THRM - Patrick Industries: Recent Weakness Does Not Negate Upside

Summary

• Although 2022 was a great year for Patrick Industries, the final quarter of the year was a time of weakness.
• This may be painful to the bullish case for some investors, but the company is already doing well on that front.
• The easy money has been made, but some additional upside is likely warranted.

One of the really great things about being a value investor is that many of the prospects you might choose from already have most or all of their future pain priced in. This can mean that, even when fundamentals deteriorate, upside for investors can be rather significant. One really great example I could point to that has recently turned the corner in a negative way is Patrick Industries ( PATK ). Based on the data currently available, the company has come under pressure from both a sales and profit perspective. Cash flows are also, for the most part, showing signs of weakness. Even with this and even in spite of a significant move higher, shares of the company are trading at very low prices, both on an absolute basis and relative to similar firms. While I am not as bullish on the company as I was previously, I do still think it offers some upside for investors from here. As such, I have decided to retain the 'buy' rating I had on the stock previously.

The picture is changing

Over a year ago, in January of 2022, I wrote an article discussing the investment worthiness of Patrick Industries. In that article, I talked about how the company had consistently grown its top line while generally posting positive cash flow data, over the prior few years. I also found shares of the company to be quite cheap. All of these factors combined made me comfortable in rating the business a 'buy'. This kind of rating coming from me is an indication of my belief that shares should outperform the broader market moving forward. And that's exactly what the company achieved. While the S&P 500 has dropped 7.5%, shares of Patrick Industries have seen upside of 13.7%.

This move higher was based on two primary things. The first of these was the fact that shares of the business looked quite cheap. We will get to that more near the end of this article. The second is the fact that, for the most part, the firm's fundamental condition continued to improve. If you look at data for 2022 versus 2021, for instance, you will see some rather bullish results. Revenue in 2022 totaled $4.88 billion. That's 19.7% higher than the $4.08 billion the company reported for its 2021 fiscal year. Management attributed this increase to strong demand for RVs in the first half of the 2022 fiscal year. They also said that more consistent marine and housing demand throughout the year helped, as did some acquisitions completed in both of the most recent fiscal years.

The sales increase brought with it drastically improved profits. Net income, for instance, shot up from $224.9 million to $328.2 million. Operating cash flow also rose nicely, climbing from $252.1 million to $411.7 million. On an adjusted basis, the growth was a bit slower, with the metric climbing from $362.2 million to $472.4 million. And finally, EBITDA for the company spiked from $480 million to $643.1 million.

If we look at the data presented for the fiscal years in their entirety, you might think that the company's growth spurt continues to this day. But that wouldn't be the case. In the final quarter of 2022, for instance, management reported revenue of $951.9 million. That's down 17% compared to the $1.15 billion reported one year earlier. This plunge was driven largely by a 47% decrease in the number of wholesale RV industry unit shipments that impacted RV revenue negatively to the tune of 39%. Marine revenue helped to offset this to some degree, climbing by 35% thanks to an 11% rise in wholesale powerboat industry unit shipments. Unfortunately, this was the only bright spot for the company in the final quarter. Motor home revenue rose only 3%, with a 12% plunge in unit shipments impairing potential. And industrial revenue managed to drop by 2% thanks to a 16% fall in housing starts.

This drop in sales brought with it a drop in profits as well. Net income declined from $61 million to $40.2 million. Whenever you see sales in a low-margin space contract, the drop in profits and cash flows will be even worse most of the time. This is because low-margin industries are often capital-intensive and you end up with less revenue to spread across the firm's fixed costs. It is true that operating cash flow rose year over year, climbing from $104.7 million to $181.9 million. But if you adjust for changes in working capital, you would see that the metric actually fell from $91 million to $71.8 million. Over that same window of time, even EBITDA took a hit, dropping from $128.8 million to $108.4 million. One positive for investors to consider is that, even though some fundamental data has been disappointing, management did decide in December of last year to increase their share repurchase program to $100 million from the $38.2 million that they had prior to the increase. This shows at least some vote of confidence for investors to enjoy.

Based on the data from 2022, shares of Patrick Industries are trading at a price-to-earnings multiple of 5.2. The price to adjusted operating cash flow multiple comes in at 3.6, while the EV to EBITDA multiple should be 4.6. If we use data from the 2021 fiscal year instead, these multiples would be 7.6, 4.7, and 6.2, respectively. Now, given that conditions are worsening because of a plunge in demand for RVs, it stands to reason that the firm's fundamental condition will likely continue to worsen from here. If we assume that financial performance reverts back to what the company experienced in 2019, prior to the COVID-19 pandemic, we would still get multiples that are reasonable. The price-to-earnings multiple would come in at 18.9. The price to adjusted operating cash flow multiple would come out to 9.5. And finally, the EV to EBITDA multiple would be 12.3. As part of my analysis, I compared the company with five similar firms. On a price-to-earnings basis, these companies range from a low of 7.5 to a high of 909. Using the EV to EBITDA approach, the range was from 4.8 to 38.1. In both of these scenarios, Patrick Industries was the cheapest of the group. And finally, using the price to operating cash flow approach, the range would be from 2.6 to 282.4. In this case, only one of the five companies was cheaper than our prospect.

Takeaway

Given what's happening in the recreational vehicle market, I suspect that some additional pain lies ahead for Patrick Industries. Having said that, the company continues to post positive results, even if they aren't improving. In the next couple of quarters, I suspect the picture will show continued signs of worsening. But even a return to pre-pandemic levels of profitability would result in shares looking attractively undervalued. To be clear, I do think the easy money has been made in this case. But absent something coming out of left field, I believe that Patrick Industries still warrants a buy rating at this time.

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