Morningstar - Q3 2021 - 52

Strategies
The three main areas we are focused on are:
gPotential for increasing the corporate business tax.
gIncreasing foreign corporate profits with a
calculation on a country-by-country basis.
gRepealing the foreign-derived intangible income
deduction.
The rate to which the corporate tax rate may rise
and how the other proposals are structured
remain subject to a wide range of change before
any actual legislation is enacted. If these changes
are enacted as proposed, we estimate that they
could reduce the intrinsic value of U.S. firms by a
mid- to upper-single-digit percentage. However,
that amount will vary by firm. Some of the factors
that will influence the impact of those potential
changes are the amount of revenue and expense
recognition domestically; the location of
intellectual property; debt/equity capitalization;
and the potential for specific companies to
increase revenue greater than our current forecast
from the increased infrastructure spending.
In addition, corporate lobbyists will look to
influence the details of the final tax changes and
minimize their clients' tax increases as much
as possible. While Szapiro's article noted
that we estimate the tax cuts in 2017 increased
valuations by around 8%, the decrease in
valuations by reversing those cuts may be more
muted. Our expectation is that higher tax
rates will not necessarily result in a sharp sell-off
across the broad U.S. equity market, but that
the implementation will act as a headwind for
further valuation increases.
Five Industries That Stand to Gain
Many traditional infrastructure companies
are already fairly valued or overvalued, but the
stocks that will benefit the most will mostly
be found in the basic materials and industrials
sectors (EXHIBIT 1 ). In addition, specialized
subsectors such as engineering/construction and
project management software will see
greater demand.
Of these companies, those that stand to realize
the greatest valuation impact will be in the
small- to mid-cap categories, as the benefit to
diversified, large-cap companies may be diluted by
52
Morningstar Q3 2021
their other business lines. In addition, we
expect that we will see the preponderance of
earnings growth concentrated in the value
category, which contains the cyclical and most
economically sensitive corporations.
1. Basic Materials Already Incorporate Extra Growth
We are confident that companies providing cement,
concrete, and construction aggregates will
benefit from greater infrastructure spending. Of
those companies, we cover Martin Marietta MLM,
Summit Materials SUM, U.S. Concrete USCR,
and Vulcan Materials VMC.
In our base case, we have already incorporated
our expectations for the heightened spending
from the infrastructure plan. Even after
incorporating the impact of this spending into our
models and forecasting total EBITDA growth
of up to 80% over our five-year projection period,
we think that Martin Marietta, Summit, and
Vulcan are already overvalued, with Morningstar
Ratings of 2 stars. We think U.S. Concrete is
fairly valued at 3 stars.
2. Heavy Equipment Manufacturers: Most Upside
Already Priced In
Companies like Caterpillar CAT and Deere DE,
which provide the heavy equipment needed
to support infrastructure improvement, will benefit
from the increased activity. However, similar
to the aggregates manufacturers, on a probabilityweighted
basis, we have already incorporated
the higher demand into our projections for these
two companies.
Once the infrastructure plan is enacted and
additional information is provided, there is
a strong likelihood that we may further increase
our projections. However, we estimate that
any additional revenue would only move our fair
value estimates incrementally.
3. Some 3-Star Industrials Have Upside Potential
In addition to the first-order effects, a wide
range of industrials will realize additional demand
from the traditional infrastructure spending as
well as several other nontraditional initiatives
within this framework. For example, JBT JBT gets
about 30% of its revenue from airport equipment,
including jetways, as well as cargo loading, aircraft
deicing, aircraft towing, and aircraft ground
power and cooling systems. To an extent,
Honeywell HON will be a secondary beneficiary
through its investments in airports as well as
its building technologies segment, which will be
active in multiple infrastructure initiatives.
Other industrials that could see an uptick in
traditional as well as nontraditional infrastructure
spending include Eaton ETN and Hubbell
HUBB, both of which provide equipment to
electrical transmission systems to make the grid
harder (more robust and resistant to power
outages) and smarter.
To a lesser extent, General Electric GE and Emerson
EMR may also benefit in this area. GE sells
transmission solutions, although this is a smaller
part of the company's overall mix, and Emerson
recently acquired a business that provides
advanced distribution management software for
transmission and distribution.
4. Transportation: Surging Economy Has Already
Elevated Stock Prices
Transportation will also come into play when all
this raw material and equipment needs to
be delivered to the project sites from suppliers and
manufacturers. Additional transportation
resources may be required from railroads and
trucking companies to move all the material and
machinery around.
But, in our view, investors have already
overextrapolated the impact from the resurgence
in the U.S. economy this year and next and
pushed these stock prices too high above their
intrinsic valuations.
5. Engineering/Construction and Software:
Someone Needs to Plan All These Projects
Finally, to organize all this work, most of these
projects will require experienced engineering
and construction firms that specialize in large-scale
projects, such as Fluor FLR, Jacobs Engineering J,
and Aecom ACM. As these engineering firms
plan the infrastructure projects, they may
need to expand their relationships with firms that
provide computer-aided design and simulation
software, including Ansys ANSS, Autodesk ADSK,
and Dassault Systemes DASTY.
Morningstar - Q3 2021

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