product cycles, typically stretching over decades, with mandatory replacement at specific age or usage intervals.  These factors, along with the fact that many of the various components involved are not a large percentage of the overall project cost, mean tremendous pricing power for suppliers.

As Eric Ruden of Ironvine Capital put it on an episode of Business Breakdowns on HEICO:

“[Aerospace] is a market with extremely long product cycles.  So I think average life of an aircraft is anywhere from 25 to 30 years.  The average production run for an aircraft platform is 10 to 20 years.  So that gives you 35 to 40, sometimes more, years, too, to be selling parts into maintaining those aircraft, which I think is something that people end up classing over.

When you think 30 years ago, I wasn’t alive, and we are still thirteen years away from the first iPhone, but we are still flying 737s, so a long duration cycle.  And then the second most important thing to understand is this is an industry with very high regulatory capture, so the only way that you can sell a replacement part to an airline is if it is approved by the FAA [Federal Aviation Administration].”

The current environment seems especially attractive for suppliers to the aerospace aftermarket.  That is because production issues have hampered deliveries of new airliners (via AerCap IR)…

…meaning that the existing fleet of airliners is steadily aging (via IATA):

Putting it altogether, you have what seems like a very attractive set-up:  strong, secular growth in air travel powered by increased global connectedness and a rising global middle class, along with attractive industry dynamics enhanced by production bottlenecks for end markets.  It certainly seems that the future for aerospace is just as bright as ever.

At time of publication, both the author and clients of Fortune Financial Advisors, LLC own shares of HEICO.

The post Aerospace: After A Century of Growth; A Bright Future Ahead appeared first on Fortune Financial Advisors.

More than a century ago, Willis Carrier designed the first modern air conditioning unit, and the device quickly caught on as a necessity to make the humid North American summers more bearable.  As it stands, close to 90% of all U.S. households feature air conditioning of some kind, including most houses built before 1950, which have been modified to accommodate something Americans increasingly cannot live without.  According to HVAC distributor Watsco, the installed base of central A/C units in the United States stands at about 120 million units, a series that has grown without interruption since 1980 (source – Watsco IR):

What is more, the Construction Financial Management Association estimates that some 92,000,000 units, which represents more than 75% of the installed base, is more than ten years old.  Given that the useful life of an A/C unit can range from ten to twenty years depending on usage rates and operating conditions, and given that A/C has become a necessity for households, there would appear to be a very long runway for those who repair and replace A/C systems.

The opportunity is just as strong on the commercial side as it is with residential units.  Earlier this year, Lennox’s Geoff Dethlefsen commented on the opportunity:

“You look at the [commercial] installed base from that 2000 to 2005 time period, there was a massive installed base put into service.  And when our units get to be about 15, 20 years, that’s when they typically need to be replaced.  And there tends to be a catalyst there with the repair, the cost of repairing them really goes up, a lot of parts and service in that time frame.  So we’re now coming up in that zone and even talking to some of our customers, they’re planning 2, 3 years out for this wave, talking to us about how do we prepare for that.”

An additional catalyst for a replacement cycle to newer, more efficient systems is the increased demand on the nation’s power grid from electric vehicle adoption and data center demand.  Carrier’s David Gatlin mentioned this dynamic late last year at the Baird Industrial Conference:

“We’ve been meeting with utilities…There’s a lot of interest [in smart energy solutions] because, obviously, the capacity of the grid can’t support the demand in the United States with the increased demand from data centers.”

As more people in the developing world adopt central cooling, and as large installed bases in North America come due for repair and replacement, including incentives to modernize, the future would appear bright for the HVAC industry.

Both the author and clients of Fortune Financial Advisors, LLC, own shares of Carrier.

The post The Tailwind of An Aging Installed Base – HVAC appeared first on Fortune Financial Advisors.

From 1959 through 2007, housing starts for single family homes in the U.S. averaged more than 1.1 million per year.  The housing bubble and subsequent bust that was largely responsible for the 2007 – 2009 financial crisis resulted in depressed housing starts for more than a decade; in fact, from 2008 through 2019, single family housing starts averaged just 660,000, not even 60% of the long-term average.  Housing starts are only now beginning to catch up to the long-term average:

As a result, the housing stock in the United States has become very old very quickly:  more than 60% of single family houses in the United States were built more than 35 years ago:

To complicate things further, homeowners are more frequently electing to stay in their homes for longer, due to reasons such as that they own the home outright and do not wish to hold a mortgage, or the current housing shortage means they would not receive more value in moving to a new location for the increase in costs incurred.

These trends have large implications for investors, and I wanted to highlight some of the segments that stand to benefit from them.

Remodeling / modernization:  Many, if not most, of the homeowners electing to stay put are of the baby boom generation, now in their retirement years, and typically close to their peak wealth due to a long bull market in stocks, and with their houses most likely paid for.  This wealth effect paired with an aged residence makes for a strong setup for remodeling or modernization of a home’s infrastructure.  In 2023, Fortune Brands Innovation’s Nicholas Fink remarked that:

“[The average home is over 40 years old, and homes built during the early 2000s boom are coming into prime R&R [repair & remodel] age.  Additionally, the baby boomer generation continues to prefer aging in place and investing in their homes, while millennials and other first-time homebuyers are purchasing homes in need of upgrades due to limited available inventory and affordability concerns.  These demographic trends are all supportive of repair and remodel.”

These modernization projects can obviously cover a lot of different things, but a few that stand out to me as especially interesting are water-related infrastructure such as “smart showers” and improved digital meters (the EPA estimates that the average house wastes up to 10,000 gallons of water a year), energy efficiency (this can be anything from better windows and insulation to more modern HVAC systems), and composite materials as a longer-lasting replacement for wood in things such as decks.

Pest control:  As houses age, the need for pest control rises, mainly due to such factors as outmoded construction materials and design, cracks in foundation walls, siding, and so on.  This only serves to reinforce a long-term trend that has been in place for decades:

Plumbing:  Plumbing is a critical service that should benefit from older houses with older pipes.  These can range from simple calls related clogged drains to more complex issues such as backed up sewers.  Plumbing services is severely fragmented, leaving industry-wide data hard to come by, but we can glean some insight from Chemed, which owns Roto-Rooter, the nation’s largest plumbing company.  Since 2005, Roto Rooter’s revenues have compounded at about 6% per annum, a rate above nominal GDP over the same period.  For reasons we have already listed, this rate of growth for plumbing services seems set to continue.

Until the housing market finds a new equilibrium in which housing starts reliably stay at a level needed to meet demand, and homeowners feel confident enough that selling their house in order to upgrade will justify the added expense, the trend toward aging in place and spending wealth on improving living quarters seems to have many years yet to play out.

Disclosure:  Both the author and clients of Fortune Financial Advisors, LLC, own shares of Chemed.

*via data.census.gov

The post The Implications of an Aged Housing Stock appeared first on Fortune Financial Advisors.

Here below are a few simple diversification strategies that I think enhance a portfolio’s resilience through market and economic turbulence:

I.  Beware Factor Concentration

You don’t have to be a stock picker to find yourself overweighted a given factor; the current stock market structure in the U.S. as measured by the S&P 500 or the MSCI USA indices is heavily weighted toward technology issues, with that sector alone comprising more than 30% of the index’s weighting.  What’s more, if you consult Professor Ken French’s database, which has not been as arbitrary, I would argue, with sector categorization as the major index providers, you will find that the unadjusted (see here for details) technology weighting in the U.S. market is closer to 40%, higher than the tech bubble peak weighting.  On the other hand, the non-durables sector, which contains classically defensive industries such as tobacco and beverages, now constitutes barely 3% of the U.S. market:

From a factor standpoint, this matters because as MSCI demonstrates in their index literature, information technology is more heavily loaded on the momentum factor, and heavily negatively loaded on the low volatility factor, thus making a generic index fund more exposed than an investor intends (source – MSCI):

Conversely, consumer staples (another term for non-durables), tend to be more neutral as it relates to momentum loading, but heavily loaded on low volatility (source – MSCI):

These differing factor exposures make the two sectors nice complements in a diversified portfolio, as illustrated by their heavily negative correlation with each other.  In sum, if you are concerned that your index fund or your portfolio’s heavy tech exposure leaves you too exposed from a factor perspective, – momentum has tended to sharper and longer drawdowns, historically, – , an allocation to consumer staples may be useful in a barbell approach, which we explored previously here.

II.  Gold As A Complement to Fixed Income

Before you roll your eyes at the mention of gold, please allow me to explain.  Gold is unique in its lack of correlation to major asset classes, it is not beholden to any central bank action, and it is universally liquid.  Because of these qualities, it has tended to be a safe haven during periods of global turmoil (source – State Street):

Gold, unlike a lot of fixed income such as intermediate- and long-term bonds, has also proven useful during inflation periods such as the last few years.  This is because correlations between stocks and bonds tend to rise during inflationary periods, thus rendering traditional fixed income less useful as a portfolio diversifier than it typically is when inflation is low and stable.  Inflation shortens investors’ time horizons, so low- and no-duration assets such as Treasury bills and gold tend to come into favor with investors.  For example, since the end of 2020, a period of higher inflation, long-term bonds languished, TIPs broke even, and Treasury bills outperformed both:

Gold, as measured by the SPDR Gold Trust, handily outperformed Treasury bills, perhaps because it has theoretically unlimited upside, whereas bills are limited in upside based on their defined maturity.  Of course, gold skeptics will say, stocks continued to do well despite inflation, and that is obviously true, so why do investors need gold exposure?  To be sure, I do not disagree entirely:  stocks are real assets that can pass on costs to consumers, and as such, they have historically been the best hedge against long-term erosion in purchasing power.

It is not my contention that investors should consider supplementing their equity allocation with gold, but rather I argue an investor’s fixed income allocation could stand to benefit from such an allocation, especially in an era with heavy government indebtedness, noisy inflation, and periodic economic turmoil.  Investment success over the long-run depends on surviving periodic short-term liquidity crunches, and given fixed-income’s vulnerability to inflationary pressures, gold has proven its utility as a diversification tool.*

*An entirely separate discussion is how best to obtain exposure to gold; I tend to favor royalty and streaming companies, but that is a topic for a future post.

III.  Diversify Your End Revenue Sources

One of the least discussed secular growth trends is the growth in government spending; the federal government is currently spending trillions annually, running deficits that are the largest in a non-recessionary, peace-time world:

How can investors use this profligacy to their advantage?

For one, government spending tends to be steady and predictable, and often counter-cyclical; it is one of the main reasons that defense primes, for example, have been one of the few industries to score a higher risk-adjusted return than the market over the long-term, and have yet to record a ten-year period of negative total returns.  This characteristic of being almost consumer staple-like is a major reason that defense companies tend to outperform during market downturns.  Witness the performance of Lockheed Martin versus broad industrials during the 2007 – 2009 financial crisis, and the COVID crisis of 2020:

Another example would be government spending on policing and public safety.  Since 1959, state and local spending on this category has grown consistently and without interruption, compounding at around 5.75% per year without a year-over-year decline in spending, not even during the financial crisis of 2007 – 2009 when many municipal budgets were stretched to the breaking point:

Because of this relative lack of uncertainty regarding revenue projections, government spending beneficiaries across the spectrum, – software, defense, law enforcement, etc., – tend to exhibit lower betas than the market and their peers, making them useful portfolio diversifiers:

Of course, each investor should take into consideration his or her own unique situation, goals, and resources in order to determine what is the best asset allocation for him or her, but I hope these ideas offer some food for thought for those examining their portfolios after a long bull market and looking for additional ways to diversify their nestegg.

Disclosure:  At time of publication, both the author and clients of Fortune Financial Advisors, LLC, own shares of Lockheed Martin and Booz Allen Hamilton.  Clients of Fortune Financial Advisors, LLC, own shares of Tyler Technologies and AXON Enterprises.

The post A Few Thoughts On Diversification Strategies appeared first on Fortune Financial Advisors.

In this episode—the second part in our series on the beneficiaries of the spending on the interstate highway system of the United States—Preferred Shares explores the aggregates industry. In particular, we go over the early history of Birmingham Slag, the family-owned business that evolved into Vulcan Materials Company (VMC).

The post The Rocks That Connect America appeared first on Fortune Financial Advisors.

Please download the entire research paper here.

The post Research Paper: The Implications of Migration to the Southern United States appeared first on Fortune Financial Advisors.

Asset placement, – which can be described as the purposeful allocation of a specific investment or asset class into a specific type of account as distinguished by tax classification in order to maximize tax-efficiency, – is an often overlooked part of investment management and estate planning.  Perhaps because investment return reports are illustrated on a gross of tax basis, while tax-inefficiencies are evident only on the investor’s tax return, little thought seems to be given as to how a portfolio that encompasses not only various asset classes but also accounts with differing tax classifications can be organized in such a way that frictional costs such as taxes can be reduced as much as possible.

Before getting into specific examples, let us assume for the sake of this post that there are three basic types of accounts by tax classification:  a “non-qualified” or taxable brokerage account funded by after-tax monies; a tax-deferred account such as a traditional IRA, a SEP IRA, a 401(k), 403(b), etc., funded by pre-tax contributions; and a tax-free Roth IRA or Roth 401(k) funded by after-tax contributions, but in which the earnings and distributions are both tax-free.  As it relates to asset placement, the tax classification of each type of account will have a huge impact on how it should be utilized to maximize after-tax returns for a given asset allocation because the tax code treats various asset classes differently when it comes to tax rates.

For example, growth stocks, if held for greater than one year in a taxable account, might be subject to more favorable long-term capital gains rates,   In some cases, long-term capital gains may not even be taxable at all.  Qualified dividends are treated similarly.  Conversely, however, distributions from REITs are taxed at ordinary income tax rates, making them ill-suited for ownership within a taxable account.  On the fixed income side, interest paid on Treasury bills, notes, and bonds are federally taxable, but state income tax exempt, while interest earned from holding municipal bonds is income tax exempt federally, but is taxable at the state level if it is from an entity outside your state of residence.

Another reason why an asset class such as growth equities are suited for a taxable account is because in such an account you start off from behind having already paid income tax on the dollars used to fund it.  To compensate for this initial tax hit, an investor is better served investing after tax funds in asset classes such as growth stocks that have a higher expected rate of return.  Similarly, an investor who wants to invest in some more speculative bets should consider using the taxable account for such an endeavor as the potential losses, if realized, can be deducted against gains or a portion of taxable income, whereas they are stranded within other account types.*  This is especially true for Roth accounts, in which a sizable loss is effectively losing capital twice:  once to taxes and again to market forces.

A notable exception for taxable accounts would be when investors are using a portion of the taxable funds for liquidity purposes, such as retirement cash flows, a down payment, and so on.  In such a case, an investor might hold a portion of the taxable account in Treasurys and municipal bonds as the need for liquidity and relative safety trumps trying to maximize returns; it would obviously be less than optimal to have to access liquidity from growth investments in the midst of market downturn.  I would also add that because interest received from corporate bonds is both federally and state taxable, corporate bonds are not as well suited for a taxable account unless it is a rare occasion when an investor has bought the bonds as more of a trade with the intention of realizing a capital gain as opposed to holding it for income.

As it relates to foreign stocks, holding them in a taxable account can be advantageous as taxes paid on dividends from those investments to their local governments can earn you a credit or a deduction on your U.S. tax return, but this is not available to an investor who owns the foreign shares inside a qualified account.

To summarize how I think about this, I built on Fidelity’s example, and created my own matrix of asset classes and account types based on how I think about them:

With this in mind, let us take a look at how an investor with a $1 million portfolio of 70% stocks and 30% cash & fixed income spread across a taxable account of $100,000, an IRA of $700,000, and a Roth IRA of $100,000 might use asset placement in attempt to optimize tax-efficiency while maintaining adequate liquidity:

To take this analysis a step further, suppose that the individual in the example above is approaching the age at which he or she is required to take a Required Minimum Distribution or RMD.  Because he or she is required to start taking a distribution from the IRA, the immediate need for liquidity from the taxable account is relaxed, so the fixed income allocation in that account can be kept to a minimum.  Furthermore, if this individual has children to whom he or she plans to leave the assets upon his or her death, then it makes sense to reduce the growth allocation within the IRA, all else equal, as not only has the investor’s time horizon compressed due to RMDs, but also current law requires, with few exceptions, non-spousal IRA beneficiaries to liquidate inherited IRAs over a period of at most ten years, whereas assets held in the taxable account benefit from a step up in cost basis, which can result in a more tax-efficient transfer of wealth.  Similarly, Roth assets are inherited free of tax to beneficiaries, making them excellent estate planning vehicles.  In sum, all else equal, you would want to have the most growth in a portfolio to occur in the taxable and Roth assets due to favorable legacy treatment, whereas more moderate growth might be more advantageous within IRAs and so on.

As the reader can see, there are multiple considerations and layers of complexity involved when developing not just an appropriate asset allocation but also how best to organize those assets in the most tax-efficient manner, as well as considering not just current needs but implications for beneficiaries and their own unique tax circumstances.  Given these complexities, investors should consult frequently with both their financial and tax professionals to ensure their portfolios are both allocated and organized according to their ever-changing means and circumstances.

Disclaimer:  Lawrence Hamtil is not a tax professional.  The views expressed in this post are not to be construed as tax advice.  Investors should consult with their tax professionals to see if their asset allocation is appropriate for their unique tax circumstances.

*Prior to 2018, losses in a Roth IRA could be deducted as a miscellaneous deduction if the account were closed out at less than its total contributed value, but this is no longer available given miscellaneous deductions have been phased out.

The post A Few Thoughts on Asset Location appeared first on Fortune Financial Advisors.

(source:  Wikipedia Commons)

Inspired in large part by the German Autobahn, President Eisenhower envisioned a coast-to-coast network of high-quality paved highways that would serve a multitude of purposes, from facilitating faster travel and greater logistical flexibility (the railroad networks had been stretched to their limits during the World Wars), to aiding in military resupply in times of war or evacuations in the event of a national catastrophe.  The greatest and most immediate impact, however, was economic; researchers at the University of California, San Diego estimate that for every $1 put into building the interstate highway system, $1.80 was returned in greater economic activity.  With travel distances between the coasts cut down from weeks to days if not hours, the United States became a much more mobile society with entire regions now open to consumer-driven travel and further industrialization.

First, however, the interstate would have to be built, and that required a lot of manpower, machines, and material.  In his wonderful history of the Interstate, The Big Roads, Earl Swift writes:

“Each billion dollars spent on construction provided the equivalent of forty-eight thousand full-time jobs for a year and consumed an almost inconceivably vast pile of resources:  sixteen million barrels of cement, more than half a million tons of steel, eighteen million pounds of explosives, 123 million gallons of petroleum products, and enough earth to bury New Jersey knee-deep.  It also devoured seventy-six million tons of aggregate– so much aggregate, some in the business have surmised, that the United States could not mine enough rock to rebuild the interstates today.”

Among the beneficiaries of this huge outlay were the quarry owners and aggregate miners, who provided the gravel and rock on which the interstates were laid, the heavy machinery manufacturers who provided the graders, tractors, and steamrollers that turned those rocks into roads, and the oil and gas producers and refiners who made the gasoline and diesel that fueled the project.  Some of the firms involved in the creation of the interstates took the opportunity to advertise their participation in the great national project, such as this 1961 ad from Caterpillar [via Transit Maps]:

As families began to set out exploring the country on the new interstate system, restauranteurs such as Ray Kroc and Howard Johnson recognized the need to provide traveling families with predictable, familiar service.  The idea of the chain restaurant was born as interstate exit ramps guided hungry motorists to McDonald’s and Howard Johnson’s.  Families would also need places to say on longer journeys, so hotels followed restaurants in the chain model as franchises like Holiday Inn became a staple of interstate exits; early ads for the hotel underlined the value of the familiar by stating, “The best surprise is no surprise.”

The logistical flexibility provided by the interstate system also gave rise to a whole new model of retailing:  big box stores began to set up in small towns offering rich variety and low prices to consumers previously left unserved by larger retailers.  Walmart’s 1975 annual report detailed just such a model:

Whereas not quite a century before the railroads had aided in the rise of Sears, Roebuck, and Co. as the first retailer with national reach, the interstate in the 1960s and 1970s would provide the backbone of Walmart’s logistical operations, with large distribution centers situated at critical points throughout the interstate network to facilitate inventory replenishment, as Professor Jesse LeCavalier has noted on his blog (map of Walmart distribution centers via Jesse LeCavalier):

Southern states like Tennesse (home to Fedex) and Arkansas (home to Walmart, JB Hunt, and others) saw their economic fortunes change in large part to the interstates as the new highways allowed them to become manufacturing centers of choice given they typically had lower labor costs than their Northern and Midwestern counterparts, and many were situated at ideal points in the country to become logistics hubs.  Prior to the creation of the Instate Highway System, for example, Arkansas’s per capita personal income hovered around 60-65% of the national average; after the interstates were created, that number grew to 75% in the mid-1970s, and is around 80% today:

In sum, the Interstate Highway System changed the face of American society and business forever.  It reduced regional fragmentation as distances became shorter.  It strained old industries such as railroads with new, disruptive competition, and gave rise to entirely new business models as small town America became the hunting ground for large, faceless corporations.

This post is meant as a kind of overview of some of the main talking points as it relates to the Interstate Highway System; we plan on covering these topics in greater detail in an upcoming miniseries on the Preferred Shares podcast, which you can find on your favorite podcast app.

This post is purely for informational purposes; any mention of specific companies is not to be construed as a recommendation of any kind.  The author, as well as employees and clients of Fortune Financial Advisors, LLC may hold positions in any stocks mentioned, though that is subject to change at any time.

The post How The Interstate Highway System Changed American Industry appeared first on Fortune Financial Advisors.

-Peter Lynch in One Up On Wall Street, 1989

What Peter Lynch observed thirty-five years ago is still true today:  the rock business is boring but extremely profitable.  The absolute dollar values of crushed stone and sand are not eye-popping; a ton of crushed rock might sell for $12 or $13 per ton, while gravel might sell for $10 per ton.  But, collectively, these “aggregates” as they are called are extremely valuable because they are the critical ingredients that form the basis of the buildings in which we work, the houses in which we live, and the roads that connect us.  This bizarre combination of absolute necessity but relative worthlessness is the key to the strong economics of the aggregates business which relies on persistent pricing power.

Consider that over the last fifty years, despite nasty recessions, conflicts, plagues, and so on, pricing for aggregates has increased at around 4.7% annually, well above the 3.85% annual inflation rate, and without a single year-over-year decline:

Furthermore, as Martin Marietta’s CEO, C. Howard Nye remarked at a 2020 industry conference, aggregates fall into the coveted “critical, but non-core” part of the value chain:

“So remember, we’re 10% of the cost of building a road, 2% of building a home, and somewhere between those two on [non-residential]. So we’re never going to make or break a project.”

In other words, aggregates producers have unique pricing power because they are essential but also do not constitute a significant cost of any construction project.  A good illustration of this is that in the decade spanning 2012 – 2022, total construction spending grew at a ~7.3% annualized rate, but aggregates spending grew at a ~5.6% rate, thus falling as a percentage of the overall cost:

Another attractive feature of the aggregates business is its highly fragmented industry structure.  Estimates vary, but there are somewhere between 1,000 and 2,000 going aggregates concerns in the United States with almost half of the operators with marginal market share in revenue terms*:

One of the reasons for the extreme fragmentation in the industry is the boom in infrastructure spending during the Eisenhower presidency with massive federal spending to build out the interstate highway system.  Many operators trace their roots to that period and remain family-owned, but now, in many cases, the younger generations are not necessarily interested in continuing in the aggregates business.  In addition, because permits for new quarries or mines are difficult to come by, it is simply more efficient for larger companies to grow within the industry via acquisition.  These dynamics create an opportunity for the larger players to consolidate the industry and provide the benefits of scale.  As I discussed in 2022’s The Optimal Industry Structure, it is often these types of industry consolidators that create some of the biggest long-term winners in the stock market.

It is this formula of consistent price increases along with opportunistic acquisitions that have propelled two of the larger aggregates companies, Vulcan Materials and Martin Marietta, to market-beating results over the last ~30 years:

It seems safe to assume that as long as the United States remains a dynamic and wealthy country with shifting populations, increased urbanization, and massive transportation spending needs, the rock business will continue to thrive for decades to come.

*In 2022, John McPherson of Vulcan Materials mentioned an estimated 5,000 operators in the industry, but this is certainly one of the highest estimates I’ve seen.

Disclaimer:  At time of publication, the author owned shares of Knife River while clients of Fortune Financial Advisors, LLC, held positions in Knife River and CRH.

The post Rock Pile Riches appeared first on Fortune Financial Advisors.