Investor Essentials Daily

This distributor has all things we need to improve our infrastructure

July 18, 2023

The next decade is a decade of investments in infrastructure.

The pandemic showed us how vulnerable our infrastructure and supply chains are. Now, the U.S. government and companies are doing what they can to improve them.

We are rebuilding roads, making services like the Internet and public transit accessible, and improving the water infrastructure.

One of the big beneficiaries of this Core & Main (CNM). It is a scaled distributor providing all the essential products for efficient water infrastructure; the company is poised to benefit from the increasing investments.

And yet, the market fails to see this, resulting in the undervaluation of the stock.

That is why Core & Main showed up on our screen. Its potential for high returns and low valuation make it a great FA Alpha 50 name.

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The pandemic unearthed all the problems with our infrastructure and supply chains.

Lead times got extended, orders got canceled, and manufacturers could not get their hands on raw materials essential for their products.

Now, the government and companies are working together to solve these problems.

The Bipartisan Infrastructure Deal that came into effect in 2021 has already announced more than $185 billion in funding in its first year.

These funds are used for rebuilding roads and bridges, making public transit accessible, bringing internet service to underserved areas, and improving the water infrastructure.

The deal continues to fund projects that are making the U.S. infrastructure more resilient.

In the meantime, companies are bringing their manufacturing facilities home to improve supply chains. They are benefiting from the bill to build new facilities and improve the infrastructure around them.

We call this the supply-chain supercycle. This is just the beginning of a decade of investment in these areas.

There are big beneficiaries of this cycle, especially those that provide products and services to allow these investments to be realized.

One of them is Core & Main (CNM). It is a scaled distributor focusing on water infrastructure products. It provides water, wastewater, storm drainage, fire protection products, and related services.

Its biggest customers are municipalities, private water companies, and professional contractors in the U.S.

Surging investments in infrastructure means more demand for Core & Main’s products. The company has already benefited from this trend.

Thanks to this high demand, its return on assets (“ROA”) jumped from 22% in 2021 to 40% in 2023.

As investments in infrastructure ramp up during the rest of the decade, Core & Main is likely to see these high returns go even higher. It might also see a big potential to scale up even further.

And yet, the market fails to recognize this opportunity.

We can see this through our Embedded Expectations Analysis (“EEA”) framework.

The EEA starts by looking at a company’s current stock price. From there, we can calculate what the market expects from the company’s future cash flows. We then compare that with our own cash-flow projections.

In short, it tells us how well a company has to perform in the future to be worth what the market is paying for it today.

At the current stock price, the market expects the company’s ROA to fall to 14%, even lower than what it was in 2021 before the investments started to increase.

Given the key position in an industry that is going to see increasing investments going forward, these expectations seem overly pessimistic.

The next decade is the decade of improving infrastructure. Core & Main has a big opportunity to enhance its operations and be a bigger and better business.

That is why Core & Main showed up on our screen. Its potential for high returns and low valuation make it a great FA Alpha 50 name.

Throughout financial market history, many of the world’s most successful investors have been candid in their belief that Generally Accepted Accounting Principles (“GAAP”) distort economic reality.

Warren Buffett, for example, once said investors should “concentrate on the world of companies, not arcane accounting mathematics.”

Investors who neglect the very real issues with as-reported accounting can find themselves caught up in investing with the crowd, blindly following hot “themes” without a thorough grasp of how to understand the businesses in question.

The only true way to focus on the “world of companies,” as Buffett suggests investors do, is to present a clear picture of how a business operates, something that can only be done by adjusting financial statements to reflect the arbitrary nature of certain accounting rules that leave much to discretion.

The world’s best investors understand the need to make these adjustments, which allows them to focus not on picking out the most popular companies but rather on looking for great names in sleepy areas that the market isn’t paying much attention to. From there, the goal is to then identify quality companies with significant growth potential at reasonable prices.

That’s exactly what we’ve set out to do with the FA Alpha, our monthly list of 50 companies that rank at the top for quality, high growth, and low valuations.

This list has outperformed the market by 300 basis points per year for over 20 years now, effectively doubling the performance of the market by focusing on the real fundamentals and valuations of companies with our proprietary Uniform Accounting framework.

To see the other 49 names on the list, click here.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research

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