Since my initial article, BlueLinx Holdings Inc (BXC) stock gained 12% but dropped 30% during the earnings call. In this article, I will provide a summary of the latest results, why the market took the results so negative and whether our thesis has changed.
Source: Seeking Alpha
On November 5th, BXC announced 3Q19 results. On the positive side, gross and EBITDA margins improved by 210bps and 89bps respectively. On the negative side, revenues declined 180m to 679m. Almost 40% of that decline was due to deflation in the price of structural lumber and the rest due to market share loss in overlapping markets with the pre-merged Cedar operation. Cash flow from operations was still negative but less negative than 2Q18 by 4m (-55m vs. -59m). That was financed with the sale of assets and real estate.
Source: Company 10Q
EBITDA margins improved from 1.9% to 2.8% or 2.3m to 18,972m.
Source: Company 10Q
However, I am a fan of not adding back share-based compensation (SBC), even though it is a non-cash expense, it is an expense that shareholders pay through share dilution. Adjusting EBITDA for SBC, the improvement is even better, EBITDA grew by 19.5% rather than 14.2% and margin expanded by 89bps rather than 86bps.
Source: Based on the Company 10Q
The main reason for the decline in revenues is the decrease in lumber prices (15% for framing lumber and 29% for structural lumber). However, as illustrated in the tables below, by the fourth quarter, the year-over-year impact of the price decline won’t exist.
Source: Company 10Q
But I am inclined to believe that the increased demand in single-housing, will cause prices to recover some of the ground lost. So far, the Fed Funds Rate has declined 75bps this year from 2.25%-2.50% to 1.50%-1.75%. Lower fed rates reduce mortgage rates, lower mortgage rates mean lower mortgages or bigger houses for the same mortgage. In both scenarios, the demand for housing increases, thus demand for lumber.
Initially, BXC declared they had 160m in assets for sale. Now they stated that they have 28 properties left for sale valued at 100m implying that the assets sold so far generated proceed of 60m, close to the higher end of my estimate in my previous article.
Gross margin for both segments improved. According to BXC, both segments are at their historical level.
Source: Company 10Q
While that is true for the Structural segment, gross margin for the Specialty segment is above the historical average of 13.6%.
Source: Company 10-Ks
Why did the stock drop by 30%?
As the stock dropped only 3% to $31.00 before the call but 30% to $21 during the call, I would guess that the financials were not the reason and it was purely based on the changed outlook or strategy of BXC. So what was said in the call that the market did not like?
While 70m of the 180m drop in revenues was due to the deflation of lumber prices, the rest was due to losing market share and one key product brand. After the merger with Cedar, there were many overlapping markets (the main reason for the merger in the first place). The loss in market share in those overlapping markets was higher than expected by BXC. As a result, BXC has decided to postpone capturing the promised synergies in order to recover market share. So, the new priorities of BXC are recovering market share and deleveraging.
During the quarter, BXC lost one key product brand which will cause revenues in the following three quarters to decline 45m, 30m and 15m respectively. As a response, BXC has already replaced the lost brand with other high-end products on its catalogs to reduce the downswing.
Three initiatives that are in place are strengthening local sales teams, growing supplier relationships and streamlining the operation mainly by reducing from seven to five regional business units. BXC admitted that recovering market share won’t be quick and will take some quarters but have already seen some positive signs as in some of the overlapping markets, revenues have been recovering.
While losing market share is bad, I do not think it justifies a 30% drop in the stock price. I believe BXC's new strategy makes sense. Most of the synergies can be captured in the future, so delaying that would only impact the time value of money, especially for a levered company like BXC. However, once you lose a customer, recapturing that customer is more costly. So, ensuring that customers have a great customer service rather than cutting warehouses and personal for the synergies is a better long term strategy. You can always optimize in the future once you have properly integrated the customers into the merged business.
The main revisions to the valuation are revenues (market share) and postponing synergies. Thus, I opted to use my DCF model and add back the value of the assets for sale (100m). My valuation declined from $65 in my initial thesis to $50. However, if the synergies and market share recovery are delayed beyond 2021, the share price could go as low as $12.5.
The main reason for that was due to two assumptions, I pushed synergies to 2021 and I assumed half of market share recovery in 2020 and the rest in 2021. Some small adjustments were in SG&A more inline with the guidance provided in the call and the revision of NOLs to 68m. For 4Q19, SG&A assumed was 80m and then by 2021-2024, SG&A would return to historical levels. My estimates for FY 2019 would be:
Gross margin: 13.5%
Net Income: -11m
The 30% drop was disappointing, but in the great scheme of things, I believe there is still value in BXC stock. The postponement of capturing the synergies translates to a $15 per share loss. However, at $20 the stock still offers an attractive risk profile with a target price of $50(+150%) while a downside of 37.5% to our worst-case scenario of $12.50.
Disclosure: I am/we are long BXC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.