Description

Executive Summary: Carlisle is a leading manufacturer of roofing products and building envelope solutions for the commercial construction market. It is an attractive business. It operates in a relatively consolidated market with rational competitors and demand is supported by a high degree of replacement activity, an aging installed base of commercial roofs, and increased demand for building efficiency that is driving increased content per building. It enjoys high returns on capital and generates strong steady cash flows, and its building products business has been very resilient in past recessionary periods (you can defer a roof replacement, but only for so long). The company has increased its dividend for 46 consecutive years, increasing it at a 14% CAGR since 2011 (current yield 1.4%), and it has repurchased ~$2.4bn in shares since 2017, reducing shares outstanding by 21%. The business sports a fine balance sheet with net leverage of just 1.4x trailing EBITDA and its debt is fixed at <4% interest rates.

The company has been on a decade plus long simplification journey which has taken it from a mediocre diversified industrial with 9 distinct business units to a focused building products platform that has generated attractive organic revenue growth, margins, and returns on invested capital. Today, their journey is almost done with only ~10% of consolidated profitability outside of its core building products business. We expect management to divest its two remaining non-building product businesses in the next 1-2 years which, combined with its solid free cash generation, would generate close to $3bn in excess cash flow, enough for CSL to buyback ~25% of outstanding shares at current prices.

Despite its strong market position and favorable demand characteristics CSL is trading at a meaningful discount to its historical valuation as investors believe the company is meaningfully over-earnings. We think profits will be more resilient than the market expects and believe that investors will re-rate the stock higher as this becomes evident, particularly if the company is successful shedding its non-core businesses. We would not be surprised to see shares trade 30-50% higher in that scenario.

Company description: Carlisle Companies (CSL) is a manufacturer of a broad range of products selling into commercial construction, aerospace and transports, and general industrial end markets. It operates four segments: Carlisle Construction Materials (CCM); Carlisle Weatherproofing Technologies (CWT), Carlisle Interconnect Technology (CIT), and Carlisle Fluid Technology (CFT). It’s building product-focused segments, CCM and CWT, account for ~90% of profits with demand primarily related to commercial roofing and building envelope solutions though CWT is more balanced between residential and commercial. The CIT segment sells connectors, sensors, and cable assemblies primarily into the aerospace & defense and industrial end markets and the CFT segment manufactures adhesives and sprayers used in a variety of industrial end markets.

The company traces its roots back to 1917 as Carlisle Tire and Rubber Company focusing initially on rubber tires before branching into a more diversified enterprise with businesses serving a variety of industrial applications. It IPO’d on the NYSE in 1960 and developed a synthetic rubber to enter into the roofing business a year later. Decades later in 2008, the company launched its Carlisle Operating System (COS) based on Lean and Six Sigma in 2008 to help the company drive operational excellence and focus on its core businesses. This ultimately led to Carlisle gradually de-conglomeratizing their operations, exiting businesses operating in trucks/trailers, tire & wheels, power transmission, foodservice, and braking while simultaneously deploying capital to round out its capabilities in building products. It efforts over the past 10 years have helped drive attractive mid-single digit organic growth, meaningful margin expansion, and drove returns on invested capital from 13% to 22%.

Carlisle Construction Materials (CCM) – 59% of sales and 74% of EBITDA: The CCM segment is a diversified manufacturer and supplier of premium roofing products and technologies primarily for the commercial construction market. It has evolved from a supplier of single-ply ethylene propylene diene monomer (EPDM) roofing membranes in the 1960s to providing easy-to-install and energy-efficient solutions for customers, and its offerings include EPDM, thermoplastic polyolefin (TPO), polyvinyl chloride (PVC), architectural metals, and roof garden systems.

It's products are sold together in warranted systems and separately in non-warranted systems to the new construction, re-roofing and maintenance, general construction, and industrial markets, and its key brands include Carlisle SynTec, Versico, Weatherbond, and Hunter Panels in the US and Resitrix and Hertalan in Europe.

In FY22, the CCM segment generated $3.89bn in revenues, ~70% of which was for repair/remodel/replace markets vs. 30% for new construction. The vast majority of sales (~90%) are in commercial construction, with the remaining 10% into the residential end market. CCM has been benefiting from a strong reroofing cycle in the US. Its products and solutions for non-res buildings are non-discretionary and can only be deferred for so long. Management expects the market to grow from $6bn to $8bn in the next decade (~3% market CAGR).

• U.S. Commercial Market: CSL generated ~$3.3bn in sales to the U.S. Commercial market where it sells roofing systems (i.e. an EPDM or TPO roof + insulation + fasteners + adhesives). In general, EPDM is more common in northern, colder climates while TPOs are more common in warmer climates where its light refracting properties are most valued. Content per type of system is generally the same, though EPDM generally has a touch more. Management noted that EPDM growth is slower than TPO.

CSL created the EPDM category and is the market leader with strong market share, while Firestone was a fast-follower with its Elevate brand. Johns Manville also has a line. In TPO, CSL is a big player with mid-30% market share while Elevate has high 20% to low 30% share, and both GAF (privately held) and Johns Manville (owned by Berkshire Hathaway) have mid-teens % market share. In the insulation market, CSL competes with the other roofing suppliers in addition to a private company Atlas.

• Architectural Metals: The U.S. Architectural Metals business generates ~$300mn in sales for CSL, half of which comes from the residential end market. Management believes this business has a $2.5bn TAM and is growing at 2x GDP. This business is closer to 50/50 new construction vs. replacement.
• Europe: Carlisle generates ~$300mn in revenues in Europe. This is much more fragmented market that management sizes at a $10bn TAM

Carlisle Weatherproofing Technologies Segment (CWT) – 24% of sales and 15% of EBITDA: CWT is a leading provider of high-performance waterproofing and moisture protection products, protective roofing underlayments, integrated air/vapor barriers, spray polyurethane foam and coating systems, and block-molded polystryrene insulation for the building envelope. It’s primary markets are the US and Canada, and the majority of its sales are through distribution. The segment was created in 2022 following Carlisle’s late 2021 acquisition of the Henry Company/ Henry is a best-in-class provider of building envelope solutions that control the flow of water, vapor, air, and energy in a building to minimize air, water, and energy loss. Henry accounts for ~$600mn of sales (~40% of segment revenues) and had ~23% adjusted EBITDA margins as a stand-alone business not including the $30mn potential benefit (~600bps benefit) from cost synergies to be realized by year 5 of the deal. Henry is 57% residential and 43% commercial, while repair & restoration is 52% vs. new construction at ~48%. The business increased sales by a 5% CAGR since 2007 (sales did decline 9% in GFC)

Besides Henry, the CWT segment includes a spray foam insulation business (~$300mn in revenues), weatherproofing technologies (~$150mn in revenues) and a variety of diversified building product offerings. Overall, the segment is more balanced between both non-residential/residential and new building/remodel. A key growth strategy for this business is to bundle products with its CCM business to be a full service provider from the foundation all the way up known for creating value-added solutions that save customers time and money.  

Carlisle Interconnect Technologies (CIT) – 13% of sales and 7% of EBITDA: The CIT segment manufactures sensors, connectors, cable assemblies, and complex harnesses for use in commercial aerospace, military, defense electronics, medical device, industrial, and test and measurement markets. The business over-indexes to commercial aerospace, and saw its sales decline from $973mn in 2019 to $688mn in 2021 and $845mn in 2022, while its EBITDA pre-COVID was closer to $200mn vs. $118mn in 2022. Companies most similar to this business include Amphenol (16x EV/Fwd EBITDA) and TE Connectivity (12x EV/Fwd EBITDA).

Carlisle Fluid Technologies (CFT) – 5% of sales and 3% of EBITDA: The CFT segment manufactures and sells liquid, powder, sealants and adhesives, as well as high pressure foam equipment and solutions for spraying, pumping, mixing, metering, and curing automotive, industrial, transportation, wood, and protective coatings. The company acquired this business from Graco in 2014 for $590mn, as Graco was compelled to sell this business by the FTC in order to complete its acquisition of ITW’s liquid and powder finishing business. Graco (17x EV/Fwd EBITDA) is its primary competitor, as well as Nordson’s (16x EV/Fwd EBITDA) industrial coating business.

Valuation: At $218, CSL is trading at 10.3x forward earnings and 8.5x forward EBITDA, both discounts to its historical averages, while its trailing FCF yield of 7% is also a discount despite being depressed by ~$500mn of increased working capital over the past 2 years.  Notably, building products peers trade at average forward P/E and EV/EBITA multiples of 14.5x and 10x, respectively.

While the market clearly believes earnings are not sustainable, our opinion is that the market is overly discounting cyclicality and expectations that industry pricing will correct after surging input costs lead to meaningful price increases the past few years. While these factors will weigh on revenues, the impact will be less meaningful to profits as the company benefits from favorable price/cost dynamics with commodity deflation. Notably EBITDA for CSL’s construction materials business was flat from 2008 to 2010 despite a non-res construction spending declining 31% over the same timeframe. EBITDA increased slightly during COVID.

See upside from SOTP value – bonus potential if they divest non-core businesses to become a pure play building products company: On our numbers, CSL is trading at a 20% discount to its sum of the parts value. However, with Carlisle shares trading at a discount to its historical valuation and versus peers, we think management has an opportunity to divest its non-core businesses and use the proceeds to buy back shares opportunistically. On our numbers, CSL could generate as much as $3bn of excess cash flow this year, enough to repurchase 26% of outstanding shares.

• Sale of CIT - $1.4bn (12x 2022 EBITDA): This business is under-earning due to still feeling the impact of COVID. It isn’t not worth an APH multiple (16x), but a company like Amphenol could potentially pay 12x for this business to beef up a cyclically depressed end market consistent with their strategy of acquiring to maintain diversification. Assuming APH could drive margins towards their consolidated average (+1,000bps vs. CIT),  returns would be inline or better than their historical experience.
• Sale of CFT - $700mn (12x 2022 EBITDA): This CFT business was purchased in 2014 for 11x EBITDA in an all-cash transaction worth $590mn. Notably, the deal was a forced by regulators so that Graco could complete a large transaction with ITW and satisfy competitive concerns.  We think a 25% haircut to Graco (17x) and Nordson (16x) is appropriate here.
• Excess cash flow: Carlisle historically converts ~100% of net income into free cash flow. On consensus earnings, CSL is expected to earn $1.1bn in profits. Assuming historical conversion and the payment of ~$130mn of dividends, CSL should generate a little under $1bn in excess cash flow in 2023.  

Once the divestitures are complete, we think the company would receive a valuation more inline with building products peers. At a 10x multiple, with divestiture proceeds and cash flows utilized to buy back shares, we see almost 40% upside from current levels.

Catalyst

Continued execution

Divestiture of non core business lines