2023-09-14 18:31:41 ET
Summary
- GMS reported strong quarterly results despite rising steel prices, indicating its ability to address increasing demand in the construction industry.
- The company is focused on expanding its platform through acquisitions to capture additional market share and increase profitability.
- GMS is undervalued and has the potential for 58.9% growth in stock due to positive industry trends and its expansion efforts.
Investment Thesis
GMS ( GMS ) is a distributor of construction products in North America. It has recently reported strong quarterly results despite the rising steel prices. The company is highly focused on expanding its platform through acquisitions which can help it to grow by addressing the increasing demand in the industry.
About GMS
GMS manages a network of over 300 distribution centers with a product portfolio of ceilings, wallboard, steel framing, and complementary construction products. The wallboard, complementary products, steel framings, and ceilings contribute 40%, 29%, 19%, and 12%, respectively to the company’s total net sales. The complementary products further consist of Insulation, Joint Treatment, Lumber, EIFS/Stucco, and Tools & fasteners. In addition, the firm offers building products and solutions for its commercial contractors & residential consumer base. It has a strong presence across six Canadian provinces and 47 U.S. states . The Residential end market contributes 45% and the Commercial end market accounts for 55% of the company’s portfolio. The Residential segment includes Single-family New, Multi-family New, and Repair & Remodel products. The Construction segment comprises new construction as well as Repair & Remodel.
Financials
We can observe in the above chart that the company has been experiencing a strong demand since FY2022 which is translated into revenue of $4.63 billion or 40.3% YoY growth which is slightly offset by deflationary steel framing product pricing. The company has been experiencing solid growth over the last three years. Its revenue has increased from $3.3 billion in FY2021 to $5.33 billion in FY2023 which resulted in 3-year CAGR of 17.11%. However, the rising interest rates to combat inflation led to a significant downturn in the real estate industry. The single-family constructions were highly affected due to the industrial headwinds. Multi-family house construction remained comparatively positive. In addition, lower steel prices contributed to negative performance in the construction sector. GMS sells steel framing as one of its primary products and it is facing deflationary pressure due to lower steel prices. The company has experienced a 25.5% YoY decline in Prices for Steel Framing products in last quarter. However, recently t he shortage of supply in the resale market has boosted new house construction in the U.S., where a majority was contributed by single-family houses. The construction experienced a 3.9% YoY growth in July to an adjusted annualized rate of 1.452 million which is slightly higher compared to market expectations of 1.448 million. The single-family housing starts surged by 6.7% . These recent trends in the construction sector have helped to maintain a positive demand and have created opportunities for the participants. To capitalize on these opportunities the company is highly focused on acquisitions. In 2023, the company completed three acquisitions of Blair Building Materials, Engler, Meier & Justus, and Home Lumber & Building Supplies. These acquisitions have significantly helped the company to penetrate deeper into the markets and capture additional market share by expanding its platform. It has utilized about 53% of its cash for acquisitions for FY21, FY22, and FY23 which reflects its strong momentum in expansion. I believe the company can sustain this growth for a long period by expanding its platform as its future acquisitions are expected to highly benefit it to increase the sales of its core products in growth markets. GMS has $81.4 million of cash on hand and $816.2 million available liquidity under revolving credit facility. The company has also managed to decrease its EBITDA debt leverage from 1.8x (Q1FY2023) to 1.5x (Q1FY24). Its improving balance sheet's strength and liquidity position show that the company's capacity for new acquisitions. In addition, it can also help to add more products to that are complementary to their core ones which can further boost its profitability by increasing its customer base and help it to capture the growing demand in the market. Further, the firm can sustain this growth in the long run by utilizing its strong market presence, as construction in the United States is anticipated to reach $1.8 trillion by 2037 which is a 30% increase.
The company has recently delivered its quarterly results . It reported net sales of $1.40 billion, up 3.68% compared to $1.35 billion in Q1FY23. This growth was mainly fueled due its recent acquisitions, resilient pricing, and continuous commercial construction demand. The company has managed to surpass the market’s consensus by $26.76 million or 1.95%. Net income dropped by 2.95% from $89.47 million to $86.83 million. The decreased net income resulted in a diluted EPS of $2.09. The net income decreased due to higher interest expenses and a one-time charge related to the refinancing of the term loan. The company has missed the market expectations by $0.04 or 1.88%. GMS reported $81.4 million in cash and total debt stood at $1.1 billion. Adjusted EBITDA stood at $173.3 million.
The company performed well despite the lower steel prices which reflects its well-positioning and the continued strong demand in the industry. I believe the company can sustain this performance in the long run as it is highly focused on expansions through acquisitions which can help it increase its market share and profitability. The firm estimates Q2 net sales to drop by single digits and adjusted EBITDA between $160 million to $165 million. It anticipates capital expenditures of $50 million for FY2024, with free cash flow of 50%-60% of full-year adjusted EBITDA. I think the second quarter estimates can be correct as the industry is slightly affected by steel prices. However, I believe the company can perform well in FY2024 as the demand is gradually rebounding and GMS is also focused on acquisitions to increase its production capabilities which makes it strong enough to capture growing demand in the market. According to Seeking Alpha, the company’s revenue for FY2024 might be $5.38 billion. After considering the rising demand for single-family housing and increasing capabilities with acquisitions, I think this revenue estimate is accurate. I am only considering the last nine quarters while calculating the average net income margin as the company has been facing issues with steel prices and strong demand since the last nine quarters. The company’s average net income margin is 6%. After considering the results of Q1FY24 and rebounding market demand, I believe the company can maintain a net income margin of 6% in FY2024.
The revenue of $5.38 billion and net income margin of 6% give a net income estimate of $326.36 million or an EPS estimate of $7.79.
Valuation
The company holds a large market share and has achieved a deep penetration into the construction sector. As the demand in the industry is rising, it can highly benefit the company to accelerate its growth and acquire a large customer base as it is continuously focused on acquisitions which makes it well-positioned to capture additional market share. This expansion can help the company to serve more market consumers and increase its profitability. Further, this growth can be sustained for a longer period as this industry has positive long-term prospects. After considering all the above factors and revenue & net income margin estimates, I am estimating EPS of $7.79 for FY2024 which gives forward P/E ratio of 8.39x. The company’s forward P/E ratio is 48.5% lower than its sector median of 17.24x. I think the company’s primary competitors are Lowe's Companies ( LOW ), The Home Depot ( HD ), Beacon Roofing Supply ( BECN ), and Boise Cascade ( BCC ) as all of them offer similar services.
GSM’s forward P/E ratio of 8.39x is 37.11% lower than industry average of 13.34x. The comparison of forward P/E ratio with industry average and sector median indicates that the company is undervalued. I believe the company might grow in coming quarters as a result of positive industry trends and its expansion of its platform through acquisitions which can help it to trade at its industry average P/E ratio. Therefore, I estimate the company might trade at a P/E ratio of 13.34x in coming period, giving the target price of $103.92, which is a 58.9% upside compared to the current share price of $65.39.
What is the Main Risk Faced by GMS?
The company highly depends on multiple manufacturers and suppliers as it procures its products from them to distribute to its customers. Its ability to distribute the products highly relies on smooth and adequate product supply from its suppliers. If the supply gets disrupted due to a shortage of raw materials, work stoppages, natural disasters, manufacturing challenges, civil unrest, military conflicts, or difficulties in production, it can negatively impact the company’s ability to serve its customers which can further lead to reduced revenues and profit margins. In addition, if the suppliers elect to distribute their products directly to the end market, it can reduce the company’s market share by reducing its profit margins.
Conclusion
The company has reported strong financials despite the lower steel prices. The demand has recently been positive for house construction and I believe the company is well positioned to capture it as it is continuously focused on expanding its platform through acquisitions. However, it can incur losses if the supply of products is disrupted by the manufacturers. The stock is undervalued and we can expect a healthy 58.9% growth in stock from the current price levels as a result of positive industry trends and its increasing expansion of platforms which can help it to increase its customer base. After considering all the above factors, I assign a buy rating to GMS.
For further details see:
GMS: Strong Q1FY24 Results Confirm The Potential Upside