2023-09-01 13:30:08 ET
Summary
- Pool Corporation's growth is based on optimistic projections of household pool and patio spending.
- The company is the largest wholesale distributor of swimming pool supplies in the US, with 61% of revenue coming from non-discretionary pool owners.
- Despite strong earnings, the stock is overvalued at $360 and a more reasonable valuation is $245.08.
Thesis
The growth of the Pool Corporation ( POOL ) is based on overly optimistic growth in household pool and patio spending. I expect that the company will have a better-than-average summer earnings report due to the record heat in North America combined with seasonally strong pool upgrades this season. Even with optimistic top and bottom-line numbers, the current share price hovering in the $360 range implies that the company will grow an expected 5.5x and capture nearly 50% of the pool maintenance market share over the next 10 years. My analysis based on corporate guidance and more modest growth prospects prices the stock at $245.08.
Company Overview
Pool Corporation is the world's largest wholesale distributor of swimming pool supplies equipment and related leisure products in the United States. Since the industry is highly fragmented, the Pool Corporation buys products from manufacturers and distributes them through their 420 Sales Centers. Out of the $6.2B done in sales in 2022, 61% of its revenue is from non-discretionary to pool owners, and the remaining amount of sales is comprised of non-discretionary spending such as new installations and significant re-models and equipment.
POOL Revenue Breakdown (POOL Investor Presentation 6/7/2023)
Market Sizing
Nearly 90% of sales for the company come from the United States, and within the United States, there are a reported 10.7 million swimming pools . The total market size for non-discretionary and semi-discretionary spending on swimming pools in the United States was approximately $66.8B, assuming an extra 20% of non-discretionary spending was put in each year to semi-discretionary purchases (which I named remodel). Today, this implies that POOL has captured almost 10% of the market share.
Pool Market Size Estimate (Author)
Projections
Through the last 5 years, the company has posted a 17% CAGR , more than doubling revenue from $2.8B to $6.2B in that time period. The COVID years gave the company a boost in sales due to consumers upgrading their pools and relaxation spaces during lockdown. As we emerge from COVID, guidance from the company primes investors for a lower growth period of 6-9% revenue increases and operating margins in the low-teen percentage. Combined with management's plan for capital allocation (4:1 return of capital vs re-investing), this should signal to shareholders that growth and margins should remain modest.
DCF Valuation
My valuation of POOL given an optimistic case comes to $245.08 per share, implying that the company is overvalued by nearly 40% -- even with the higher range of growth assumptions. Though POOL may be a great company with a strong industry presence and leadership, any company can be a bad investment when an investor overpays.
Revenue growth assumptions are 15% for the next FY and 10% for the next 5, tapering off to 4% by 2033 to revenues of $14.2B. Tying back to the market size of the pool industry, this represents that POOL doubles its capture of the pool market to 20%. Layered on top of this, the company will maintain strong operating margins of 15% in the next year and eventually tapering to 13% in accordance with management projections in the "High Teens"
Driving the growth of the company will be POOL's efficient management and capital deployment. New investment in the company will drive sales to capital by 3.0x in the next 5 years and even out to 2.0x thereon after. This is in line with the company's best years of a 31% marginal ROIC. In the last few years (which have been good to the company), sales to capital of POOL have been close to 2.0x.
My discount rate for the POOL was assumed to be closest to those in the homebuilding sector . As the company operates in a few business lines (pool chemicals & building materials), I think it's most appropriate to assume the industry beta of a homebuilding company with that of a chemicals company as their line of business mostly falls in the semi-discretionary consumer budget. Starting out, POOL's WACC is 9.75% and tapers to 9.00% in 10 years as the company reverts to the median for the industry.
Share Price Summary (Author)
Financials and Balance Sheet Risk
During my valuation, there were two items on the balance sheet that struck me as slightly concerning: debt loads and the amount of goodwill on the balance sheet. While companies can do a great job of growing through acquisitions, thereby accumulating goodwill on the balance sheet, it is an anomaly to see roughly 20% of a distribution company's assets accounted for in goodwill. The effective damage for metrics such as ROIC since there is nothing physical or inherently valuable to back it up yet is capital spent on acquisition above PPE or intangible IP that can be amortized. In an event of distress for the company, goodwill simply disappears as it can't be sold or collateralized.
Total Assets, Company 10-K (POOL)
POOL has also taken advantage of leverage at low rates, given it has done well with interest rate swaps on its existing debt load. However, 50% of the long-term debt reported to be due in 2026 is under the company's revolving credit facility. The company will need to seek a new arrangement in the coming years as a significant percentage of the FCFF will need to be used to pay down the creditors to open a new line. As of now, POOL does not have ratings from any of the major ratings agencies. As long as the company continues to operate as projected, the company should not have cash flow concerns, but I would be wary if POOL has a down-year in its top or bottom lines.
Conclusion
POOL may be a great company that reliably delivers pool supplies to builders and homeowners, but at its current price near $360, I would take the profits and sell. If everything goes in line with management expectations and POOL captures up to 20% of the pool market share, the stock should be valued at $245.08. New homes are getting smaller in the USA and in line with that, many of the new builds will not be adding a swimming pool while the homeowners of existing pools will not be enough to carry the growth of the industry. As an investor, I would towel off from the pool and allocate the funds elsewhere.
For further details see:
Pool Corporation: Overpriced Growth