SSD - Simpson Manufacturing: A Good Long-Term Bet

2023-10-04 07:03:00 ET

Summary

• The company has a history of outperforming the end-market by expanding in adjacent product lines and is executing its playbook well during the current slowdown.
• The company's strong execution, relationships with national home builders, and focus on innovation position it well to outperform in the new housing market.
• The company is also expected to benefit from increased transportation infrastructure activities and revenue synergy from the ETANCO acquisition in Europe.

Investment Thesis

While Simpson Manufacturing (SSD) faces some headwinds from the near term slowdown in its end-markets, it has a good track record of outperforming its end-markets by growing into adjacent product lines, increasing distribution and launching new innovative products. The company continues to execute well and is focusing on growth initiatives to outperform the markets in this downturn as well.

Once the interest rate cycle reverses over the next couple of years, the company should see solid growth driven by strong execution, synergies and cross-selling opportunities post ETANCO integration, and secular drivers like undersupply in the U.S. housing markets and trends towards sustainable wooden construction in Europe. The company has a good history of enhancing shareholder value and is currently available at lower than historical valuations. I believe the stock is a good buy for medium to long term investors at current levels and have a buy rating on it.

Revenue Analysis and Outlook

Following the pandemic, Simpson Manufacturing's revenue growth benefited from good demand across all of its end-markets. The company also benefitted from pricing increases as well as the acquisition of ETANCO last year.

In the second quarter of 2023, SSD's growth benefited from increased sales across the National Retail and Building Technology end-use markets and, as a result, the company reported an 0.76% year-over-year increase in net sales, which reached $597.6 million despite the tough macro environment. In the North America Segment, net sales increased 2% year-over-year to $465.5 million, primarily due to good growth in the National Retail market. In the Europe segment, net sales decreased 4% year-over-year to $127.8 million due to the slowdown in the residential housing market.

Looking forward, while the end-market conditions are tough, the company has a history of outperforming the end-market by expanding in adjacent product lines and expanding its reach to outgrow end-markets and the company is executing the same playbook which is helping during the current slowdown as well.

For instance, the majority of the building product companies have reported a decline in their U.S. retail and remodel sales last quarter as the retail channel slowed more than anticipated in the recent quarters. However, for SSD, National Retail volumes improved double digits Y/Y as the company expanded its product line and off-shelf merchandising efforts within the home center channel. This continued solid execution makes me optimistic that the company can continue to outperform the end-market moving forward as well.

While the new housing market is expected to be down Y/Y in 2023, it is performing much better than feared, and SSD's strong execution track record with deep relationships with most of the national home builders, focus on innovation, and best-in-class field support, technical expertise, digital tools and training to make product selection easier should help drive outperformance in this market as well. Further, the long term fundamentals in this market is favorable given over a decade of underbuilding post the great housing recession of 2008 and, once interest rate cycle reverses, we should see a swift rebound in this market in the next couple of years.

The company should also benefit from the increase in transportation infrastructure activities of late which are benefiting from the stimulus under Infrastructure Investments and Jobs Act (IIJA) funding in the U.S.

Moving to Europe, the housing markets there have seen a steeper slowdown than the U.S. and might see some lag in recovery compared to the U.S. However, there are a couple of drivers for the company there as well.

The ETANCO acquisition last year has strengthened the company's position in the European market and there is a good potential for revenue synergy as the company sells its traditional product line through ETANCO's distribution channel and vice versa.

The company should also benefit from the New European Bauhaus initiative which aims to promote sustainable and innovative building practices, with a focus on using wood as a primary construction material in Europe. Wood Connectors & Trusses account for approximately two-third of the company's sales and the company has 54% market share in this $2.5 billion market. The company's strong foothold in this industry positions it well to benefit from this initiative.

The company has a healthy balance sheet with cash and cash equivalents of $408 million as of the last quarter end and long term debt of $566.8 million resulting in a net debt balance of $158.8 million. With trailing twelve months EBITDA of $554.6 million , the company's net leverage ratio (net debt to EBITDA) is less than 0.3x positioning it well for both organic and inorganic investments to drive growth.

Overall, while the end-market conditions are tough in the near term given the macroeconomic uncertainty, SSD is well positioned to outperform its end-market. There is also a good long term opportunity for growth once the interest rate cycle reverses given the under supply of homes in the U.S. post a decade of underbuild post the great housing recession of 2008, and sustainability trends which are expected to drive wooden construction in Europe.

Margin Analysis and Outlook

Last year, the company saw a margin declined due the acquisition costs related to ETANCO, rising inflationary input costs including energy and labor costs, volatility in the steel market, and supply-chain constraints.

However, of late these headwinds are reversing. In the second quarter of 2023, SSD's margins benefited from lower raw material costs and volume growth which were partially offset by higher factory and tooling, warehouse and freight costs. As a result, the gross margin increased 440 basis points YoY, reaching 48.1% while the operating margin increased 140 basis point YoY to 24.3%.

Looking forward, the slowing end-markets, costs associated with integration of ETANCO, and the investment in growth initiatives are expected to impact margins in the near term. However, in the medium to long term, as the company realizes cost-synergies from ETANCO integration and see operating leverage benefit from end-market recovery and the company's growth initiatives, its margins should improve.

Valuation and Conclusion

SSD is currently trading at 17.51x FY23 consensus EPS estimates of $8.33 and 16.48x FY24 consensus EPS estimates of $8.85. This is a discount versus its 5-year historical average P/E ((FWD)) of 20.75x.

The company has a good track record of outperforming its end-markets and returning cash to its shareholders. Since 2019, the company has returned 47% of its cumulative free cash flow to its shareholders through dividends and share buybacks.

I believe the recent contraction in valuation multiple in response to the tough market conditions is an excellent opportunity for long term investors to buy this quality stock at an attractive price. Once the interest rate cycle reverses, the company should see a good growth driven by strong execution, ETANCO acquisition synergies and long term end-market drivers like undersupply in the U.S. housing market and trends toward sustainability and wooden construction in Europe. Hence, I have a buy rating on the stock.

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