BMC STOCK HOLDINGS INC BMCH
November 07, 2016 - 6:26pm EST by
WeighingMachine
2016 2017
Price: 16.30 EPS .93 0
Shares Out. (in M): 66 P/E 17.5 0
Market Cap (in $M): 1,070 P/FCF 17 0
Net Debt (in $M): 447 EBIT 117 0
TEV ($): 1,517 TEV/EBIT 13 0

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  • Residential Real Estate
  • Homebuilder
 

Description

BMC Stock Holdings

We are long shares of BMC Stock Holdings (BMCH), the second largest distributor of residential building materials in the United States.  We believe the normalization of the residential housing market in the US over the next several years will allow BMCH to increase its EBITDA 50-70%, creating a situation with 30-40% upside (on a present value basis) for long-term investors.  To be clear, despite subpar economic growth and a strong likelihood of a rising interest rate environment, we are bullish on the prospects for single family residential housing in the US given nearly a decade of underbuilding.  Further, we believe that distribution industry consolidation coupled with labor shortages at builders (creating product opportunities in pre-fab, construction services, and Ready Frame, a proprietary software enabled solution for framing).

Background

Stock Holding came public in 2013 (see a very good write-up by Mrmgr from Sept 2013 for background info).  Following the acquisition of ProBuild by market leader Builders Firstsource (BLDR) in early 2015, Stock merged with the larger BMC Holdings a couple of months later creating BMCH which is now the number 2 player in residential building materials distribution industry. 

BMC has a strong regional presence in Texas and the West.  BMC (was public under the ticker BLG) was built through a series of debt-fueled acquisitions in the go-go housing market of the 2000s.  While there was industrial logic for many of these transactions, the implosion of the housing market forced the company into bankruptcy in 2009.  Like the former Stock Building Supply, the implosion of the housing market forced the old BMC through a dramatic cost reduction whereby it dramatically reduced headcount, the number of branches it operated, reduced the number of IT systems, integrated and improved procurement.  Many of these improvements were overdue rationalizations given the large number of acquisitions the company had done during the boom years (and never properly integrated given then-management’s focus on the next deal as well as using operational resources to meet strong customer demand rather than integrate acquired companies). 

BMC had higher EBITDA margins than Stock in the years leading up to the merger (BMC had done a 5.8% EBITDA margin in the 12 months to 3/31/15 vs. 3.1% for Stock).  The extent to which this is due to management versus product/geographic mix is unclear though it is worth noting that upon merging the two businesses, BMC management took a somewhat larger role in running the combined entity with BMC CEO leading the combined company (CFO & COO from Stock, Chief Integration Officer from BMC).  BMCH initially targeted $30-40 million in synergies but has increased the target to $40-50 million.  This represents 1.3-1.7% of revenue and is somewhat lower than 1.7-2.0% targeted by Builders Firstsource following the acquisition of ProBuild though BMC-Stock had less geographic overlap.  On today’s 3Q results conference call management reiterated its synergy targets.  55-65% of synergies are coming from sourcing/supply chain with the remainder coming from SG&A (SG&A is includes of branch & distribution savings) by 4Q17. 

BMCH primarily caters to single family residential homebuilders (sales to single family homebuilders represent 77% of revenue, 12% is repair/remodel, 11% is multifamily/commercial) and counts most of the large publicly traded homebuilders as customers (though no customer represents greater than 5% of revenue).  With ~$3 billion in revenue, BMCH benefits from both scale and scope as it is able to offer its customers a broad product offering (claims to supply products representing approximately 50% of the construction cost of a new home).  Scale benefits the company in terms of lower procurement costs as well as fixed cost leverage – particularly at the local market level whereby sales/distribution efficiency is increased through density.  

Forecast & Valuation

Here is our simple valuation framework for BMCH:

BMCH - Projections & Valuation

             

$ million

               
   

PF

PF

         
 

2013

2014

2015

2016

2017

2018

2019

2020

Single Fam Housing Starts

 618,000

       650,000

      710,000

     750,000

     800,000

     875,000

     950,000

       1,000,000

 Growth YoY

 

5.2%

9.2%

5.6%

6.7%

9.4%

8.6%

5.3%

                 

Total Revenue

      2,407

           2,606

           2,800

         3,148

         3,389

         3,724

         4,070

               4,342

  Growth

 

8.3%

7.4%

12.4%

7.7%

9.9%

9.3%

6.7%

Sing Fam Home Rev

   

           2,156

         2,477

         2,692

         2,998

         3,315

               3,556

Commercial Rev

   

308

317

327

337

347

357

Remodel Rev

   

336

353

370

389

408

429

                 
                 

Adj EBITDA

           88

               114

              132

            187

             221

             254

             289

                  316

 EBITDA margin

3.7%

4.4%

4.7%

5.9%

6.5%

6.8%

7.1%

7.3%

                 
                 

Working Cap

248

261

273

299

314

335

356

382

  Work Cap/ Revenue

10.3%

10.0%

9.8%

9.5%

9.3%

9.0%

8.8%

8.8%

Working Capital Drain

     

-26

-15

-22

-21

-26

                 

Less Taxes

     

-40

-52

-64

-76

-85

Less Capex

     

-60

-60

-60

-65

-65

                 

FCFF

     

               61

               94

             109

             127

                  140

  PV of FCFF

     

         60.57

         90.33

         95.71

       102.44

             103.40

                 
                 
                 

Valuation

               

PV of Interim Cash Flow

         452

             

PV of Terminal

      1,393

7.5x EBITDA-Capex; Present Valued

       

Less: Debt

-447.6

Beginning of 2016 - Incls Cap leases

       

Value to Equity

      1,398

             
                 

Shares outstanding

66.25

             
                 

Value per share

     21.11

             

Price today

16.35

             

Upside

29.1%

             

 

The most important assumption here is that we assume housing starts (and completions) revert to their long term (50 year average – see page 15 of investor presentation) by 2020.  This drives our volume growth assumption for single family home revenue to which we add 200 bps reflective of pricing (have seen deflation past couple of years though this reversed in 2016) as well as market share gains.  We assume 3-5% revenue growth in the commercial and remodel space.  EBITDA assumes an incremental $10 million in synergies from 2017 and assumes incremental EBITDA margins of 10% (at low end of management’s 10-12% guidance). 

Our 7.5x operating profit multiple equates to roughly 12x normalized FCF. 

 

Why BMCH instead of BLDR (Builders Firstsource)?

In short – it has a lower risk profile.  To be sure, I own shares of both though I have greatly reduced my ownership of BLDR while increasing my holding of BMCH.  The case for BLDR was laid out 14 months ago on VIC by Ringo962.  Since that time BLDR has underperformed Ringo’s estimates, my estimates and BMCH.  While BMCH has also underperformed my estimates (by a lower magnitude than BLDR), it has a much stronger balance sheet than BLDR with ND/EBITDA of less than 2x my 2017 estimates vs. ~5x at BLDR (though to be fair BLDR has termed out its debt to 2022-2024 I believe; BMCH recently refinanced the bulk of its debt at 5.5% coming due in 2024 replacing 9% debt due in 2018).  Additionally, management depth at BLDR seems a bit thin (CEO is nearly 80), which is of greater importance while integrating a large acquisition with a highly leveraged balance sheet.  That said, the upside for BLDR is clearly higher assuming it works things out (shares could be worth $20-25 so +100-150% upside in PV terms).  

 

Risks

-        Housing market does not come back to ‘normality’.  Clearly a large increase in residential single-family housing is needed to make this idea work.  There are 2-3 common counter-arguments to this: the first is that millennials are more inclined to live in urban areas (and be dwellers in multi-family housing to which BMCH is less exposed – 77% of revenue comes from single family new build) rendering historical figures less relevant in determining normalized single family housing completions.  Secondly there is an assertion that millennials are more comfortable renting having seen the downturn in housing during the Great Financial Crisis (as well as tougher borrowing standards) and in part linked to their inclination to live in urban areas (where single family housing is less available/affordable).  Lastly there is concern that millennials (record for usage of millennials in a single paragraph on VIC?) are entitled little brats and will perpetually live in the basements of their adoring parents.  We contend that while current trends support the aforementioned ideas, as ‘life happens’ millennials age, leave the basement, marry, and procreate (not necessarily in that order) they will eventually seek the relative comfort of suburban living.  I am not a millennial but have experienced and observed this phenomenon amongst my cohort of former die-hard city slickers who now find themselves in the suburbs. 

-        There are various constraints (labor shortages, lack of suitable building plots) negatively impacting the residential developers.  I view these as transitory in nature.  Similarly, labor shortages offer opportunity for companies like BMCH which can create pre-fab solutions that reduce jobsite labor intensity. 

-        Interest rates will probably go up over the next 5 years I said boldly.  Higher mortgage rates could reduce the attractiveness of own vs. rent (depending of course on rents, tax policy, magnitude of interest rate hikes, etc). 

 

-        Texas – BMCH has Texas-sized Texas exposure, representing 34% of 2015 proforma sales (probably ~33% of 2016 revenue given relative underperformance vs. rest of the business). Texas is clearly a near term risk given oil price weakness.  That said, while Texas was down YoY in the third quarter, it is up slightly for the first 9 mos despite a very tough oil patch environment.  We like Texas long term given strong population growth partially driven by favorable tax positioning.   

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Housings starts show signs of life

    sort by    

    Description

    BMC Stock Holdings

    We are long shares of BMC Stock Holdings (BMCH), the second largest distributor of residential building materials in the United States.  We believe the normalization of the residential housing market in the US over the next several years will allow BMCH to increase its EBITDA 50-70%, creating a situation with 30-40% upside (on a present value basis) for long-term investors.  To be clear, despite subpar economic growth and a strong likelihood of a rising interest rate environment, we are bullish on the prospects for single family residential housing in the US given nearly a decade of underbuilding.  Further, we believe that distribution industry consolidation coupled with labor shortages at builders (creating product opportunities in pre-fab, construction services, and Ready Frame, a proprietary software enabled solution for framing).

    Background

    Stock Holding came public in 2013 (see a very good write-up by Mrmgr from Sept 2013 for background info).  Following the acquisition of ProBuild by market leader Builders Firstsource (BLDR) in early 2015, Stock merged with the larger BMC Holdings a couple of months later creating BMCH which is now the number 2 player in residential building materials distribution industry. 

    BMC has a strong regional presence in Texas and the West.  BMC (was public under the ticker BLG) was built through a series of debt-fueled acquisitions in the go-go housing market of the 2000s.  While there was industrial logic for many of these transactions, the implosion of the housing market forced the company into bankruptcy in 2009.  Like the former Stock Building Supply, the implosion of the housing market forced the old BMC through a dramatic cost reduction whereby it dramatically reduced headcount, the number of branches it operated, reduced the number of IT systems, integrated and improved procurement.  Many of these improvements were overdue rationalizations given the large number of acquisitions the company had done during the boom years (and never properly integrated given then-management’s focus on the next deal as well as using operational resources to meet strong customer demand rather than integrate acquired companies). 

    BMC had higher EBITDA margins than Stock in the years leading up to the merger (BMC had done a 5.8% EBITDA margin in the 12 months to 3/31/15 vs. 3.1% for Stock).  The extent to which this is due to management versus product/geographic mix is unclear though it is worth noting that upon merging the two businesses, BMC management took a somewhat larger role in running the combined entity with BMC CEO leading the combined company (CFO & COO from Stock, Chief Integration Officer from BMC).  BMCH initially targeted $30-40 million in synergies but has increased the target to $40-50 million.  This represents 1.3-1.7% of revenue and is somewhat lower than 1.7-2.0% targeted by Builders Firstsource following the acquisition of ProBuild though BMC-Stock had less geographic overlap.  On today’s 3Q results conference call management reiterated its synergy targets.  55-65% of synergies are coming from sourcing/supply chain with the remainder coming from SG&A (SG&A is includes of branch & distribution savings) by 4Q17. 

    BMCH primarily caters to single family residential homebuilders (sales to single family homebuilders represent 77% of revenue, 12% is repair/remodel, 11% is multifamily/commercial) and counts most of the large publicly traded homebuilders as customers (though no customer represents greater than 5% of revenue).  With ~$3 billion in revenue, BMCH benefits from both scale and scope as it is able to offer its customers a broad product offering (claims to supply products representing approximately 50% of the construction cost of a new home).  Scale benefits the company in terms of lower procurement costs as well as fixed cost leverage – particularly at the local market level whereby sales/distribution efficiency is increased through density.  

    Forecast & Valuation

    Here is our simple valuation framework for BMCH:

    BMCH - Projections & Valuation

                 

    $ million

                   
       

    PF

    PF

             
     

    2013

    2014

    2015

    2016

    2017

    2018

    2019

    2020

    Single Fam Housing Starts

     618,000

           650,000

          710,000

         750,000

         800,000

         875,000

         950,000

           1,000,000

     Growth YoY

     

    5.2%

    9.2%

    5.6%

    6.7%

    9.4%

    8.6%

    5.3%

                     

    Total Revenue

          2,407

               2,606

               2,800

             3,148

             3,389

             3,724

             4,070

                   4,342

      Growth

     

    8.3%

    7.4%

    12.4%

    7.7%

    9.9%

    9.3%

    6.7%

    Sing Fam Home Rev

       

               2,156

             2,477

             2,692

             2,998

             3,315

                   3,556

    Commercial Rev

       

    308

    317

    327

    337

    347

    357

    Remodel Rev

       

    336

    353

    370

    389

    408

    429

                     
                     

    Adj EBITDA

               88

                   114

                  132

                187

                 221

                 254

                 289

                      316

     EBITDA margin

    3.7%

    4.4%

    4.7%

    5.9%

    6.5%

    6.8%

    7.1%

    7.3%

                     
                     

    Working Cap

    248

    261

    273

    299

    314

    335

    356

    382

      Work Cap/ Revenue

    10.3%

    10.0%

    9.8%

    9.5%

    9.3%

    9.0%

    8.8%

    8.8%

    Working Capital Drain

         

    -26

    -15

    -22

    -21

    -26

                     

    Less Taxes

         

    -40

    -52

    -64

    -76

    -85

    Less Capex

         

    -60

    -60

    -60

    -65

    -65

                     

    FCFF

         

                   61

                   94

                 109

                 127

                      140

      PV of FCFF

         

             60.57

             90.33

             95.71

           102.44

                 103.40

                     
                     
                     

    Valuation

                   

    PV of Interim Cash Flow

             452

                 

    PV of Terminal

          1,393

    7.5x EBITDA-Capex; Present Valued

           

    Less: Debt

    -447.6

    Beginning of 2016 - Incls Cap leases

           

    Value to Equity

          1,398

                 
                     

    Shares outstanding

    66.25

                 
                     

    Value per share

         21.11

                 

    Price today

    16.35

                 

    Upside

    29.1%

                 

     

    The most important assumption here is that we assume housing starts (and completions) revert to their long term (50 year average – see page 15 of investor presentation) by 2020.  This drives our volume growth assumption for single family home revenue to which we add 200 bps reflective of pricing (have seen deflation past couple of years though this reversed in 2016) as well as market share gains.  We assume 3-5% revenue growth in the commercial and remodel space.  EBITDA assumes an incremental $10 million in synergies from 2017 and assumes incremental EBITDA margins of 10% (at low end of management’s 10-12% guidance). 

    Our 7.5x operating profit multiple equates to roughly 12x normalized FCF. 

     

    Why BMCH instead of BLDR (Builders Firstsource)?

    In short – it has a lower risk profile.  To be sure, I own shares of both though I have greatly reduced my ownership of BLDR while increasing my holding of BMCH.  The case for BLDR was laid out 14 months ago on VIC by Ringo962.  Since that time BLDR has underperformed Ringo’s estimates, my estimates and BMCH.  While BMCH has also underperformed my estimates (by a lower magnitude than BLDR), it has a much stronger balance sheet than BLDR with ND/EBITDA of less than 2x my 2017 estimates vs. ~5x at BLDR (though to be fair BLDR has termed out its debt to 2022-2024 I believe; BMCH recently refinanced the bulk of its debt at 5.5% coming due in 2024 replacing 9% debt due in 2018).  Additionally, management depth at BLDR seems a bit thin (CEO is nearly 80), which is of greater importance while integrating a large acquisition with a highly leveraged balance sheet.  That said, the upside for BLDR is clearly higher assuming it works things out (shares could be worth $20-25 so +100-150% upside in PV terms).  

     

    Risks

    -        Housing market does not come back to ‘normality’.  Clearly a large increase in residential single-family housing is needed to make this idea work.  There are 2-3 common counter-arguments to this: the first is that millennials are more inclined to live in urban areas (and be dwellers in multi-family housing to which BMCH is less exposed – 77% of revenue comes from single family new build) rendering historical figures less relevant in determining normalized single family housing completions.  Secondly there is an assertion that millennials are more comfortable renting having seen the downturn in housing during the Great Financial Crisis (as well as tougher borrowing standards) and in part linked to their inclination to live in urban areas (where single family housing is less available/affordable).  Lastly there is concern that millennials (record for usage of millennials in a single paragraph on VIC?) are entitled little brats and will perpetually live in the basements of their adoring parents.  We contend that while current trends support the aforementioned ideas, as ‘life happens’ millennials age, leave the basement, marry, and procreate (not necessarily in that order) they will eventually seek the relative comfort of suburban living.  I am not a millennial but have experienced and observed this phenomenon amongst my cohort of former die-hard city slickers who now find themselves in the suburbs. 

    -        There are various constraints (labor shortages, lack of suitable building plots) negatively impacting the residential developers.  I view these as transitory in nature.  Similarly, labor shortages offer opportunity for companies like BMCH which can create pre-fab solutions that reduce jobsite labor intensity. 

    -        Interest rates will probably go up over the next 5 years I said boldly.  Higher mortgage rates could reduce the attractiveness of own vs. rent (depending of course on rents, tax policy, magnitude of interest rate hikes, etc). 

     

    -        Texas – BMCH has Texas-sized Texas exposure, representing 34% of 2015 proforma sales (probably ~33% of 2016 revenue given relative underperformance vs. rest of the business). Texas is clearly a near term risk given oil price weakness.  That said, while Texas was down YoY in the third quarter, it is up slightly for the first 9 mos despite a very tough oil patch environment.  We like Texas long term given strong population growth partially driven by favorable tax positioning.   

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    - Housings starts show signs of life

    Messages


    SubjectSF housing construction bear theses
    Entry11/10/2016 02:38 PM
    Membermiser861

    Thanks for the good write-up. BMC and BLDR both appear to be fairly pure bets on single family housing construction volumes. What's the best bear case on housing start numbers you've heard?


    SubjectRe: SF housing construction bear theses
    Entry11/12/2016 03:31 PM
    MemberWeighingMachine

    Thanks for your message. The best bear case we've heard is articulated in the first bullet point of the 'Risks' section of the writeup.  However, while we believe that generational changes in behavior can impact the timing of the eventual return to normality, we think that the eventual return to normality is inevitable.  The disallusionment millenials may be feeling could intensify and negatively impact their optimism regarding the economy - confidence is a necessity for buying a new home.  It is also worth pointing out the obvious - the move we've seen in interest rates over the past couple of sessions could challenge affordability though our assumed normal housing starts have been consistently achieved in higher interest rate environments.  


    SubjectRe: Author Exit Recommendation
    Entry12/09/2016 11:44 AM
    MemberWeighingMachine

    This is now within 5% of our sell target as small caps have marched higher post Trump.  While a lower tax rate could increase intrinsic value (if the tax rate went from the 35% we've modeled to 20% and was considered to be permanent, fair value could be 23% higher), we have exited a significant portion of our holding.   

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