2023-04-15 09:40:54 ET
Summary
- UFP Industries faces a tough start to 2023 with a double-digit revenue decline.
- The company has a strong balance sheet and can pay its dividends.
- The stock looks undervalued, but investors should consider buying the stock during market volatility.
UFP Industries (UFPI) is well-managed, with a strong balance sheet and good long-term growth prospects. The company faces short-term headwinds to revenue and profits in 2023. The company's valuation will increase considerably if it consistently achieves a 7% or higher free cash flow margin. Investors can consider buying the stock during times of increased market volatility.
Double-digit drop in revenue expected in 2023
UFP Industries achieved record sales and profitability in 2022. The company nearly reached its goal of $10 billion in revenue by 2027, achieving $9.6 billion (Exhibit 1) . But, analysts expect the company to report lower revenues in 2023. The consensus revenue estimate for Q1 2023 is $1.86 billion, a drop of 25% y/y. The company booked $2.48 billion in revenue in Q1 2022 (Exhibit 2) . The company is projected to book revenues of $8.04 billion for the full year 2023, a drop of 16% compared to 2022.
Exhibit 1:
UFP Industries Annual Revenue, Gross, Operating Profit, and Margins (%) (2013 - 2022) (Seeking Alpha, Author Compilation)
Exhibit 2:
UFP Industries Quarterly Revenue, Gross, Operating Profit, and Margin (June 2020 - December 2022) (Seeking Alpha, Author Compilation)
The company generated record profits in 2022 with annual gross margins of 18.5% compared to its average of 14.8%, with a standard deviation of 2.3% over the past decade (Exhibit 1) . Its operating margins were 9.87% in 2022 compared to its average of 5.4%, with a high standard deviation of 2.17% over the past decade. The company is expected to earn $7.74 per share in 2023 compared to $8.46 in 2022. On the surface, UFP Industries looks undervalued based on its results in 2022. But, given the projected fall in revenue and profits in 2023 and prospects of slow growth in the next few years, it may be best to wait for the first quarter earnings release on April 26 before building a position in the stock (See section on valuation) .
Cannot repeat record cash flows of 2022
Given the growth in 2022, the company generated record operating cash flows, with an operating cash flow margin of 8.6% and a free cash flow (after CapEx) margin of 6.8%. These margins will drop in 2023 with the expected decline in revenues. But, if the company can achieve about $8 billion in revenue and a 7% operating cash flow margin close to its pre-pandemic levels, its operations could generate over $300 million after paying for CapEx and dividends (Exhibit 3) .
Exhibit 3:
UFP Industries Estimated 2023 Cash Flows (Seeking Alpha, Author Estimates and Calculations)
The inflation as measured by the Producer Price Index [PPI] PPI inflation report added credence to the notion that inflation is fading. The Federal Reserve may be closer to achieving the peak Federal Funds rate, giving the economy more certainty about interest rates for mortgages and other consumer loans. The slowing economy may further cool the labor market, reducing interest rates in the second half of 2023.
There are signs of much pent-up demand for housing in the U.S., even as the economy has seen the fastest rate of increase in interest rates in history. During the first week of April, the housing market saw a jump in demand as mortgage rates dropped by a minuscule ten basis points. Mortgage applications increased by 8% in the first week of April compared to the previous week. But, if the unemployment rate spikes above 6% or 7%, the U.S. economy may enter a recession and take longer to recover. A recession would depress housing and consumer demand even as home prices cool further.
Inventory costs have peaked
The company has deftly managed its inventory level despite a surge in demand in 2021 (Exhibit 4) . Its inventory costs increased by $230 million in 2021, but the company has kept a lid on further increases in 2022, with inventory nearly flat. The increased inventory costs in 2021 led to a substantial decrease in operating cash flows, with its operating cash flow margins dropping to 5.9%.
Exhibit 4:
UFP Industries Days Sales in Inventory (2013 -2022) (Seeking Alpha, Author Compilation)
The company's account payables declined from $319 million in 2021 to $206 million at the end of 2022. This cash outflow to pay its suppliers pressured operating cash flows in 2022, even as the company recorded its highest operating cash flows in its history with over $800 million. The company's inventory has peaked and should decline and normalize in 2023. The cash outflows due to accounts payable commitments should reduce and normalize in 2023.
Decreased inventory costs and lower accounts payables commitments should bolster the company's cash flows in 2023. Any housing market recovery in the second half of 2023 may further boost its cash flows. But, the company expects new home construction to fall 15% to 20% from its 2022 levels. The company serves both multi-family and single-family home construction markets, and the rising populations in the U.S. bolster the case for long-term demand for both market segments.
Strong balance sheet
The company has low debt levels, with total debt of $278.1 million at the end of December 2022 (Exhibit 5) . The company has cash and a short-term investment of $595 million. The company reduced its total debt by 13.3% Q/Q in December 2022. The company's debt-to-EBITDA ratio of 0.29x shows that the company has prioritized a strong balance sheet.
Exhibit 5:
UFP Industries Quarterly Debt, Cash, and Net Debt (June 2020 - December 2022) (Seeking Alpha, Author Compilation)
The company's dividend is well covered, given its low annual payout of $58.9 million compared to the free cash of $657.5 million (Exhibit 6) . The payout ratio is 8.6%. The company's dividend yield is 1.28% , which is too low for the current rate environment, where the risk-free U.S. 2-year bond yields 3.9%. The Vanguard S&P 500 Index ETF ( VOO ) yields 1.6%. The company has increased its dividend at a 22% CAGR over the past decade. The company has grown its dividend over the past decade and has consistently paid a dividend for the past 29 years, an excellent track record.
Exhibit 6:
UFP Industries Operating Cash Flow, Free Cash Flow, and Dividend Payment (2013 - 2022) (Seeking Alpha, Author Compilation)
Opportunistically buy UFP Industries during increased market volatility
The company generated an excellent return on invested capital of over 26% in 2022. A discounted cash flow model estimates a per-share equity value of $76 (Exhibit 7) . This model assumes $8.04 billion in revenue based on the consensus estimates and a revenue growth rate of 3% in the short term and a 4% growth rate for the long term. The model assumes a 3.36% free cash flow margin, the average over the past decade. This free cash flow margin assumption may be too low.
Exhibit 7:
UFP Industries Discounted Cash Flow Model with Free Cash Flow Margin of 3.3% (Seeking Alpha, Author Calculations)
A 7% free cash flow margin may put the per-share value at $154, nearly 94% higher than its current price of $79 (Exhibit 8) . The company trades at a forward GAAP PE of 10x. The company may be undervalued based on its future demand prospects for housing and cash flow generation powers, but the short-term economic headwinds may pressure the stock in the first half of 2023. Some economic reports released this week point to the U.S. economy only slowing down. Investors can consider buying UFP Industries if any poor economic news leads to market volatility and weakness in the stock. The question remains whether the company can consistently generate a free cash flow margin of 7% or higher over the long term.
Exhibit 8:
UFP Industries Discounted Cash Flow Model with 7% Free Cash Flow Margin (Seeking Alpha, Author Calculations)
The U.S. economy faces much uncertainty, and the home construction market may weaken further. The stock has declined 8.8% over the past three months and faces much short-term negative sentiment. Investors can consider building a small position or adding to an existing one during market volatility and wait to hear the management's earnings commentary before increasing the stake in UFP Industries. The company will release earnings on April 26 .
For further details see:
UFP Industries: Long-Term Growth Still Intact