PGT, Inc. (NASDAQ:PGTI) is a leading company in the impact resistant windows and doors market in Florida. Despite its superior gross margins relative to most of its peers, PGT is valued at a discount on a trailing twelve months EV/EBITDA basis compared with them. In addition, PGT has further potential to grow its sales and enhance profit margins. In terms of revenue growth, the relatively low industry penetration rate of impact resistant windows and doors at 30% and the normalization of housing starts in Florida to historical averages should drive PGT's top line going forward. When it comes to profitability, PGT's launch of a new premium vinyl window product line in the first quarter of 2015, should see it realize margin expansion from economies of scale in its vinyl product line.
Potential to expand both revenues and profits with new premium vinyl window product line
At its Annual Shareholder Meeting on May 7, 2014, PGT announced plans to introduce an entirely new premium vinyl window line in Q1 2015. While no exact details were given about the potential and size of this market, management was quoted as saying that this will be the 'largest new product launch in the history of the company.' This is the latest move by PGT to expand its presence in the vinyl market. In February this year at the NAHB International Builders' Show in Las Vegas, it introduced a new Vinyl French Door.
In 2013, PGT's sales of vinyl products grew by 47% year-on-year, compared to 36% for its aluminum products. In traditional aluminum market strongholds like Southeast and Southwest Florida, PGT's vinyl product sales in these regions increased by 58% in 2014. Viewed from a wider historical perspective, PGT's vinyl sales as a proportion of total revenues have expanded from 6% in 2006 to 25% in 2013. This reflects the increased popularity of vinyl windows and doors vis-a-vis their aluminum counterparts, as vinyl products are usually more aesthetically appealing and energy efficient. For example, PGT's new Vinyl French Door reduces energy costs with its highly insulating frame and panel construction, and also offers the aesthetics of a traditional wood door with its wood grain appearance. PGT's new vinyl window line launch in early 2015 is expected to help it gain a larger market share of the growing vinyl product market.
In addition, notwithstanding the price premium associated with vinyl products relative to aluminum ones, PGT's margins on vinyl products estimated by management to between 5%-7% lower compared with those on its aluminum windows and doors. Going forward, PGT has plans to narrow the margin gap between the two product lines. Firstly, PGT will capitalize on operating leverage associated with greater economies of scale in producing larger volumes of vinyl products. Secondly, it will increase its bargaining power by consolidating its supplier base.
As a comparison, PGT's gross margins were in the 35%-38% range between 2004 and 2006, when vinyl products were a much smaller proportion of its total sales. In contrast, PGT achieved gross margins of 34.2% and 33.5% in 2012 and 2013 respectively. I expect PGT to inch closer towards its higher margins historically, as it expands its vinyl product line and improves profitability as a result.
Leading position in impact resistant windows business
Putting aside the choice between aluminum and vinyl windows & doors, PGT boasts a strong financial track record, despite the cyclicality and capital intensive nature of the business. It has been free cash flow positive in nine out of the past 10 years, and maintained positive quarterly EBITDA throughout the 2008-2009 Global Financial Crisis.
PGT has been able to maintain its strong financial performance and leading market position in the core impact resistant windows business (accounting for 77% of Q1 2014 sales) for two key reasons.
Firstly, the strength of PGT's flagship WinGuard brand is a key differentiating factor, particularly in Florida which is hurricane-prone. More than three million WinGuard products have been sold in PGT's three decade-long history with no single case of reported impact failures. As a result, WinGuard has become synonymous with high quality, safe impact resistant windows and doors, due to its long track record of safety. As a result, PGT is able to charge a price premium for its products, as end-consumers will weigh the relative low cost of such products against the benefits of protecting one's valuable lives and properties. As of the first quarter of 2014, PGT boasts approximately a 500 basis points premium in gross margin over the median gross margin of a peer group made up of Headwaters (NYSE:HW), Masco (NYSE:MAS), Trex (NYSE:TREX), Fortune Brands (NYSE:FBHS), American Woodmark (NASDAQ:AMWD) and Quanex (NYSE:NX).
Secondly, PGT's relative size advantage in terms of product range and distribution channels makes a big difference in its dominant home market Florida. It claims to have 'more impact SKUs than any other manufacturer,' and a distribution base of over 1,000 customers comprising window distributors, building supply distributors, window replacement dealers and enclosure contractors.
Organic growth opportunities
While PGT already has approximately 70% market share of impact resistant window and door market in Florida, there are other growth opportunities beyond market share gains.
One of the growth drivers relates to industry penetration rates. While the penetration rate of impact resistant window and door market in Florida has grown almost 10-fold over the past decade from 3% in 1999 to 30% in 2013, PGT has the potential to increase its sales by encouraging consumers to substitute other impact-resistant options such as shutters for its own products.
Another bright spot relates to the health of the Florida housing market, a key driver of PGT's sales. In 2013, Florida registered 54,000 single-family housing starts and this is way below the 20-year average housing starts of 114,000 between 1988 and 2007 prior to the Global Financial Crisis. While Q2 2014 housing starts in Florida remained flat year-on-year, factors such as continued population growth driven by migration from other parts of the country and eventual improvement in the Florida economy and housing market should eventually drive normalization of housing starts to historical levels.
Investors should watch the quarterly gross margin trend for PGT closely starting from 2015. If and when PGT manages to raise its gross margin to the 35%-38% historical levels achieved between 2004 and 2006, it will be the clearest indication that PGT has started to realize economies of scale from its increased sales of vinyl products and that should act as a strong catalyst to drive the share price of PGT.
PGT's valuations look attractive. Despite boasting higher gross margins on average, it trades at a discount to the peer average trailing twelve months EV/EBITDA multiple.
|Company||Gross Margin (Trailing Twelve Months)||EV/EBITDA (Trailing Twelve Months)|
|Mean (With PGT)||26.3%||13.87|
|Mean (Without PGT)||25.3%||14.00|
PGT has moderate financial leverage, with a gross debt-to-equity ratio of 117% and a net gearing of 67%. This is partly mitigated by PGT's consistent free cash flow generation (positive free cash flow in nine out of the past 10 years) and its trailing twelve months interest coverage ratio of 5.8.
PGT could underperform, if the Florida housing starts disappoint or it fails to execute on its new product launch.
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