Description

Thesis summary

• De-risked public-co LBO-like opportunity, nearing end of merger integration following a transformative acquisition in 2015 (ProBuild), with leverage to single-family housing (SFH) cycle and a key beneficiary from now pervasive building product inflation

• BLDR is the #3 Lumber & BMAT distributor in the U.S. behind ABC/L&W and BECN/Allied, with broad geographic reach (400 locations in 75 of top 100 MSAs) and balanced end-market exposure (72% sales to new SF Housing / 22% R&R / 6% MF housing)

• Positive outlook for SF Housing and R&R spend (combined > 90% of BLDR sales exposure) should drive +MSD revenue growth next few years and provide incremental margin upside; end market guidance on 2018 for SF Housing +MSD-HSD%, R&R +3%, with 5-6% product inflation  

• Risk of rising mortgage rates to new starts trajectory is overblown (current 4.6% 30-yr mortgage rate likely on track towards 5% by 2020, is still below 5.8% historical avg), builders have flexibility in size and options to maintain affordability (which is still far better than historical averages), and own vs. rent economics are still highly-favorable across nearly every MSA

• In addition to the housing growth drivers, BLDR benefitting from a mix-driven margin tailwind as homebuilders migrate from traditional building materials (sheet lumber) to pre-fabricated products (roofing trusses, flooring) in construction, which yields material labor savings.  Pre-fab carries a 1000 bps GM% premium over lumber sheet goods and 60% of homes in the U.S. currently built w/o any pre-fab components.

• BLDR’s pre-fab offering (a unique competitive differentiator) adds resilience to the business model, allowing the company to remain agnostic towards the ultimate mix of SFH housing demand (entry-level vs move-up vs luxury).  While move-up and luxury homes carry revenue per unit for BLDR, entry-level homes are the most-likely to use pre-fab components (b/c labor savings are more material to overall cost), yielding similar EBITDA per unit contributions.  In general pre-fab is an example of a benefit of BLDR's scale in a fragmented market and we expect it to be a key driver of share gain going forward.

• Deleveraging story in “public LBO” with Q118 ND/EBITDA at 4.5x on pace to fall by 1.0x per year supported by EBITDA growth and high FCF conversion on low cap-intensity (capex 1.6% sales) + solid WC mgmt + NOL tax shield in 2018.  Multiple capital-structure transactions reduced run-rate cash interest expense by over $30m + material cash-tax benefits from tax reform (BLDR is 100% US taxpayer) provide further support to mgmt guidance of $170-190m FCF for 2018, a 10% FCF yield

• New capital allocation option likely emerges within the next 12 months as BLDR approaches 2.5x-3.0x leverage target, with another potential med/large deal and a repeat of the prior successful M&A integration playbook;  several mid-sized competitors (5 with $2-3B annual sales, 6 others with $500m–$1.5B in sales) and over 100 smaller comps (avg $100m of revenues) make potential targets

• Highly-favorable near-term valuation and risk/reward setup, with stock trading at 7.6x / 6.7x our base case 2018 / 2019 EBITDA ests of $505m / $573m and over a 10% FCF yield;  at 8.0-8.5x 2019 EBITDA on a pro-forma B/S (still conservative versus historical building product and distributor multiples), stock is worth high-$20’s to low-$30s, for 50-60% upside

• If BLDR continues toward its long-term growth targets of doubling 2016 EBITDA and tripling FCF generation by 2021, we think the stock would be worth $50 (over 100% upside)

Housing cycle

• We believe that the historically cyclical housing market is in the middle of a secular upswing.  We see a multi-year runway ahead supporting +MSD SF housing demand growth as HH demographics + labor tailwinds + improving consumer balance sheets + historic lows in existing home inventory drive new home construction

• HH formation demos are hugely-favorable as prime home-buying 30-35 yr age group increases sharply over the next 10 years and the 20-29 yr age group peaks, providing an echo boom supporting incremental demand; barring a material recession, we think there could be a potential super-cycle for single family housing in the next 5 years

• Labor market strong and getting stronger, with labor participation rate still at late 1970’s levels, the employment / population ratio improving (but still at early 80’s levels) and wage growth is happening

• Household B/S have improved significantly since the recession.  Unlike prior post recessionary periods, HH Debt / disposable income has fallen dramatically as a focused deleveraging (including defaults and BK’s) has repaired broken balance sheets.  

• Lack of inventory will continue to drive existing home pricing and new construction demand.  Monthly supply of homes is currently at a historic trough, despite the recovery since 2009, as a lack of skilled labor acts as a governor on new construction, driving a slower steadier growth cycle.  The lack of inventory drives both new construction and demand for R&R as homeowners feel more comfortable investing in their homes as prices rise.

• Growing age of housing stock drives order-of-magnitude growth in HH R&R spending.  Homes built in 2000 or later spend an avg of $1500/home per year vs homes built 1980 or earlier spend an avg $3500/home per year (according to Home Depot mgmt).  â…” of the current U.S. housing stock is greater than 30 yrs old. We think this supports the secular story in R&R spend as well, and lends credence to BLDR’s long-term growth guidance of +3%/year for this category.

Valuation and Assumptions

• Base case = $28 stock (50% upside).  8.0x 2019 EBITDA of $573m based on +10%/7% revenue growth for 2018/2019 and 40-50 bps of EBITDA margin expansion / yr

• Bull case = $34 stock (79% upside).  8.5x 2019 EBITDA of $610m based on +10% revenue growth for 2018/2019 and 50-60 bps of EBITDA margin expansion / yr

• Bear case = $22 stock (18% upside).  7.5x 2019 EBITDA of $521m based on 9% / 6% revenue growth for 2018/2019 and 30-40 bps of EBITDA margin expansion / yr

Catalyst

Housing starts, permits, EPS reports, easing lumber price inflation