PGTI - PGT Innovations: Optimistic On Volume Outlook And Valuation Has Gotten Cheaper

2023-09-13 07:54:08 ET

Summary

• I upgraded my rating to a buy due to the valuation becoming more attractive and my positive outlook for volume growth.
• Recent results show improvement in sales guidance and pricing contribution, suggesting a more manageable volume decline.
• Anticipation of increased demand for impact-resistant products post-Hurricane Ian and investments in production capabilities set the stage for future growth.

Overview

My recommendation for PGT Innovations ( PGTI ) is a buy rating, as valuation has now dipped to cheaper levels than I wanted. Note that I previously gave a hold rating to PGTI as my optimism appeared to have already been priced into the valuation (the forward EBITDA multiple has reverted to the average since then). Aside from valuation, my upgrade is also because of my positive outlook for PGTI volume growth in the coming quarters, as the trend seems to be improving.

Recent results & updates

I am turning my recommendation to a buy as the dip has come, PGTI forward EBITDA valuation has retracted back to it 1 standard deviation level at 7.8x vs 8.8x average. I continue to be optimistic because the fundamentals are sound. Despite management's concerns about macro uncertainty and a 13% drop in 2Q23 volume, I believe we have passed the worst. When compared to the 1H23's double-digit volume decline, 3Q23's 0-5% growth range in sales guidance and 2% pricing contribution suggests a much more manageable volume decline in the low single digits. If this trend continues, 4Q23 could see positive y/y volume growth as PGTI laps easier comps, potentially leading to a dramatic shift in sentiment. PGTI's focus on custom-build products is a strength, and the fact that it expects stability in R&R sales despite a higher proportion of larger-ticket R&R items is indicative of this. In particular, the company has not been affected by de-stocking because its products are all made to order, and its management is confident that it will resume growth in 2024.

As a result of Hurricane Ian, I believe that consumers will have a greater appreciation for PGTI's impact products in the future. I anticipate a spike in the market share of impact-resistant products as the next hurricane season approaches Florida. In the wake of Hurricane Ian last year, consumers became more aware of PGTI's services, and this has translated into increased demand, as evidenced by the company's growing backlog (which was driven by demand in the Southeast, primarily in Florida). The fact that lead times have nearly returned to normal suggests that the backlog growth is being motivated by consumer demand. Given the current influx of new residents to the Sunshine State, this paves the way for substantial future growth.

Looking at the big picture, PGTI's recent investments in expanding its production capabilities and streamlining its manufacturing processes have set the stage for rapid growth. Due to the labor-intensive character of the sector and the distinctiveness of PGTI's offerings, the primary challenge when demand surges, as it did in 2021, is to match the pace while still keeping lead times low. Since then, PGTI has put considerable effort into growing its Florida operations in order to gain access to a larger pool of potential employees and has taken measures like bringing more glass capacity in-house in order to lessen its reliance on external suppliers. I anticipate PGTI's efforts to regain market share lost due to supply constraints will continue unabated now that lead times have returned to normal.

Overall, I see a bright future for PGTI's bottom line, with volume expected to pick up in the near future (4Q sees an easy comp and automation to ease supply constraint) and a positive outlook for the long term (consumer awareness increasing with each passing hurricane season). Upon examining the management guidance, they are suggesting a 3Q23 EBITDA margin ranging from 18.4% to 19%. It is worth noting that these margins align with PGTI's previous peak margins. The fact that the increase is due in part to recouping inefficiencies and pricing means that I believe this margin level to be sustainable. There should be no concerns regarding the adjustment of prices, particularly in relation to PGTI's lag in keeping up with inflation amidst its prolonged lead times. The forthcoming demand increase due to Hurricane season should allow for a comfortable price increase. Additionally, as previously stated, the implementation of automation, I expect it to have a positive impact on profit margins in the long run.

Valuation and risk

According to my model, PGTI is valued at $27.45 in FY24, representing a 30% increase. This target price is based on my forecast that growth will accelerate in the coming years (on track to 10+%, just as it did historically), due to my bullish viewpoints above. My expectations for margin are anchored to management's 3Q23 guidance and my assumption that it should improve modestly given the investments in automation and increase in pricing. The way to value PGTI is by attaching the mid-cycle multiple, which is the average of 8.8x forward EBITDA.

The downside here lies in PGTI not growing volume as fast as I expected, which would indicate that the underlying demand is simply not as strong as I expected. Specifically, consumer awareness of impact-resistant products is not translating to sales for unknown reasons, and PGTI is not winning share that it has previously lost due to supply constraints. The latter is a major risk as it suggests that the alternative to the PGTI product is good enough.

Summary

I have upgraded my recommendation for PGTI to a buy rating. First, PGTI's valuation has become more attractive, with its forward EBITDA multiple now aligning with historical levels. Second, I am optimistic about PGTI's volume growth in the upcoming quarters, as the company appears to be recovering from recent challenges. While macro uncertainties and a 13% drop in 2Q23 volume were concerning, signs of improvement are emerging. The projected 0-5% growth range in sales for 3Q23 and a 2% pricing contribution indicate a more manageable volume decline in the low single digits. In addition, the focus on custom-built products, consumer awareness, and the potential for increased demand post-Hurricane Ian all contribute to a positive outlook.

For further details see: