IBP Holdings: Price target: $130 (~20% upside); 14%+ 3-year IRR

IBP is a leading end-to-end insulation installer for single family homes in the US (180 locations serving all 48 continental states – 70% of all residential permits - with #1/2 market position for half the markets based on permits issued). Its primary competes via scale economies and process efficiency. Similar to any local distribution business, scale economies accrue to local density (read: waste management, soft-drink distribution, pest control), the idea being fewer rolls [sending out trucks, software based optimization], more jobs per roll, higher margins. The business is owner-operator led by a proficient capital allocator (Jeff Edwards) who owns 23% of outstanding shares.

With 28% of the national installation market (2nd to TopBuild w/ roughly 1/3), IBP also enjoys the benefit of national scale from a procurement perspective (huge buyer of fiberglass insulation from big 3 producers), as well as more job prospects from its large national relationships (homebuilders are willing to pay a slightly higher price for guaranteed performance through fewer, healthier, national suppliers. Effiiciency to avoid backlog of jobs on site is important for homebuilders to keep costs low (time delays + rescheduling). IBP’s top 10 customers have been customers for over 10 years, and IBP serves its top customer out of 67 separate locations nationwide)

Backdrop

In terms of end markets, the thesis of a housing normalization was already in play prior to COVID and has since been accelerated (particularly on the demand side). Total housing starts were just less than 1.3m in 2019, and one could conservatively assume LSD growth back to ~1.5m long term averages over the next 5 years. Instead, it is likely we see starts approach that level this year (2021, given recent YoY increases YE2020):

(below, per Evercore)

*Roughly 2/3 of IBP’s revenues is derived from SFH starts, and ¾ from total housing starts in general. Basically reverse of Ferguson

LT housing demand has been ~1.6m accounting for population growth (largely due to headship rate; aka maturing population, and a sprinkling of housing demolition)[1]. There are numerous sources that cite the decline in headship rates over the past decade, particularly within the 35-44 cohorts. Evercore believes there has been a ~4m missing gap of household formation since 2003, and believe half of that will be “catch up” over the next 3 years, leading to estimates of ~2m household formations through 2023[2]. Tacking on ~200k for demolition and ~200k from increased vacation home demand, a plausible case is made for ~2.4m in demand. Regardless, the point being we are likely to see a demand/supply imbalance over the next few years above the normalized 1.6m LT average.

LEN (12/17): “It has simply never been this easy to sell as many homes as we would like in every market, in every price range across the country.”

IBP (11.5): “So we have a tremendous amount of pent-up, if you will, demand that builders are working hard to address, but the reality is that the whole construction industry can't size out by 30% to meet that demand. So, we believe, what's going to happen is, you're going to have elongated cycle through 2021-2022, working through all this demand. We definitely think that the seasonality that the business has normally experienced might be muted a little bit in 2021 because of this and we think that it really sets up 2021 for the whole industry, to be very, very constructive.”

For IBP: insulation is typically installed 4-5 months after housing starts; and the interior (shower, garage doors, blinds, etc.) comes after that. With housing starts surging in 2H’20 (12.8% in November[3]), the flow through to IBP revenues will come in Q1, Q2’21. With housing starts continuing to be up double digits potentially this year, IBP will have strong growth visibility through 2022 (and will benefit from recent Sept’20 + Jan’21 insulation price increases).

Why is this a good business?

A look at the historical operations of the company (during a period when housing starts has been significantly below long term averages) probably qualifies this as a “compounder”:

Since 2011, revenues have grown at 26% CAGR, while EBIT has swung from -$17million to $121.2m (-7% to +8% margins, with incremental margins in mid-teens in 2019 but >30% YTD’20). EBITA is a higher $145.7m as IBP is highly acquisitive and the amortization of intangibles is a reasonable add-back to true profitability. Organic growth since 2014 (volume and mix, measured as same store sales) has been in the range of 12-13% (so roughly half organic, half acquisitive growth). IBP is targeting 20-25% incremental margins in the medium/long term.

Beyond the ability to grow organically above end markets ($/permit increase), the company’s ability to deploy capital accretively is strong, with ROICs maintained at ~20% (most of last decade, and improving, measured as EBITA / ROIC) while making over 150 acquisitions since 1999. Even when adding back all accumulated amortization and goodwill (one occasion of goodwill impairment), ROIC is still a steady ~17%. This is a combination of strong execution along with prudent capital deployment.

Over the past 5 years, IBP has constantly made acquisitions at roughly ~1x revenues (1.0x, 7x, .9x, .8x, 1.2x). My best guess for annualized multiples for 2020 thus far is ~.7x (assuming no seasonality). In the most recent call, Edwards cited multiples were generally the same with slightly more attractive pricing in commercial side

IBP has its own jobCORE software stack that operational and financial data to each branch and monitors KPIs.  Along the lines that “every company will become a software company,” smaller local competitors are unlikely to compete efficiently without these productivity tools (allowing for a higher margin capture for IBP), but also lack the scale to invest in them, creating a catch 22.

The Company

IBP generates roughly 2/3 of revenues from insulation (by products); similarly, it generates 2/3 of its revenues from new single family homes:

Insulation is pretty straightforward; 85% of IBP’s insulation installation is the form of fiberglass and cellulose (blankets or loosefill), with the remainder from spray foam, which is a better insulator but also more expensive (chemicals need to be combined on site). Generally insulation is installed in the attic, basement/crawl space, and overall enveloping of a home.

It’s a pretty laborious task and not likely to be disrupted by technology anytime soon. This isn’t a huge sexy growth business and so new entrants are unlikely to enter (similar to pest control or waste disposal), allowing leaders to reap the benefits of consolidation.  IBP sells other products like gutters, garages, showers/doors, etc. which are lower margin than insulation (but improving at a faster pace), but is a logical cross-sell for the business. The commercial business is relatively evenly spit between heavy commercial and light commercial (does do slightly different things like waterproofing, fireproofing).

Growth

As IBP has scaled its density in markets, it has also moved from pure insulation installation into waterproofing, fireproofing, rain gutters, garage doors, and other various products that can easily be cross-sold with insulation (typically happens towards the end of a home completion). As a market matures, revenues per residential permit increases ~4-5x as non-insulation products increases from 10% of revenues to ~45% (and as commercial/multi-family mix increases from ~10% to 30%). While these are commoditized installation offerings, the ability to “add on” the service is highly incremental as the cost of the roll/customer win is fixed.

With regards to the potential of these commoditized goods, while IBP has just under 30% of the residential insulation market, it has just 3% of garage doors, 5% of gutters and blinds, and <10% of shower shelving and mirrors. It’s main competitors BLD, which has roughly ~30% market share in insulation as the market has consolidated over the past decade. IBP is generally able to gain share organically in end markets (see IBP outperformance) against a smaller competitors (not unlike Ferguson in HVAC/plumbing). Over the last couple years, IBP has gotten its feet wet in commercial end markets and has prioritized selling more commercial products at existing new residential locations.

Some Risks

·        Interest Rate Risk: 30 year rates still just at about all time lows; affordability will drop as rates begin to climb. The entire stock market is held up by assumptions of low rates for longer and so this is a broad systematic risk of owning equities – at least with housing related companies you are likely to enjoy some record cash flows up front vs. having all the value in a terminal multiple 10-20 years away. This defrays some of the interest rate risk given the more even distribution of cash flows. Furthermore, IBP is an insulation installer and while any decrease in home price acceleration means more pressure on costs for home builders, insulation is only 2% the cost of the home, and is a critical step to prep a house for interior design/finishing

·         Commercial never recovers/recovers slower than anticipated: This is harder to have confidence on vs. residential, but IBP reported 5% YoY growth in commercial backlog and stable end markets during its Q3’20 update. Overall, heavy commercial is <10% of the company’s business and any weakness should be more than ameliorated by strong residential in the short term. In the long term, Edwards believes the commercial rollup opportunity is equally as attractive as the residential side

·        M&A returns fall as previous decade of acquisition opportunities dries up: Multiples paid in 2020 are more conservative than 2019 (so far doesn’t seem like return hurdles are being challenged). However, it's definitely a risk to monitor as IBP continues to shift more towards commercial (18% of the company’s total revenues). 

·         Supplier concentration of insulation: insulation manufacturers regularly put through price increases and in 2018 IBP was taken off guard due to a supply shock. IBP did not pass on price increases aggressively to its customers as it prioritized its partner status. However, with IBP and BLD constituting ~60% of the SFH insulation demand in the US, the relationship dynamic is symbiotic

Valuation:

The stock had a strong 2020, up 48% but it still seems relatively attractive in these markets at an estimated ~14x 2021 EBIT(A). IBP has typically grown (organically) 3-4% above housing completions. With starts up teens towards the end of 2020, I believe completions can hit double digits for 2021 (current year completions is generally ~97-98% of last years starts); with revenue growing ~20% for 2021, and low teens thereafter (I assume all FCF used to make acquisitions at 1.0x revenues)

I model starts hitting 1.6 million by 2023, though one could believe starts could be higher than normalized levels given “pent up” demand (i.e. at 1.7 million, IRR would be around ~15-16%)

I model incremental margins at ~20%, the lower end of mgmt. target of 20-25%

Assuming an exit multiple of  ~13.5x EBIT(A), or roughly 11.5x EBITDA, you get an EV of ~$5.0bn in 2023 and a 14% IRR.

Housing starts: