2023-07-31 18:41:27 ET
Summary
- High mortgage rates could further dampen new home sales and consumer spending, potentially impacting revenue growth and margins.
- UFP Industries could see further declines in volumes, pressuring revenues and margins.
- The company offers good dividend growth, but investors may want to seek a higher yield.
- Investors could consider selling covered calls to generate income after this epic run in the stock.
I am unfazed by the 30% rally in UFP Industries ( UFPI ) since I rated it a hold in April 2023. Although the home construction market has benefited from a lack of existing home inventory for sale, mortgage rates are near 20-year record highs. These high rates could further dampen new home sales and consumer spending. The markets anticipate a soft landing and much of this assumption is based on inflation continuing to go lower and the Fed pausing further rate hikes.
From Russia backing out of the grain deal to India banning certain rice exports , supply disruptions could drive inflation higher and wreck the Fed's and the market's well-laid plans for a soft landing. Given the uncertainties facing the company and the construction sector, with the stock near 52-week highs and flirting close to overbought levels, I continue to rate it a hold. Investors fortunate enough to ride this rally should consider taking some profits after this epic run in this and other building product companies. Or, they could consider selling covered calls to generate income. The probability of the calls being assigned is low in my view, given that this stock may not have much upside.
Revenue growth and margins
In Q1 2023, the company saw its revenue drop by 26.7% y/y (Exhibit 1) . The decline in sales can be attributed to a 20% decline in selling prices and an 8% decrease in organic unit sales. A 1% increase in unit sales due to acquisitions reduced the pain slightly. Most companies in the building products' industry have experienced lower sales volumes. Simpson Manufacturing, which reported Q2 earnings on July 24, saw a "low-single-digit" decline in volumes in its residential market. Michael Olosky, CEO of Simpson Manufacturing, mentioned that housing starts in 2023 will finish below 2022 levels. Masco saw a volume decline of 12% in Q2. Investors should expect further volume declines from UFP Industries, which could lead to more pressure on revenue.
Exhibit 1:
UFP Industries Revenue, Gross, Operating Profits, and Margins (%) (Seeking Alpha, Author Compilation)
Although sales declined y/y, UFP Industries gross margins expanded to 19.6%, compared to 19.2% in the same quarter in 2022 and nearly a 100 basis points improvement from the 18.6% gross margin in the December quarter. The operating margins improved during the quarter due to the improvement in the gross margins.
As the company points out in its quarterly filings (Exhibit 2) , its profits are not affected by the lumber prices, but margins are boosted when lumber prices drop. The company typically passes along the price of lumber to its customers while tacking on an "adder" to its products for added value. The company is expected to book $2.29 billion in revenue in Q2, a steep 21% fall from the $2.9 billion the company booked in the June 2022 quarter. In the company's defense, expecting the company to book revenues attained in the 2021-2022 fiscal years may be unrealistic. Those years outperformed due to Federal government stimulus and pandemic-era work-from-home growth.
Exhibit 2:
UFP Industries Impact of Lumber Prices on Gross Margins (SEC.GOV, Minor Formatting by the Author)
Inventory costs begin to normalize
The company moderately reduced its inventory costs for the trailing twelve months to $960.3 million from $973.2 million at the end of FY 2022 (Exhibit 3) . Although its inventory costs went down, its days' sales in inventory increased to 48, close to its long-run average of 49, due to a steep decline in sales and, thus, cost of goods sold.
Exhibit 3:
UFP Industries Days' Sales in Inventory (Seeking Alpha, Author Calculations)
The company's outstanding receivables climbed to 33 days, above its average of 30 days over the past decade (Exhibit 4) . This increase may be due to seasonality, with the company seeing the highest demand for its products in the March and June quarters, and the company strives to push inventory into its various channels.
Exhibit 4:
UFP Industries Days' Sales in Receivables (Seeking Alpha, Author Calculations)
Share buybacks and dividends
The company is buying back its shares, which should aid it in achieving the $2.39 EPS estimate for Q2. The company repurchased $33 million in shares in Q1 and $129 million since March 2022 (Exhibit 5) . However, the company may be buying its shares at its peak, potentially destroying shareholder value.
Exhibit 5:
UFP Industries Share Repurchases (Seeking Alpha, Author Compilation)
The stock yields 0.98%, much lower than the 1.4% yield of the Vanguard S&P 500 Index ETF ( VOO ) and the 1.3% yield of the Vanguard Industrials Index Fund ETF ( VIS ). The stock's yield is much lower than the 5% yield on the 1-year U.S. Treasury. But, the company offers good dividend growth with a CAGR of 22% over the past ten years. Although the stock offers incredible dividend growth, it may be worthwhile for investors to seek close to a 1.5% yield. If the stock retreats to $70, it will yield 1.4%. Although the stock has offered excellent dividend growth in the past, it may not be worth it for long-term investors to invest at such a low yield, especially when there is a continuing overhang of economic uncertainty.
Over the past ten years, the stock has handily beaten the S&P 500 Index with a 730% total return compared to 227% for the index (Exhibit 6) . Dividends contributed 83% to the stock's ten-year return.
Exhibit 6:
Sell covered calls
The options markets imply a 5.1% move based on its Q2 2023 earnings, putting a price range of between $96 and $107 (Exhibit 7) . The lack of investor interest in the options on this stock can impede selling calls. The $105 strike calls expiring on August 18 last sold for $1.75, yielding 1.6%, but there is not much demand for these calls with an open interest of 5 (Exhibit 8) .
Even the in-the-money $100 calls have an open interest of just 39. But, it may be worth selling $105 strike calls expiring in a few weeks if the premium exceeds 1%. The company is set to report earnings on August 2. Analysts cannot decide about the company's performance in Q2, with 3 up and 3 down EPS revisions during the past 90 days.
Exhibit 7:
UFP Industries Expected Move in the Stock After Earnings Release (E*Trade)
Exhibit 8:
The RSI and MFI technical indicators may signal a top for this stock, with both indicators near overbought levels (Exhibit 9) . The stock has returned 29.6% over the past three months compared to the sector median of 10.7%. Although the stock looks cheap compared to many others in the building products segment, its forward PE of 12.3 aligns with its five-year average of 12.2. The company's forward EV to EBITDA multiple of 7.5x aligns with its five-year average of 7.6x.
Exhibit 9:
UFP Industries RSI and MFI Technical Indicators (Seeking Alpha)
A discounted cash flow model estimates the per-share equity value at $100, close to its current price of $101 (Exhibit 10) . This model assumes a growth rate of 3%, a free cash flow margin of 3.3%, its average over the past decade, and a discount rate of 8%. This model also assumes pre-tax free cash flows; investors may have to account for a lower valuation after taxes.
Exhibit 10:
UFP Industries Discounted Cash Flow Model (Seeking Alpha, Author Calculations)
Strong balance sheet
Given this industry's economic uncertainties and competition, the management strives to maintain a strong balance sheet with low debt and lots of cash. The company's cash is down from its December quarter, from $595 million to $460 million (Exhibit 11) . The company's total debt (short-term and long-term debt) is unchanged at $278 million. Over the past twelve months, the company generated $970 million in EBITDA, putting its debt-to-EBITDA ratio at 0.3x (Source: Seeking Alpha) .
Exhibit 11:
UFP Industries, much like most of the building products sector, is trading near its 52-week high. The markets are hoping that the Fed is done increasing rates and the economy will continue staying strong. Many building products companies have run up in the face of declining revenue and volumes. Further volume decline should be a concern for investors. Investors should consider taking some profits after this strong run or generate income by selling covered calls. The stock looks fully valued, and new investors may have to wait to acquire a good stock with a margin of safety and better dividend yield.
For further details see:
UFP Industries: Not Trusting This Rally