2023-06-12 12:21:08 ET
Summary
- Pool Corporation, a wholesale distributor of pool-related supplies, experienced exceptional growth between 2012 and 2022 but faced headwinds last year, causing its stock to drop significantly.
- The company also benefited from effects of COVID-19 when people moved from cities to rural areas and upgraded their homes in low interest environment.
- The company has a history of solid execution, stable margins, and impressive cash flow growth, making it a potentially attractive long-term investment.
- Despite concerns about debt levels and short-term economic pressures, Pool Corporation's undervalued stock, dividend growth, and market leadership in a niche industry could make it a good buy for investors with a long-term horizon.
Pool Corporation ( POOL ) is a wholesale distributor of pool related supplies and products including but not limited to chemicals, maintenance products, pool accessories, filters, cleaners, heaters and pumps. After having an exceptional performance from 2012 to 2022, the company's stock got punished heavily since last year and this might have created a sufficient dip for long term investors to buy.
Both the company and its stock performed exceptionally well soon after the 2020 pandemic. The company was already growing at a nice rate prior to the pandemic but its growth accelerated to even higher levels after the pandemic because a lot of people moved away from cities to small towns and rural areas where they could enjoy luxuries they didn't have before such as having much bigger yards or having pools. As work-from-home became a norm in many companies, people sold their homes and condos in city centers and bought much larger homes with much larger yards outside of cities which increased the demand for POOL's products. Now the company had a bunch of new customers and new markets which helped it almost triple its EPS in 2 years since the start of the pandemic.
Last year the company faced some headwinds and its stock took a beating from mid $500s to low $300s. The fact that we were in a bear market didn't help things either.
Just to give one example of tailwinds turning into headwinds, in 2020 and 2021, in addition to selling their city homes and moving to smaller areas to buy bigger homes with bigger yards, many people were also able to refinance their existing homes to take advantage of their rising home equity and near-zero interest rate environment and make additions to their property (such as adding a new pool) with cheap money. This was another tailwind that helped the company's business but it's mostly gone now because mortgage refinance rates make it very expensive for people to refinance their existing loans to make home improvements because it would mean giving up your 3% mortgage rate for a 7% mortgage for many years.
Last year's supply chain problems and poor weather also affected some of its business. Home owners with pools delayed repairing their pools because of the poor weather and supply chain issues also reduced availability of some important parts. This year supply chain issues seem to be mostly fixed but now we have recessionary pressures where people are more careful about spending money on luxury items not to mention lay-offs and return-to-office mandates are happening in the tech industry which is one of the highest paying sectors in the US and one of the sectors where people were able to work remotely and move to places where they could buy homes with pools. This means that the company's target market might be more careful about spending their money.
One could also make the argument that people who own pools tend to be much wealthier than an average citizen and they tend to get less affected by inflationary pressures in the economy. This is probably true for the ultra-wealthy in top 2-3% of the population but there are also a lot of people who are upper-middle class and able to afford a home with a pool in small towns and rural communities and these people will certainly get affected by recessionary pressures.
Keep in mind that these are short term pressures and they shouldn't affect investors with long-term horizons. In fact, I invite investors with long-term horizons to look at the big picture. In the last decade, the company was able to grow its margins at a slow but steady pace which accelerated even more after the start of the COVID-19 pandemic due to the reasons we've mentioned above. When a company has stable (or growing) margins over time, it tells me that its management has strong execution skills. Otherwise you'd see margins fluctuating wildly up and down based on external factors. This is encouraging for long-term investors with longer time focus.
Second, the company has been able to grow its cash flow impressively over the years both in terms of free-cash-flow and cash-from-operations. Over the years, the two cashflow metrics trended very similarly which means the company was able to keep most of the cash it generates from operations. If this trend continues in the long run, it will allow the company to return more cash to shareholders in the future.
I must add one concern I have though. In the last couple years, the company's debt grew exponentially because of investments and acquisitions it made. The company launched new products, made a couple acquisitions and expanded into a few new markets (internationally). These are costly moves but they should pay off in the long run. Currently, the company pays about $50 million per year in interest expenses which it can comfortably cover with its existing cash flow but it's a good idea to keep an eye on the company's debt levels.
The company also returns a lot of money to shareholders in shape of dividends and stock buybacks. In the last decade the company was able to reduce its outstanding diluted share count from 48 million to 39 million which is a reduction of almost 20%. In the last 12 months the company spent $459.36 million on buybacks and it has another $250-500 million to spend for the next 12 months which will further reduce the share count. This will make each share more valuable and help the company grow its dividend payments.
Speaking of dividends, the company currently has a low dividend yield of 1.35% but it's been raising its dividends for 12 years straight. Moreover, the company hasn't cut its dividend since launching it 19 years ago and there has been only one year without a dividend raise which was 2010 during the great recession and even then the company kept its dividend payments flat year-over-year instead of cutting. In the last decade the company has raised its annual dividends at a compounded average rate of 19% which puts it on top tier in terms of dividend growth even though the stock has a low yield. It is safe to say that this stock is more suitable for dividend growth investors than investors seeking immediate high yields.
There aren't that many analysts covering this stock and those covering it only provided estimates for the next 3 years. Analysts expect the company to see its earnings drop by 19% this year but they also expect it to return to double-digit growth starting next year. We are looking at forward earnings of $15.14 for this year, $16.88 for the next year and $18.98 for 2025. This gives us a forward P/E of 21 for this year, 19 for next year and 17 for 2025. I wouldn't call this dirt cheap but I wouldn't call it expensive either. Considering the company's history of execution, growth and profitability, I would say its fair P/E value should be closer to 20-22 range so it's a bit undervalued. The company's price-to-CFO (cash flow from operations) is a bit lower than its P/E at 16.
Conclusion
This is a good company with good management and it's a market leader in a niche (but growing) industry. The company has a history of solid execution and returning ever increasing amounts of cash to shareholders even though its dividend yield isn't that great. This could be a good time to buy the dip for investors with long-term time horizon. As I always say, when buying the dip in a company you don't want to go all in at once. You want to start a small position and slowly add to it over time. If you are inclined to buy a full position in this company, it's wise to start with a 1/3 position and slowly build it up to full position over the course of next 12 months.
For further details see:
Pool Corporation: It May Be Time To Start Buying The Dip