TRG | The Bottom Line – 12-6

We have been bullish on Granite Construction since it was below $40. We have stayed bullish even as the stock price rose up because we expected EBITDA margin to rise further. The 2027 targets validated this expectation (see top chart). What surprised us, and we think would be easy to overlook, is that the good news of rising EBITDA margin overshadows the even better news of more steeply rising cash flow generation of the company.

Past operating cash flow generation was fairly choppy in prior years. In that period, Granite was in the midst of executing on large projects and also acquired Layne in 2018. The large projects caused significant pressures on margins and caused accounting issues, while certain segments of Layne had did poorly at cash collections. As seen, operating cash flow margins were barely positive in FY’21.

Granite’s new management, which started in mid-2021, shifted the strategy to: 1) run off the megaprojects, 2) reduce its focus on winning large projects, 3) divest parts of the Layne business, 4) focus on winning quicker burn projects that utilize its vertical-integrated capabilities with its Materials assets, and 5) acquire more vertically-integrated businesses.