When I am looking for penny stocks to buy, I like to focus on companies that have a competitive advantage. A great example is the construction materials producer Breedon (LSE: BREE).
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Following a positive trading update from the group this morning, this is no longer a penny stock. However, as a small growing business, it is still on my list of stocks to buy.
According to its latest trading update, group revenue increased 31% in the 10 months to the end of October compared to 2019 levels. On a like-for-like basis, excluding acquisitions, revenue was up 15% compared to 2019.
Going forward, management believes this environment will continue. It has a presence in both the UK and Ireland markets, where governments have committed to “material long-term spending plans for construction“.
Breedon’s primary advantage is that it is challenging to build new production facilities for construction materials. People do not want quarries appearing in their backyards, which gives the companies that already own these resources a competitive advantage.
Breedon’s size and position in the market mean it is producing substantial profits, which management can then use to acquire other resources.
Of course, there are challenges to this approach. Breedon operates in a highly regulated industry, and it will always have to deal with competition concerns. Regulators could force the group to drop acquisitions if they believe it will distort pricing in the market.
Nevertheless, as demand for construction materials remains elevated, I think the company’s outlook is encouraging.
Construction market
I would also buy Steppe Cement (LSE: STCM) for my portfolio of penny stocks for the same reasons. A leading cement producer in Kazakhstan, I like the company because it provides exposure to an emerging market in a relatively stable and defensive industry.
It is also benefiting from some of the tailwinds driving growth at Breedon. According to its latest trading update, revenues for the first nine months of 2020 increased 16% year-on-year. Meanwhile, the cement market in Kazakhstan increased in size by 24%. Prices across the region have been rising as demand has jumped, but supply growth has struggled to keep up.
Steppe has a market share of 14%, which I think leaves plenty of scope for the company to expand and grab a more significant share of the expanding sector.
There are some risks associated with this stock, which are not present with Breedon. Steppe is active in a market I do not particularly understand and, to a certain extent, its fortunes are tied to the state of the national economy. There are also corporate governance concerns as an emerging markets business. Meanwhile, its primary currency is the Kazakhstani Tenge, and as the stock is traded in sterling, the exchange rate could be a headache.
Despite these concerns, I like the company for the reasons outlined above.
