Summary
- Builders FirstSource is a profitable business that's cheaply valued.
- The balance sheet is strong, and the company is buying back its shares.
- My point in this analysis is to talk about 2023 and the fact that BLDR is expected to be profitable this year.
Investment Thesis
Builders FirstSource ( BLDR ) is a very cheaply valued manufacturer of building materials.
The investment is not without risks. But I believe that the investment risks have been overpriced many times over. Throughout this analysis, I describe some of the negative considerations that readers should think about.
Furthermore, given BLDR's strong balance sheet, I contend that BLDR will seek to return excess free cash flow to shareholders. More specifically, I believe that BLDR will repurchase +10% of its market cap in the next twelve months.
Altogether, I believe that approximately 5x this year's free cash flow is very attractive.
Builders FirstSource's Near-Term Prospects
BLDR is not a homebuilder. But as you can see below, roughly half of the revenues are derived from value-added lines, making BLDR's prospects closely tied to the housing market.
BLDR presentation
If the housing market was to continue to deteriorate, this would be a large risk and this stock could sell off.
However, this is essentially the way to see this investment thesis. The stronger the lumber and housing market, the better BLDR's profitability.
Now, Consider These Graphs
The message is clear, irrespective of all the news facing the real estate market, it appears that sentiment in the past several weeks has substantially improved. Why has sentiment improved?
Because the housing market has been utterly beaten to a pulp, with homebuilders being so out of favor, that the market is attempting to sniff out where the fundamentals are heading.
Again, this doesn't mean that the housing market is back to strength. My argument here is only that the expectations are that we are over the worst.
Similarly, the lumber market appears to have found a floor in the past week, with lumber prices starting to migrate back to $500 bcf.
With both of these insights in mind, let's discuss BLDR's valuation.
BLDR Stock Valuation - 5x 2023 Free Cash Flow
As I previously noted, with lumber prices headed for $500 bcf, we should expect around $2.1 billion of EBITDA and somewhere near $1.6 to $1.8 billion of free cash flow. That puts the stock at around 5x this year's free cash flow.
Now, I want to make one thing clear, this is a forward-looking estimate. This does not mean that BLDR will be making these levels of free cash flow in H1 2023. This is how I view the business as a going concern in the next twelve months.
Capital Allocation, Massive Repurchases
As we stand right now, BLDR has approximately 156 million shares outstanding.
Having aggressively repurchased its shares over the past 12 months, as well as exhausting at least four different share repurchase programs in the prior 12-15 months, I believe that BLDR will continue its buyback program in 2023.
According to my estimates, BLDR will repurchase 10% of its market cap in 2023.
With the stock priced at 5x free cash flow and a rock-solid balance sheet, this investment is very compelling.
Investment Risks Facing BLDR
My bull case is reliant on the housing market not deteriorating further. With rates still expected to climb higher still in 2023, this could see weak household spending power and bust the housing market.
The building supply industry is notoriously cyclical and very price sensitive. There's no reason for a builder to pay more than necessary for what is ultimately a commodity product.
Lumber prices have been falling for some time. Even though I believe that a floor is now in, and lumber prices are rising, they could once again fall.
The Bottom Line
The key takeaway is this, the stock market is always looking six months ahead of the fundamentals. Even though I can't find enough evidence to show you that the worst is over with 100% certainty, I argue that BLDR's valuation is cheap enough at 5x this year's free cash flow to provide us with a margin of safety.
For further details see:
Builders FirstSource: Ready To Sizzle In 2023