2023-11-13 22:51:18 ET
Summary
- Builders FirstSource, Inc.'s stock has increased by ~90% since my previous coverage late last year.
- The company's revenue outlook is positive, with indications that the housing market is near the bottom of the current cycle.
- Builders FirstSource has a strong track record of gaining market share and is well-positioned for future growth.
Investment Thesis
Builders FirstSource, Inc.’s ( BLDR ) is up ~90% since I recommended buying it late last year. While the company faced challenges due to the slowdown in the single-family housing market, the decline in this market was less than what investors were fearing in late 2022/early 2023 and this resulted in a massive outperformance. Looking forward, the sequential improvement in September housing starts and recent commentary by homebuilders around encouraging order trends bodes well for the company’s revenue growth moving forward. In the medium to long term, a recovery in the housing market as the interest rate cycle reverses coupled with tight supply-demand conditions in the housing market due to a significant underbuild of new homes post the great housing recession of 2008 should drive the revenue growth. Besides organic growth, inorganic growth opportunities from bolt-on M&As should help the revenues in both the near and the long term. On the margin front, the company’s margins should benefit from cost-saving initiatives, productivity improvement, and an improved mix of higher-margin value-added products. The valuation is also cheap. Given the good growth prospects and a cheap valuation, I continue to have a buy rating on the stock.
Revenue Analysis and Outlook
After seeing good growth due to the housing boom during the pandemic, BLDR’s revenues saw a sharp decline this year as rising interest rates adversely impacted the housing market. In the third quarter of 2023, the company reported net sales of $4.5 billion, a 21.3% Y/Y decline, driven by core organic sales decline of 13.5%, commodity price deflation of 9.1%, and a negative impact of 1.6% due to one fewer selling day. These negatives were partially offset by contributions from acquisitions of 2.9%. The Y/Y decline in core organic sales was caused by a 19.2% Y/Y decline in the single-family customer segment due to lower demand in a weaker housing market. While Multi-Family and Repair and Remodel/Other increased 6.4% Y/Y and 1.4% Y/Y, respectively, partially offsetting the Y/Y decrease in sales to single-family homebuilders.
BLDR’s Historical Revenue by Product Category (Company Data, GS Analytics Research)
Looking forward, the company’s revenue outlook is positive and we are likely near the bottom of the current housing cycle. The housing market has seen good resilience in this downturn and has avoided 2008 like steep crash despite the significant rise in interest rates. One of the key reasons behind this is the supply shortage in the housing market caused by the significant underbuilt of new homes in the decade following the great housing recession. I believe this structural supply-demand gap positions the housing market really well and once the interest rate cycle reverses, there can be a steep recovery in this market.
If we look at recent data, housing starts in September were sequentially better than August and there are indications that we are likely near the bottom of the current cycle. Further, order trends at large production builders have been really strong. If we look at the recent earnings release of D.R. Horton ( DHI ), which is the largest home builder in the U.S., it reported a 39% Y/Y increase in net orders last quarter which bodes well for the future growth in this market.
One good thing about BLDR is that it has higher exposure towards production builders than customized builders. Due to recent appreciation in home prices, home buyers are looking for affordable homes and this gives an advantage to production builders as they offer relatively cheaper options than custom home builders. This should help production builders and in turn BLDR. BLDR also has a good track record of gaining market share and doing bolt-on acquisitions to strengthen its position in the fragmented market which should help it outperform end-market growth.
The company derives ~68% of its revenue from the single-family housing market and recent commentary from large home builders around order rates and data for housing starts make me optimistic about growth in 2024. Remodeling should remain flattish and while there may be some decline in the multifamily end market, the strength in single-family housing (especially production builder) and the company’s good execution and market share gains should help it deliver revenue growth in FY24. The growth should further accelerate in subsequent years as the interest rate cycle reverses. So, I am optimistic about the company’s growth prospects.
BLDR’s 3Q23 Sales Mix by End Market (Q3 Earnings Presentation)
Margin Analysis and Outlook
In Q3 2023, the company’s gross margin declined 10 bps Y/Y to 34.9% due to lower sales and core margin normalization which was offset by improved mix in value-added products, including the multifamily business. The adjusted EBITDA margin also declined 240 bps Y/Y to 17.9% as a result of lower net sales and reduced operating leverage, partially offset by improved productivity across the business.
BLDR’s Gross margin and Adjusted EBITDA margin (Company Data, GS Analytics Research)
Looking forward, the company’s core margin outlook looks good. The company’s margins are impacted meaningfully by Lumber prices which can cause volatility in its reported margin. However, management also shares the company’s core margins which adjusts for Lumber price fluctuations and gives a better sense of the core business performance.
BLDR Core Adjusted EBITDA Margins (Q3 Earnings Presentation)
Management is taking several initiatives like improving the mix of high-margin value-added products and cost savings and productivity improvement which has helped it improve its core margins in recent years.
The company is executing really well on these initiatives and last quarter BLDR increased its productivity saving targets for FY2023 from earlier $110 mn to $150 mn to the current $150 mn to $160 mn. I expect the continued implementation of these productivity initiatives and increasing high-value-added product mix should help BLDR’s core margins. It's difficult to speculate the benefit or headwind from Lumber price fluctuations but it has been a good tailwind over the last couple of years, and I expect some of that benefit to not recur as we enter a more normalized environment. However, I am not too worried about it and, as long as the company continues to take structural costs out of the core business and improve the mix, I believe investors should continue to reward the company’s stock price.
Valuation and Conclusion
BLDR is currently trading at a 10.49x FY24 consensus EPS estimate of $11.86 and a 9.03x FY25 consensus EPS estimate of $13.77. The company's national peers like U.S. LBM, 84 Lumber, and Carter Lumber are private. However, for relative valuation, if we compare the company with other high-quality housing end-market-related companies with good long-term growth prospects like Home Depot ( HD ) trading at 18.34x next-year consensus EPS estimates and Lowe's ( LOW ) trading at 13.73x next-year consensus EPS estimates, the stock looks cheap. Another comparison for a relative valuation could be with high-quality distributors in industrial space which have similar long-term growth prospects in a fragmented market from market share gains both organically and through bolt-on acquisitions. The stock looks cheap compared to them as well with W.W. Grainger ( GWW ) trading at 20.52x next-year consensus EPS estimates, Fastenal ( FAST ) trading at 28.01x next-year consensus EPS estimates, MSC Industrial Direct Co. ( MSM ) trading at 14.50x next-year consensus EPS estimates.
So, the stock looks attractive given its low valuation and the company’s long-term prospects supported by the company’s good execution, tailwinds from a significant underbuild of new homes post the great recession, accretive M&As, cost-saving initiatives, productivity gains, and a higher mix of high-margin value-added products. While the company has seen some pressure on the single-family housing end market side, I believe we are likely near the bottom of the current housing cycle and worst is already getting priced in the stock. I believe long-term investors can consider buying the stock at the current levels and continue to maintain my buy rating on the stock.
For further details see:
Builders FirstSource Is A Good Buy At Current Levels