|Shares Out. (in M):||38||P/E||0||0|
|Market Cap (in $M):||1,000||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
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Continental Building Products manufactures wallboard and other construction products, serving the residential repair and remodel market primarily, as well as the new residential and commercial markets. CBPX has a market cap of ~$1.0b and should provide above average returns over the next few years as pricing moves in their direction, recent capex spending reduces costs, and FCF generation is used to soak up shares in an ongoing buyback.
For more background, please see the recent VIC write-ups by rosie918 and bdad.
Why the opportunity exists
Continental has historically screened very poorly on a GAAP EPS basis which has obscured the fact that the P/FCF multiple has been well below peers. Management, after hitting their conservative leverage targets, began to use the prodigious FCF to take out these cheap shares. As the buybacks continue and likely grow larger, I think in 2019 you’re going to have a much higher FCF base with significantly fewer shares, which should be a boon for the stock.
Looking at the macro data around CBPX’s end markets, total housing starts are at the same level as 1993 while single family starts are still at 1991 recession levels - demand from new housing should continue to benefit Continental for the next few years as these metrics eventually move closer to long term averages. On the R&R side, remodeling market conditions are at the highest level of the last twenty years, and home prices, which are traditionally directly correlated to R&R activity, should continue to support this market as a low supply of housing pressures prices higher. Further, hurricanes Harvey and Irma either destroyed or partially destroyed tens of thousands of homes, which will lead to an increased demand for wallboard as those houses are rebuilt or repaired over the next couple of years. On the commercial side, demand is much more spotty but luckily this is the smallest of CBPX’s markets.
On the whole, demand for wallboard will be increasing, and this comes at a time when the wallboard market utilization rate is around 75%, with Continental’s utilization rate closer to 80%. Assuming a slight growth in demand for wallboard next year, the industry will be trending around 80% with Continental in the mid-80’s – this level compares to a utilization of 63% in 2013. Yet despite the large change over the last 4 years, Continental’s wallboard pricing is flat/down.
As the industry gets back over the 80% utilization rate (last seen over a decade ago) this should change – around this level prices usually trade up – they peaked above $180 (at 87% utilization versus $78% utilization today) for Continental, versus $144 today. The company recently instituted a price increase (which seems to be sticking at small/mid distributors) and has said they will possibly have another price increase later this year, which bodes well.
Continental announced at the end of 2016 that they would be investing $25-30mm in additional capex over the 2017/2018 period, with a 3 year payback on those investments, mostly related COGS. In 2017 ~$13mm of the total will have been spent, leading to ~$4mm in cost savings going forward. By the end of this year, all of the spending should be done and will lead to ~$8mm in cost savings per year. The net effect on the FCF statement is that in 2019 total capex should drop back to maintenance levels of ~$13mm, and the costs savings should add another $6.5mm in after tax cash flow, resulting in a total free cash flow increase of $18.5mm which will be used for buybacks.
Taxes should also have an impact on FCF as CBPX’s effective rate is currently ~34%. Assuming that drops to ~20%, this will result in $10mm of excess FCF on 2017’s pretax number. All-in, from taxes and capex, FCF will be ~$28.5mm higher than 2017’s actual number. Assuming no volume growth, no changes in margins, and no pricing, FCF will be ~$100mm in 2019, or 11x P/FCF.
After the IPO, CBPX was left with a larger debt balance than they were comfortable with, so management set a debt/EBITDA target of 2.0x. As the company got closer and closer to the target, they began to repurchase shares, culminating in a $50mm authorization in late 2015 that ran through all of 2016. In late 2016 the authorization was increased to $100mm, and in early 2017 the authorization was increased further to $200mm. Management has stated a few times that they will complete the buyback by end of 2018, and as of today are likely well on their way to hitting the target. Effectively, the company will repurchase about 1.8% of shares per quarter through the end of next year – 9.3% of shares from the end of 9/30/2017.
I think that the buyback authorization will be further increased soon to utilize 100% of future cash flow. A rising EBITDA and constant net debt level will leave debt/EBITDA around 1.4x by the end of this year, falling further in 2019, so repurchasing shares equal to 100% of FCF is a fairly conservative target at this point.
If the company were willing to lever up and take leverage back up to the 2.0x level, it would allow them to repurchase an additional $125mm (11.4% of shares) by the end of next year. All told they could repurchase >25% of shares between 12/31/2017 and 12/31/2019 and still be below their original debt target.
Buybacks seem to make the most sense here given very cheap debt and their relatively small size compared to peers. Currently CBPX has only a term loan (expiring in 2023) that pays LIBOR + 225bps, and no other debt. Given the enormous spread between the FCF yield and this rate, buying back shares is a much better use of the free cash flow.
In theory CBPX could also use the cash for acquisitions but of the 7 major wallboard competitors, Continental is the second smallest (in terms of capacity). USG and National Gypsum combined are about 50% of the market, while Continental and Eagle are near the bottom with 10% shares each. I think there is a decent chance we see an EXP/CBPX tie-up at some point, which will be discussed further below.
I think by the end of next year Continental will be 40%+ higher as P/FCF rises from slightly below 10x to slightly above 10x.
Revenue will come in around $485 for 2017. The Street seems to be baking in a 2-3% pricing increase next year but given increased demand and a tightening supply, a price increase that seems to be sticking this quarter, and multiple years without a substantial change in pricing, I believe the price increase will be closer to 4% this year - leading to a 9% increase in sales. I think in 2019 prices could rise another 2-3% which would leave 2019 sales 15-17% higher than 2017. I also believe that the full ~$8mm benefit from the CapEx build out will be flowing through 2019’s income statement, leading to EBITDA moving from $133mm to $163mm in 2019.
Interest will hold steady around $12mm and a 20% effective rate should result in taxes around $21mm. Adding it all up, 2019 FCF should be $117mm.
CBPX will end 2017 with ~37.0mm shares and should buy back $80mm worth of stock this year. Assuming an average purchase price of $33, shares outstanding will drop to 34.6mm. In 2019 I think the company will buy back around $120mm worth of shares – approximately equal to their $117mm in FCF. Assuming an average price as high as $40, shares outstanding at the end of 2019 will be 31.6mm.
$117mm in FCF on 31.6mm shares is $3.70 in FCF/share. I think this stream is worth 11.5x (8.7% yield) given they return virtually all current free cash flow to shareholder through a buyback and have room for growth in both pricing and demand as housing continues to normalize. At 11x, the company is worth $40.73 or ~50% higher than the stock price today.
In addition, the company could further juice returns if management increased leverage to 2.0x versus the 1.2-1.3x they will end up at in the above scenario. By doing so, they could repurchase another $125mm worth of shares in a buybacks. Even if all $325mm in total buybacks (from the end of 2017 to end of 2019) were done at an average price of $40, shares would drop to 28.9mm, FCF would decline ~$4mm due to debt, and FCF would jump to $3.90. At 11.5x, the stock would trade at $44.85, or ~65% higher than the price today.
In addition to a good IRR in the base case, I think there is a chance Eagle (EXP) ends up acquiring CBPX in the near future. There a few reasons I think this may occur, but this acquisition would mostly revolve around low plant overlap, the potential for cost cuts (and possibly some revenue synergies), and a large difference in relative valuations.
By acquiring CBXP, Eagle would become a more geographically diverse player – all of Continental’s plants are east of the Mississippi while Eagle has only one plant in the East. There would be overlap in the FL/GA/SC area but slight overlap in the center of the country, but would also allow the combined company to stretch almost the entire length of the US. The new geographic presence and combined size (20% of capacity) would put them on the same playing field as National Gypsum and USG – both of which sell wallboard on both sides of the country.
A CBPX/EXP tie-up would also produce cost synergies, as well as smaller revenue synergies. CBPX has $40mm in SG&A that is more than likely ripe for cost cutting. The overlap in the Southeast would also present potential cost cuts or the ability to direct wallboard into different regions where their combined share is smaller. If Eagle could cut half the SG&A, they’d be able to generate $20mm pretax before even accounting for manufacturing synergies or cost synergies in the combined business. If they could reach $30mm in total pretax cuts that comes out to about $24mm in after tax FCF, which would make CBPX an accretive target. EXP trades at ~1.5x CBPX’s P/FCF multiple, so either issuing shares or debt would be very accretive, and a 50/50 debt/equity split can be seen below -
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