Description

Huttig Building Products, Inc. (“Huttig” or the “Company”) is one of the few publicly-traded U.S. housing supply companies whose shares are reasonably priced on the basis of current/LTM earnings.  At roughly 12x LTM EPS, 8x forward (consensus) EPS, and 4-5x normalized EPS, it presents an attractive risk-reward profile, as its market price can be justified on the basis of current depressed levels of housing activity, with significant upside as housing activity normalizes.  This stands in contrast to most of its comps, whose share prices already incorporate an implicit assumption of reasonably rapid near-term improvement in the U.S. housing environment.  Notwithstanding the fact that a lot of ink has been spilled by investors over the last couple of years making premature ejaculatory comments about housing’s impending rapid rise back to pre-bust activity levels, the stars do seem to be aligning on a number of fronts to drive a slow, but steady, increase in housing activity for the foreseeable future.  Should this indeed play out, Huttig will be a significant beneficiary.

Huttig is a distributor of millwork (doors, windows, molding, and stair components), building materials (decking, connectors, fasteners, housewrap, roofing products, and insulation), and wood products (flooring systems, panels, and lumber) used in residential construction and remodeling.  The Company acts as a middleman between product manufacturers and its customers.  These customers include building materials dealers, national buying groups, home centers, and manufactured home producers.  The Company’s value-add is two-fold.  With a near-national distribution footprint that covers 41 states through 27 distribution centers, Huttig is able to achieve purchasing economies of scale that it shares with its customers.  These economies of scale not only provide Huttig’s customers with access to a much broader range of inventory than they would otherwise have, but do so at significantly more attractive prices than they would be able to garner if they were purchasing directly from the manufacturers.  Huttig also performs post-purchase processing on some of its products, thereby converting standard-sized building product components into job-specific configurations needed by the end customers.  These post-purchase processes include, for example, pre-hanging doors in door frames and cutting wood flooring to custom lengths.

Huttig has a long corporate history.  The Company was founded in 1885 and was owned for many years by Crane Co. (“Crane”), a diversified manufacturer of industrial products.  Crane spun Huttig out to its shareholders in late 1999.  Huttig’s longstanding history serving the U.S. housing industry has imbued it with an inherent conservatism that many of its younger competitors lack.  As a result, it began adopting a more cautious posture towards the booming U.S. housing industry in the early-mid 2000s, even as many of its younger competitors continued to expand rapidly.  Huttig peaked with 54 distribution centers (serving 47 states) and over 2,400 employees in 2003.  By 2007, when the housing market began to crack, Huttig had already reduced its footprint by roughly a third, to 36 distribution centers (serving 44 states) and 1,600 employees.  Subsequent reductions have reduced the business infrastructure by roughly an additional third, to 27 distribution centers (serving 41 states) and 1,000 employees.  Notwithstanding the aggregate reduction in the number of distribution centers and employees by over 50% since 2003, the Company continues to have the ability to service over 80% of the regions that it serviced at peak, including virtually all of the fastest growing regions in its peak footprint.

Huttig is an average quality business, in-line with what you might expect for a distribution business serving a cyclical end market.  Mid-cycle returns on invested capital are in the low-to-mid double digits, with correspondingly higher returns on equity as a result of modest financial leverage.  Management is solid (if unspectacular), and as previously mentioned, reasonably conservative.  Insiders own nearly 15% of the Company.  It appears that the Company has recently been consolidating market share, likely a result of its ability to effectively service large multi-region customers that smaller competitors lack the scale to address.

What makes Huttig’s equity particularly interesting is its valuation relative to both the vast majority of its publicly-traded competitors, as well as to its normalized earnings potential.  Huttig trades for roughly 12x run-rate earnings, an undemanding multiple in a market that is trading at over 18x comparable earnings.  The Company’s current earnings run-rate, however, vastly understates its normalized (mid-cycle) potential.  The U.S. housing industry has been in a slow, halting recovery since it cracked in 2007.  This is due to myriad factors, including tightened mortgage lending standards, a glut of foreclosed homes hitting the market, stagnant middle class incomes, and associated limited affordability.  Currently, the U.S. is adding roughly 1mm new housing units per year, a full 30% below the long-term average of 1.4-1.5mm per year, and over 50% below prior peak production rates of over 2mm units per year.  Many of the aforementioned headwinds are now either abating, or are become tailwinds.  Concrete regulatory actions have been taken recently to ease access to mortgages, and the backlog of foreclosed homes in the pipeline is beginning to wind down.  Most importantly, ongoing declines in the national unemployment rate appear to finally be driving wage improvement for middle class workers – a key requirement to increase housing affordability and drive aggregate demand.  These trend shifts have driven material improvements in home builder sentiment over the past 12 months, and there finally appears to be an increasing appetite on the part of builders to participate in the entry-level segment of the market.  Although both starts and permits have been trending favorably in recent years, single family trends have more recently begun outpacing multi-family units as the relative economic attractiveness of owning versus renting has swung decidedly in favor of owning.  This near-term trend will be disproportionately beneficial to Huttig, as its business is far more dependent on single family starts than it is on multi-family units.

Most U.S. housing stocks have been bid up aggressively over the last several years in anticipation of a robust housing recovery.  This despite the recovery having unfolded much more slowly than initially expected.  Today, a broad group of other publicly-traded housing supply companies trades at roughly 30x and 18x 2014E and 2015E earnings, respectively.  Huttig, by comparison, trades at 12x 2014E and 8x 2015E earnings, or roughly half the forward multiple of its competitors.  Moreover, since Huttig’s earnings estimates conform with the consensus for 1.1-1.2mm housing starts in 2015, this 9x trading multiple substantially overstates where Huttig is trading on the basis of its earnings in a normalized new housing market.  Given an expense structure that is significantly leaner than it was during the last upcycle, Huttig should be capable of generating more than $0.75/shr in a 1.4-1.5mm housing start environment, putting its current trading level at under 5x normalized EPS.

Huttig’s valuation is a function of its low public profile, small market capitalization, and limited trading liquidity.  The Company is covered by just a single sell-side research analyst, and the market capitalization is under $100mm.  Moreover, from late 2008 to late 2013 Huttig’s shares were not listed on a major stock exchange (since Dec 2013 it has traded on NASDAQ).  Trading liquidity is spotty, making the Company an unsuitable investment prospect for many larger investment funds.  Despite these impediments, I expect that a combination of continuing improvement in the housing market and Huttig’s upside operating leverage will continue to drive earnings momentum, eventually making the valuation disparity with its competitors impossible to ignore.  As the share price gradually begins to converge with its materially higher intrinsic value, both market capitalization and trading volume should improve, creating a positive self-reinforcing feedback loop.

Catalyst

Continued improvement in housing activity.  Improved liquidity as disparate valuation vis-a-vis comps becomes more difficult to ignore.