Description

When the trajectory of the economy is uncertain, and a recession – however mild or steep – is likely, I sleep better at night knowing my capital is invested in a business with an enviable track record of consistent growth throughout the cycle.

Hillman Solutions is the largest provider of hardware products and solutions in their categories in N. America.  There’s nothing particularly interesting or fresh about the products they sell.  It’s an incredibly boring business, but one with a mid-to-high-teens ROIC and an incredible record of stable revenue growth since its founding over 50 years ago.  Quality and dull is the name of the game here.

Hillman came public via a SPAC over a year ago, and since then has faced one of the more challenging macro environments in recent memory.  Nevertheless, its competitive advantages appear only to have gotten stronger in the process.

Business Overview

Founded in the Midwest in 1964, Hillman is the market leader across the fastening and hardware industry and is frequently recognized by their customers for their exceptional customer service with 95+% fill rates.

Hillman markets and distributes a wide variety of small, hard-to-find and hard-to-manage hardware items, functioning effectively as a category manager for retailers.  Hillman supports these products with world-class in-store service, extremely high order fill rates, and rapid delivery of products sold.  Products include fasteners, threaded rod and metal shapes, keys, and a variety of common household items, such as coat hooks, door stops, hinges, gate latches, and decorative hardware.

Big-box retailers (Home-Depot, Lowe’s, Menard’s, Walmart, PETCO, Tractor Supply, etc.) represent nearly half of all revenues, with traditional hardware stores, commercial industrial, mass merchant, specialty, and farm & ranch absorbing the other half.  Over 90% of buyers of Hillman products are DIYers and professionals.

Competitive Advantage

Hillman’s status as a national supplier of proprietary products to big-box retailers allows them to develop a strong market position and erect high barriers to entry within their product categories.  While sourcing/price are inevitably a major component of competition, HLMN’s in-store merchandising service and high-touch customer service offer a differentiated and more compelling service model for customers, leveraging the largest direct salesforce in the industry.

Top-of-mind challenges for businesses in today’s operating environment are threefold: 1) the supply chain, 2) labor, and 3) inventory management.  Hillman’s model addresses these challenges in three primary ways, erecting real barriers for competitors:

1)      Hillman makes use of its extensive distribution network (22 strategically located distribution centers) to deliver over 80% of their SKUs directly to the individual retail locations of their customers.  This removes a major pain point for Hillman’s customers, who no longer have to worry about managing Hillman inventory in their own distribution centers or spend time managing any supply chain or shipping / labor costs associated with Hillman’s products.

2)      Hillman’s superior sales force enables its customers to overcome complex labor, inventory, and supply chain challenges.  Many of Hillman’s top customers continue to struggle to find quality employees to stock shelves and manage aisles.  Hillman does this for them so they don’t have to.

3)      Over 90% of Hillman’s revenue comes from brands that Hillman owns.  As a result, Hillman is able to customize their offering to meet the particular needs of the differing retail strategies of all their customers.

The power of Hillman’s model has come into sharp focus during this protracted supply chain crunch.  As competitors struggle to keep products on the shelves, Hillman order fill rates have remained high, allowing them to win new customers during these bouts of disruption.  Because customers rely on Hillman to stock shelves and keep inventory managed, they are effectively impossible to disintermediate.  Indeed, Hillman regularly wins “Vendor of the Year” awards from Ace Hardware, Home Depot, Lowe’s, Tractor Supply Co, AutoZone, etc.

The proof, of course, is in the pudding.  Like every other retailer that imports products from overseas, Hillman has been hit by ocean freight rates substantially higher than normal, but Hillman has been able to fully offset these cost increases by taking price.  As of the end of Q2, Hillman has successfully taken price four different times since 2021, during one of the worst supply chains anyone can remember. 

Hillman’s customers accept these price increases because they have 20+ year relationships and understand Hillman’s dedication to managing the business for the long-term.  Hillman is clear that any price increases only offset cost increases (no additional profit for Hillman).  Indeed, Hillman management believes their relationships with their customers are stronger after these price increases because of the way in which they were communicated.  Of course…supply chains will ease, costs will abate, but Hillman’s price increases will remain in effect.

Demand Tailwinds

On the Q2 earnings call, management commented that lead times from suppliers were down to 160 days from January’s peak of 255.  Pre-covid lead times hovered around 130 days, so substantial progress has been made.  An easing supply chain will allow Hillman to reduce inventory levels without jeopardizing their enviable fill rates – a nice working capital release that has allowed management to maintain their FCF guidance in the face of increasing costs.

Demand for Hillman’s products is tied to maintenance and repair/remodel activity – not to new housing.  As a result, historically demand for their products has remained steady throughout all economic cycles.  What’s more, their products typically represent a tiny fraction of the overall cost of the project for which they are being purchased.  We see evidence of this in the remarkable fact that Hillman has managed to grow revenue in 56 out of the 57 years since its founding, with a 6% organic growth CAGR in the past 20 years.  The lone year of negative revenue growth was in 2009, when revenue fell by 5% but EBITDA still grew by 10% (margins expanded 250 bps).

Growth opportunities

While favorable secular trends underpin the general growth of repair / remodel activity in the U.S. going forward, management is actively investing to accelerate their growth via new product development and innovations.  The PowerPro line of fasteners and their own patent-protected line of protective gloves, Firm Grip, serve as recent examples.

Perhaps the biggest driver of future growth, however, is M&A.  Management estimates a total addressable market of $45B, including adjacent categories such as plumbing and electrical components. 

Hillman is the ideal acquirer of smaller competitors as their long-standing relationships with leading retailers and their powerful in-store model allows them to scale acquired companies virtually overnight.  Management has invested $550m into M&A over the past five years and now has a demonstrated ability to unlock value via this channel, typically purchasing assets at mid-single-digit EBITDA multiples after synergies.  With maintenance capex at ~1% of sales, Hillman’s low capital intensity results in an attractive FCF profile with a consistent source of funds for accretive bolt-on acquisitions.

For all these reasons, management is confident they can deliver on their stated growth algorithm of 6% organic revenue growth with 10% organic EBITDA growth as the product mix continues to improve.  On the Q2 earnings call, management stated that as shipping/transportation costs abate, they fully expect to deliver EBITDA growth in excess of their stated algorithm.

Valuation

Hillman currently trades at 11x conservative estimates of 23Y EBITDA, an undemanding multiple relative to other industrial distributors (ITW, GWW, FAST), which trade between 13-17x.  I’d even argue Hillman deserves a modest premium to the comps on account of its consistent revenue growth, margins at the high end of the industry, stability through the economic cycle, negligible disintermediation risk, and the M&A opportunity in front of them.

Risks

1)  Leverage – currently at 4.5x, leverage is perhaps higher than what public markets prefer as we head into a potential recession.  Additionally, the leverage may suggest to some that the M&A story is on hold until further debt paydown.

Mitigant – As a private company, Hillman operated with substantially higher leverage (>6x).  Its consistent sales growth and low capital intensity allow this, and virtually 100% of current debt is termed out to 2028.  Despite leverage, the M&A pipeline is very active and many deals can be consummated on a leverage neutral basis.

2) Customer concentration – Half of Hillmans sales are to a handful of big-box retailers.

Mitigant – Hillman’s business model is centered around directly delivery to the stores of these retailers, and Hillman’s on-site management of shelves/inventories make it almost impossible to lose this business.  Insourcing these responsibilities would be an enormous headache for these retailers.  If anything, the frequent vendor awards and customer concentration serve as further evidence of a durable competitive advantage.

3) Capital Allocation – as most of the upside in earnings growth is likely tied to M&A, the ability of management to execute a roll-up strategy is of significant importance.

Mitigant – Thus far, management has made several sensible deals that have earned well above their cost of capital.  What’s more, transformational M&A, which requires significant capital and comes with additional risk, is not a part of management’s strategy.

4) Shareholder overhang and former SPAC association – Together CCMP Capital and Oak Hill Capital own 37% of the shares outstanding and are in the process of exiting via secondary offerings.  This will put technical downward pressure on the shares over the near-term.

Mitigant – Investors with a longer horizon can afford to wait for the company to establish a longer-term shareholder base.  Former SPACs are obviously out of favor at the moment.  Hence, the opportunity.

In sum, Hillman is a boring, unsexy small cap that appears to grow the top line organically come hell or high water.  Its scale and longstanding customer relationships insulate it from competition, its end markets are not particularly cyclical, and the stock trades at an undemanding valuation given its peer set and the M&A opportunity in front of it.  Buy some HLMN and sleep tight.

Catalyst

- Full exit of CCMP and Oak Hill

- M&A

- More time in public markets