The Turnaround At Huttig Has Finally Arrived
Summary
- Huttig Building Products is one of the few housing stocks still trading at depressed levels.
- Strategic actions started in 2016 took a while. They were starting to take hold in 2019 and were temporarily derailed by Covid.
- Huttig now enjoys a strong housing tailwind and just had its best first quarter ever as a publicly traded company.
- It is also benefitting from improved sourcing, efficiencies, higher value-added products, and lower debt.
This article was amended on 5/6/2021 to include additional clarifying commentary.
I specialize in turnarounds and the majority of my recent articles have been about them. The problem with turnarounds is I usually can only find two or three really good ones a year. Last year was an anomaly and there were many. My goal is usually at least 2x return in one year. While most of the beaten down stocks from the recession have bounced back, there are still a few bargains. Huttig Building Products, Inc. (NASDAQ:HBP) is clearly one. Like the biggest turnaround movers I have found, it has been left for dead by the market after years of underperformance. Not only is it bouncing back, it enjoys a strong tailwind from a historically hot home building market.
Background
Huttig distributes and assembles building products primarily for residential construction and renovation. It sells molding, interior and exterior doors, fasteners, lumber, columns, stair parts, decking and flooring systems. Products such as fasteners are sourced primarily from Asia with most of the rest domestically. Most customers are lumber yards and home improvement stores. The company has 25 distribution centers serving 41 states. It owns about half of those centers. The work force is about 12% unionized. Huttig is not as impacted by surging prices in things like lumber and steel as other residential building suppliers. The majority of their products are made from composites.
Operating Results
Huttig has a long history of underperformance. It has earned greater than 1% on sales just twice in the past nine years. That was in 2015 and 2016. In 2016, management decided to change course and move toward more value added higher margin products. These include doors they did final assembly for, fasteners and composite decking. Commodity items such as lumber was de-emphasized. They ran into numerous challenges such as higher costs while making the shift. Finally, toward the end of 2019, things started to look up. Then Covid hit, but only really impacted the first half of 2020. With a stronger second half, earnings improved in 2020.
Operating results for the last four fiscal years (same as the calendar year) and most recent quarter are shown below.
Source: Huttig Forms 10-K, 8-K and 10-Q
As shown above revenues declined in 2020 and 2019. Part of this was design as the company moved away from more commodity like products such as lumber. Earnings picked up in 2020 despite Covid-19. The company earned $0.24 EPS in the third quarter and $0.01 EPS in the seasonally slowest fourth quarter.
It all came together in the first quarter of 2021. To begin with, the home building market got even stronger in that quarter and is now the strongest since 2006. But beneath the top line other good things were happening. The gross margin improved to 21.3% from 20.1% in the same quarter one year earlier. This improvement appears sustainable as much of it was from the continued shift to higher margin products along with some pricing decisions.
Operating expenses declined from 19.2% of revenues in the first quarter of 2020 to 17.2% last quarter. Much of this appears sustainable. There was some short term benefit from less travel and other items due to Covid-19. But there was also efficiencies and leverage against higher sales.
Another big positive was interest expense which declined from $1.3 million in the first quarter of 2020 to $0.7 million last quarter. This was due to lower debt levels and a lower interest rate.
The first quarter of 2021 was strong despite some headwinds. There are supply bottlenecks which reduced revenues. The Texas winter storm also closed some suppliers for a short period. The first quarter of 2021 had no material non-recurring items. They really did earn $0.30 in a seasonally slower quarter with some headwinds.
Balance sheet
The balance sheet improved significantly in the first quarter of 2021. Net worth was $51.6 million with almost no intangible assets. That is up from $43.3 million three months earlier. A bigger item was the reduction in interest bearing debt. That declined from $149.9 million on March 31, 2020 to $115.2 million on March 31, 2021. The large paydown was partially due to earnings but more due to a $24.7 million reduction in inventory. The company is getting more shipments direct from their suppliers factory to the customer, skipping the warehouse.
Huttig has some hidden assets. It had real estate with a gross book value of $37.3 million on March 31, 2021, much of which has been on the books a while. It is primarily warehouses which have as a group have mostly gone up in value recently. There is a good chance they are worth more than the gross book value. Depreciation on these appreciating assets also understates earnings some.
Huttig has a $250 million line of credit secured by accounts receivable, inventory and real estate. The balance was $111 million on March 31, 2021 with $81 million available based on their collateral formula. The line matures in July, 2022. Cash totaled $4.4 million on that date.
Positives and Catalysts
A number of catalysts and tailwinds have come together to create some powerful momentum recently.
Hot Housing Market - Obviously one of the biggest tailwinds right now is the residential housing market. I could spend a whole report on this, but its strength is very well known. According to the U.S. Census Bureau "Privately-owned housing units authorized by building permits in March were at a seasonally adjusted annual rate of 1,766,000. This is 2.7 percent (±1.7 percent) above the revised February rate of 1,720,000 and is 30.2 percent (±1.8 percent) above the March 2020 rate of 1,356,000." Almost all companies tied to the home building market are doing very well and have seen large stock surges.
Shift to Higher Margin Products - An internally generated catalyst has been the change to higher margin, higher value added products. The company has gone from a pure distributor to doing some final assembly. This proved to be challenging for several years but management stuck with it and appears to be paying off now. It can be seen in the improved gross margin and operating expense margin.
Lower Interest Expense - An improved performance in 2020 led to a lower interest rate and a large paydown further reduced interest expense.
More Direct Shipments - Huttig is getting more product sent directly from their supplier's factory directly to their customers, skipping Huttig's warehouse. This improves margins by reducing warehouse costs. It also lowered inventory allowing a large paydown in debt.
More Direct Sourcing - Huttig now deals directly with most of its suppliers instead of using middlemen.
Efficiencies - Improvements in the gross margin and operating expense margins were the result of what management calls rationalizations, essentially a cost cutting program.
Seasonality - Huttig like most construction suppliers is seasonal. The slowest quarter is usually the fourth with the just finished first quarter the second slowest. Huttig just earned $0.30 in a seasonally slow quarter and has its two best coming up.
Concerns
Sales are currently significantly held back by supply chain issues. This is across the board and similar to what many other businesses are feeling right now. In the last 10-K the company expected supply chain issues to continue throughout 2021. These issues are holding back revenues. This should eventually be a tailwind leading to higher revenues once new capacity comes online and there are less logistic bottlenecks.
There has been no insider buying in the past year. The few insider sales were to cover taxes on restricted stock grants. I would be disappointed if we didn't see some insider buying soon.
The labor market is getting tight and some wage increases are expected.
Huttig has a long history of underperformance under the current CEO. This is somewhat mitigated by a similar underperformance until recently by peer BlueLinx.
Valuation
In this section I normally compare the subject company to its peers, make adjustments and come up with a valuation. The problem here is there are no true peers right now. There are many companies in the home building industry but the only two other publicly traded distributor of size I am aware of are BlueLinx (BXC) and Builders FirstSource (BLDR). BlueLinx distributes mostly lumber, plywood and wood structures. It is more commodity driven. Normally it would be a good comparable but lumber pricing has gone through the roof as have BlueLinx's margins. Take a look, it has been eyepopping. Builders FirstSource is more similar, though larger abd offers more products. It currently trades for 0.71x revenues versus 0.18x for Huttig. The huge difference makes it difficult to use as a comp but illustrates the upside for Huttig.
For valuation purposes, 2021 earnings will be estimated and a PE ratio applied. Again, this is difficult as there are no available analyst's estimates. Even if there were they would be changing due to Huttig's blowout first quarter. Looking at 2020, the second quarter needs to be thrown out due to being in the depths of Covid. The third quarter had a $0.24 EPS. The fourth quarter (seasonally slowest) showed $0.01 in EPS.
The most recent quarter ended March 31, 2021, had an EPS of $0.30. That is also a seasonally slower quarter, but not as slow as the fourth quarter. That quarter and the 2020 quarters benefitted from some temporarily reduced costs such as travel. That is offset by improvements since 2020 in product mix and the strength of the homebuilding market. Based on the last three quarters, I estimate an EPS of $1.00 to $1.10 in 2021.
For a PE ratio, the market as a whole is currently at 20-25 depending on what criteria you use. Huttig suffers in comparison to the average company due to a lower growth rate, a more commodity offering, and being primarily a distributor. It may also be perceived to be near peak in its cycle. I personally think the home building market has a way to go, and can stay strong for a while, based on demographics. My PE ratio estimate is 10. Applied to estimated 2021 earnings that leaves a one year price target of $10 -$11.
Take Away
Huttig is benefitting from both a powerful external tailwind of a strong housing market and internal improvements in efficiencies, product mix, sourcing and a lower interest expense. While the stock price is up considerably from a low of $1.00 in the middle of 2020, it still trades well below where its recent operating results indicate. The current stock price is $5.43. I recommend a long position in Huttig with a $10-$11 one year price target. That is about double the current price.
This article was written by
Analyst’s Disclosure: I am/we are long HBP. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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s3.amazonaws.com/...BLDR Wants to Deploy $2 Billion on M&A by 2025There are a lot of M&A slides in the deck. Most important, please turn to slide 83. BLDR plans to deploy $2 bn for M&A between 2021 and 2025, or roughly $500 mm/year. At $12/share, HBP's EV would total roughly $400 mm, which would value HBP at 8.4x TTM EBITDA excluding synergies. On slide 80, BLDR shows (2021 to 2025) M&A adding $2.9 bn in revenue (midpoint of range), which implies the company plans to pay 0.69 revenue for its acquisitions ($2.0 bn in acquisition capital divided by $2.9 bn in related revenue). If HBP traded at 0.69x TTM revenue, it's EV would total $615 mm. I suspect HBP merits a lower revenue multiple than 0.69x, given roughly 20% of its business is direct delivery, which I suspect would be discounted by a would-be buyer.
* Elimination of board cash comp $0.4 mm
* Partial elimination of audit fee: $0.2 mm
* Purchasing/disti network synergies: $8.6 mm (1% of TTM HBP revenue)That number may be low. Here are the estimated cost synergies for various building supplies disti deals (estimated at time of deal announcement or closing):BECN acqs Allied (2017): $110 mm cost syn, or 4.3% of acq'd rev
GMS acqs WSB (2018): $10 mm cost syn, or 2.2% of acq'd rev
BLDR acqs BMC (2020): $140 mm cost syn, or 3.7% of acq'd revAvg cost syn as percent of rev: 3.4%HBP TTM rev: $859 mmUsing the above synergy estimates as a guide, it appears that a strategic HBP buyer could easily achieve at least $12.9 mm in cost synergies (1.5% or TTM HBP rev), if not more.
2020: 20.1% $792 mm
2019: 20.0% $812 mm
2018: 19.8% $840 mm
2017: 20.7% $753 mm
2016: 21.2% $714 mm
2015: 20.2% $660 mmIn my view, it's important to tease out how much of 1H21 margin expansion came from ephemeral pricing gains, especially from the "wood products" division vs. more permanent gains from better mix, restructuring and the closure of two underperforming sites. I'd suggest looking at slide 5 from BLDR's 2Q21 earnings report, which extracts lumber-related gains from their projected 2021 EBITDA results. Keep in mind that BLDR's lumber/wood products mix is much higher than HBP's. Also, BLDR accounts for inventory under the weighted average cost method (approximates to FIFO in their case), whereas HBP utilizes LIFO for about 90% of revenue and the average cost method for the balance of sales. If HBP's wood products segment is under LIFO, declines in lumber pricing since the spring (peaked in May and bottomed out in August) should be much less impactful than at BLDR (in fact, HBP could start to recognize LIFO income). Also, direct sales at HBP were 22.9% of revenue in 1H21 vs. 20.0% in 1H20, which most likely weighed on 1H21 GMs as direct sales carry a significantly lower margin than "from warehouse" sales. Even if HBP's estimated full-year EBITDA of $42.9 mm (my estimate) is penalized at the same rate as BLDR's lumber-gains haircut on slide 5, we end up with $29.8 mm in "base" HBP 2021 EBITDA (using BLDR's terminology). Add $12.9 mm in cost synergies (see my last post on historical cost synergies for building-supplies disti acquisitions) and the number moves back to $42.7 mm. On this type of normalized EBITDA, I'd expect BLDR to pay around 8x EBITDA (less on the non-adjusted number, of course), or close to $9/share. In a prior post, I used 6x to 7x but that was on an unadjusted EBITDA number.
My conservative full-year 2021 EBITDA: $42.9 mm (excludes stock comp)Annual cost synergies to a strategic buyer:
* Elimination of C-suite cash comp $1.4 mm
* Elimination of board cash comp $0.4 mm
* Partial elimination of audit fee: $0.2 mm
* Purchasing/disti network synergies: $8.6 mm (1% of TTM HBP revenue)Total cost synergies: $10.6 mmEstimated pro forma 2021 EBITDA with synergies: $53.5 mmValuation comps in the building supplies disti space (EV/NTM EBITDA):
BLDR 7.4x
BECN 8.8x
GMS 7.0xDisclosed EV/EBITDA multiples of transactions (pre-synergies) over the past five years:
August 2017 BECN buys Allied for 14.0x
April 2018 GMS buys WSB for 9.2x
Jan 2021 BLDR buys BMC for 10.4xProjected takeout price for HBP:To be conservative, I'm going to assume HBP does not command a EV/EBTIDA multiple comparable to any of the above transactions, given HBP's 2020 and 2019 EBITDA was only $19 mm and $3 mm, respectively, meaning this year's EBITDA may be viewed as inflated by a potential acquirer. At a minimum, HBP should command 6x estimated 2021 EBITDA (pro forma for cost synergies), or 7.6x pre-synergies, in my opinion. 6 x $54.5 mm = $327 mm in EV$327 mm EV less net debt of $96.4 mm (as of 6/30/21) = $230.6 mm in equity value, or $8.4/share (34% upside from the current stock price). Higher multiple:7x $54.5 mm = $381.5 mm in EV$381.5 mm EV less net debt of $96.4 mm (as of 6/30/21) = $285.1 mm in equity value, or $10.4/share (66% upside from the current stock price).Assuming HPB's business fundamentals are still strong, I'd buy the stock at current levels. In fact, I've roughly doubled my position in the after hours last night and this am. Remember, a deal may not happen.
Alan Weber Mgt 2.5 mm (owned most of position since 2012)
Mill Road Cap 2.3 mm (owned most since 2017)
22NW LP 2.1 mm (owned since mid 2020)
CEO Jon Vrabely 1.0 mm shares22NW LP shows a history of activism. They have launched 5 activist campaigns against 5 different companies over time. I'd view their presence as a large HBP holder as a positive. The CEO is highly incentivized to sell the company. In addition to his stock ownership, Vrabely will receive multiples of his base and annual bonuses under a takeout scenario. Please see 4b - "Termination During the Protected Period." www.sec.gov/...
I'm accumulating a position, but it's hard to believe that the stock is going down with these results. Hopefully we're not missing something.
(saying it with love)
