TopBuild Is A Good Buy At The Current Levels
Summary
- TopBuild is trading at a significant discount to its historical levels as investors are worried about a housing slowdown.
- However, the company can continue to grow its revenue and margins thanks to the recent DI acquisition.
- BLD's success in integrating previous acquisitions as well as the fragmented nature of the industry makes me optimistic about the company's inorganic growth prospects.
- I am not too worried about a housing slowdown as, unlike in previous housing downturns, there is a significant undersupply of homes in the market this time.
- I believe the stock is a good buy at the current levels.
DonNichols/E+ via Getty Images
Investment thesis
Interest rate worries have caused a significant correction in stock prices of homebuilding and building product companies. TopBuild (NYSE:BLD) is no exception and the stock has dropped over 30% since the beginning of this year. While we understand concerns regarding interest rates, unlike in previous housing downturns, there is a significant undersupply of homes in the market this time. So, the steepness and duration of decline in the housing market should be relatively less. Moreover, BLD's Distribution International (DI) and other acquisitions should help the company to increase its revenue and further enhance its margins even during the period of macro slowdown. The stock is attractively valued at 13.29x current year's PE and 11.73x next year's PE and I believe it is a good buy at the current levels.
Business Basics
TopBuild is a leading installer and speciality distributor for insulation (~80% of its revenues) and other building products. In 2021, BLD derived 68% of its revenue through installation and 32% of its revenue through specialty distribution. BLD is also a market leader in all three insulation markets namely residential, commercial and industrial. The company had a solid track record of growing margins almost every year since its spinoff from Masco (MAS) in 2015.
TopBuild's Gross and Operating Margins (Company Data, GS Analytics Research)
Inorganic growth opportunity
The insulation market is a highly fragmented market with hundreds of small private players. Since 2016, TopBuild has focused its capital allocation policy around acquisition to increase its market share and scale, and the company has acquired dozens of private companies including some larger ones like USI and Distribution International. Last year, TopBuild acquired Distribution International from private equity firm Advent International for an all-cash deal worth $1bn which was its biggest acquisition since its spin-off.
BLD's acquisition spend (Company Data, GS Analytics Research)
Prior to the DI acquisition, TopBuild was a market leader in residential and commercial insulation. After this acquisition, BLD also became a market leader in the industrial insulation end market. In addition to helping the company achieve a leadership position, DI's MRO (maintenance repair and operations) business (~50% of DI's total revenue) provides a strong recurring revenue stream.
DI had revenue of $747 million in 2020, with an adjusted EBITDA margin of 10%, or $75 million. Shortly after the acquisition (in September 2021), DI's EBITDA margin increased to 11%, indicating early acquisition synergies. Management expects DI's adjusted EBITDA margin to rise to the mid-teens once it is fully integrated into TopBuild, resulting in an additional $35 to $40 million in EBITDA (assuming a constant revenue) within two years. Furthermore, DI and BLD use the same suppliers, which increases the company's bargaining power with those suppliers.
Apart from DI, the company has also acquired 10 more private players in 2021 with annual revenue of nearly $250mn which would further add to BLD's topline and synergies.
Management has a good track record in successfully integrating and realizing synergy benefits from prior acquisitions which raised BLD's operating margins from 5% to 14.2% and doubled revenue in the last six years. We expect similar success in integrating and realising synergy benefits from the DI acquisition which would further grow operating margins for BLD.
Looking forward, I expect management to continue with its inorganic growth strategy given the fragmented nature of this industry. The company strategy to do bolt-on as well as larger acquisitions and improve the margins of acquired companies by integrating them and cutting costs should bode well for investors in the long run.
Interest rate headwinds for housing, but supply remains tight
BLD derives 63% of its revenue from the residential segment therefore the company's revenue is highly correlated to housing demand. Currently, it is expected that the Federal Reserve may hike the interest rates several times this year due to record high inflation numbers. This could negatively affect TopBuild's residential segment revenue.
Comparison of housing demand and FED fund rate (St. Louis FRED)
While we understand concerns about interest rate hikes, we believe there is a significant undersupply of homes in the US market which can limit the steepness and duration of any housing slowdown we will see this time. There had been a significant underbuild of homes since the great housing recession of 2008. New housing starts have averaged 984k homes between 2008 and 2020 whereas the historical average was around 1.43 mn from 1959 to 2007. This denotes ~446k fewer new homes built every year from 2008 to 2020. So if a downturn is triggered by a significant hike in interest rates, its impact may not be as severe as we saw in prior recessions due to tight supply-demand dynamics.
Annual Housing Starts in the US (historical) (U.S. Census Data, GS Analytics Research)
Moreover, during industry downturns, contractors who directly buy insulation products from manufacturers, turn to distributors like BLD for less than full truckload shipments which partly offsets the impact of a slowdown in end-market demand. This provides a natural counter-cycle buffer to the company.
Valuation and conclusion
According to consensus estimates the company's topline is expected to increase ~31.94% in the current year and 7.01% next year. The company is expected to post an EPS of $13.95 (up 28.53% Y/Y) in FY22 and $15.79 (up 13.26 Y/Y) in FY 23. So, the stock is trading at just 13.29x current year EPS and 11.73x next year EPS. The current valuation is at a significant discount compared to BLD's 5-year average adjusted P/E (Forward) of 19.63x. I believe long term investors can take advantage of the current concerns surrounding the housing market slowdown to buy this secular growth story at an attractive valuation. I am optimistic about the company's long term prospects and have a buy rating on the stock.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
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