The EDGE Strategy And Vertical Integration Will Strengthen Future Market Positions With High-Margin Public Projects

Key Takeaways

• Strategic acquisitions and the EDGE strategy are enhancing revenue, earnings, and margin expansion through vertical integration and optimized pricing models.
  
• Public infrastructure funding and IIJA investment in key markets promise significant growth and high-margin projects.
  
• Persistent SG&A costs, acquisition risks, and dependence on government funding may pressure margins and hinder revenue growth amidst declining product sales.

Catalysts

Provides aggregates- led construction materials and contracting services in the United States.

• Strategic acquisitions made by Knife River in recent months are expected to bolster revenue and EBITDA in 2025. The investments in aggregate reserves, construction materials, and liquid asphalt operations will enhance their market positions and support vertical integration, significantly impacting revenue and earnings.
  
• The implementation of the EDGE strategy, with a focus on optimizing pricing and quality of work over quantity has improved gross margins. Continued adoption of dynamic pricing models and process improvements are expected to drive further net margin expansion.
  
• Significant opportunities from public infrastructure funding, particularly with DOT bid schedules lined up for 2025, will provide a steady stream of high-margin projects. This strong public project pipeline will enhance revenue growth prospects.
  
• Efficiencies and improvements identified by the PIT Crews at production plants are likely to reduce costs and increase operational efficiencies, contributing to net margin expansion as these improvements are standardized across operations.
  
• Expected increase in infrastructure investment from the remaining unallocated IIJA funding and military spending in key markets like Hawaii and Alaska offers Knife River substantial growth opportunities, projecting positive impacts on revenue and future earnings.

Knife River Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Knife River's revenue will grow by 5.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 6.9% today to 9.0% in 3 years time.
• Analysts expect earnings to reach $307.3 million (and earnings per share of $5.39) by about December 2027, up from $199.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 26.3x on those 2027 earnings, down from 29.8x today. This future PE is greater than the current PE for the US Basic Materials industry at 25.5x.
• Analysts expect the number of shares outstanding to grow by 0.23% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.89%, as per the Simply Wall St company report.

Knife River Future Earnings Per Share Growth

Risks

• The company experienced higher SG&A costs in the quarter due to acquisition-related expenses and health care claims, which, if persistent, could negatively impact net margins.
  
• Reduction in Energy Services segment EBITDA was anticipated, indicating a potentially concerning decline in one of the company's revenue streams, possibly affecting overall earnings.
  
• The company relies significantly on public funding for infrastructure projects. Any downturn in government funding or delays in infrastructure projects could slow revenue growth.
  
• Recent volume declines across key product lines such as aggregates and ready-mix suggest potential challenges in sales growth, which could pressure overall revenue.
  
• The company's aggressive acquisition strategy involves integration risks and increased SG&A costs, which could offset potential earnings gains from acquisitions.

Valuation

• The analysts have a consensus price target of $118.14 for Knife River based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $125.0, and the most bearish reporting a price target of just $103.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $3.4 billion, earnings will come to $307.3 million, and it would be trading on a PE ratio of 26.3x, assuming you use a discount rate of 6.9%.
• Given the current share price of $104.85, the analyst's price target of $118.14 is 11.3% higher.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.