2023-09-06 00:09:59 ET
Summary
- Pool Corporation faces challenges in the form of a demand slowdown in new construction and constraints on consumer discretionary spending.
- The company continues to invest in new locations and introduce new products to boost sales, but its chemical sales will stay depressed in the near term.
- The stock is overvalued compared to its peers, leading to a recommendation to "sell" the stock.
POOL Has Imminent Challenges
Pool Corporation ( POOL ) distributes swimming pool supplies, equipment, maintenance products, and accessories. After Q2, the renovation market has remained strong while we see a demand slowdown in new construction. The company continues to invest in new locations, grabbing market share despite the challenges. It plans to open around ten greenfield distribution locations. It has augmented its IT-enabled product offerings and introduced new products to boost sales of its private-label chemical brands.
However, the constraints on consumer discretionary spending and the fear of a recession can lower sales in the near term. Its chemical sales will stay depressed in the near term. The company’s cash flows improved sharply in 1H 2023. It has a robust cash flow generation target for the year, which would go into debt reductions and share buybacks. The stock is overvalued compared to its peers. So, I recommend investors “sell” the stock.
The End Market Scenario
At the start of Q3, POOL’s management reckons that the end market in North America has not contracted. The permits for new privately owned housing units have grown by 6% in July. However, the housing market has weakened year-to-date. Demand has also been steady for the high-end new construction. Over the past three years, 311,000 new pools were built in this region.
In Q2, POOL’s management estimates that demand for renovation has remained strong versus a demand slowdown from new construction. Despite a declining demand environment, it continues to invest in new locations. It has opened eight new sales centers since the beginning of 2023. It has also increased its market share, grabbing additional market share through new products, technology, and acquisitions.
Explaining The Challenges
In 2023, the company expects an addition of 70,000 new pools. The average spending on new pools can also increase after shifting from lower-priced pools to more expensive ones. The headwinds in the cheaper-priced pool category are steeper. The typical challenges in this business are the adverse weather impact, interest rate hikes, and lower consumer spending following COVID-19. New pools that started in early 2023 were lower than the other years because homeowners delayed openings into cooler weather. This adversely affected the chemical usage in its maintenance business.
The Growth Drivers
Investors may note that remodeling and renovation activities are a solid source for recurring sales because automation, more efficient pumps, and alternative sanitizers encourage pool owners to increase their spending. According to the company’s estimates, owners spend ~$1000 on pool maintenance annually. However, the installation of more discretionary items is deferred during a recession.
The pool and hot tub chemicals product category accounted for 13% of its sales in FY2022. Year-over-year, the company’s revenues from chemical and minor repairs decreased in Q2 2023. The chemical sales will stay depressed in the near term. However, the long-term fundamentals remain solid because the company’s installed base has grown considerably in the past three years. The company plans to open around ten greenfield distribution locations. Plus, it has expanded the Pinch A Penny franchise network. These initiatives should steady its sales growth over the medium term.
Q3 And FY2023 Outlook
The supply disruptions that affected pricing in the previous year should stabilize and return to a “normalized” level in the medium term. In FY2023, POOL’s management expects sales to decline by 10% compared to FY2022. In Q3 2023, there will be one less selling day, which can shave 1%-2% of the net sales.
Gross margin is expected to return to a more “normalized” level in 2H 2023. The benefits of the inventory built-up passing through to the input costs keep the gross margin at 30%. In FY2023, it expects to record an EPS of $13.14 – $14.14, down from $18.7 in FY2022.
Technology And New Products
In technological innovation, POOL has introduced Pool360 and Horizon 24/7, its internet and mobile platforms. Early in 2023, it re-launched the Pool360 platform with a new user-friendly design, improved speed, and access to real-time inventory availability. It has recently launched the POOL360 water test application that provides better water chemistry that would drive sales of its private-label chemical brands.
Q2 2023 Drivers
From Q2 2022 to Q2 2023, POOL’s revenues declined by 10%. Adverse weather affected its sales across the geographies, albeit in different intensities. California sales declined 8%. Canada, the Midwest, and the Northeast continued to experience temperatures below swimming standards through June. Despite that, the company’s seasonal product sales were affected less. Compared to a 23% fall in seasonal sales in Q1 2023, the fall was arrested at 11% in Q2. Pricing in the seasonal market held steady, though.
Chemical sales were down by 3% in Q2. Building material sales dipped by 8%, suggesting lower new pool construction. On the other hand, commercial swimming pool sales revived (8% up) due to the rise in leisure travel. It added three new sales centers to expand its market presence. The company’s operating cost as a percentage of revenue fell to 13% in Q2 from 18.6% in Q1. Its operating income decreased by 22% from Q1 to Q2.
Cash Flows and Balance Sheet
POOL's cash flow from operations improved sharply in 1H 2023 compared to a mildly positive cash flow a year ago. Despite lower revenues, a reduction in inventory and receivables led to a steep rise in cash flow. Its free cash flow improved tremendously in 1H 2023 compared to a negative FCF a year ago. In FY2023, it plans to generate $800 million in cash flows.
POOL's debt-to-equity ratio (0.79x) is much higher than its peers' (BECN, SITE, MSM) average of 0.6x. As of June 30, 2023, its liquidity was $572 million. So, robust liquidity ensures fewer financial risks. In the past year, it reduced debt by $411 million. It has increased share repurchase authorization to $600 million. As it raised the cash flow generation target for the year, it plans to allot $550 million in debt reductions and share buybacks during the year.
Relative Valuation & Wall Street Rating
POOL's current EV/EBITDA is expected to expand versus the forward EV/EBITDA multiple. This contrasts the EV/EBITDA multiple contraction for some of its peers, typically resulting in a much lower EV/EBITDA multiple. The company's EV/EBITDA multiple (17.9x) is higher than its peers' (BECN, POOL, and MSM) average (13.6x). So, the stock appears overvalued, with a negative bias, compared to its peers.
In the past 90 days, seven sell-side analysts rated POOL a "buy" (including “Strong buy.”) Three of the analysts rated it a "hold," while one rated it a "sell." The consensus target price is $381.9, suggesting a 4% upside at the current price.
What’s The Take On POOL?
POOL faces stiff challenges due to adverse weather, interest rate hikes, and lower consumer spending. The housing market has subsided in the US in 2023, and consumer sentiment has not been roaring, either. In 2023, the new pool commencements have been slow. I expect the chemical sales to stay depressed in the near term. So, the stock underperformed the SPDR S&P 500 ETF ( SPY ) in the past year.
Partially offsetting the negative impacts is the company’s growth in installed base in the past three years. It has opened eight new sales centers since the beginning of 2023, which helped expand its market share. The gross margin is expected to improve in 2H 2023 as pool owners increase spending. Its cash flow from operations improved sharply in 1H 2023, allowing the company to target accelerated debt reductions for a leveraged balance sheet. Given the relative valuation stretch, I suggest investors “sell” the stock, although returns should improve in the medium-to-long term.
For further details see:
Pool Corporation Has Several Headwinds But Retains A Steady Profile