ferrantrae
In March, I believed that the actions of TopBuild (New York stock market :BLD)a premium insulation player, has warmed up. I view TopBuild as a solid operator, benefiting from secular tailwinds in the housing market, driving increased demand for insulation and adjacent products.
The company has combined organic growth with add-on acquisitions, which has generated impressive sales and margin pressure. Unfortunately, pricing expectations have risen significantly, too much to revisit.
TopBuild – A Great Performer
Originally, part of Masco Company (MAS)TopBuild was founded in 2015 as a $1.7 billion buyer, installer and distributor of insulation products. A $20 stock was about to experience a huge boom, amid growing environmental concerns, as well as higher utility bills, which drove the need and economic sense to install better insulation.
Fast forward seven Over the past few years, the company had essentially tripled its sales to $5 billion in 2022, while expanding its EBITDA margins to nearly $15 billion. That was all about to change, as rising interest rates led to a lower outlook for 2023, with the company initially forecasting sales to decline to $4.8 billion, with EBITDA of about $865 million. That could weigh on the company’s earnings power by as much as $2 to $3 per share.
Nonetheless, earnings close to $20 per share could be expected in 2023, which looks quite attractive with shares trading in the $150-200 range in early 2023.
The combination of organic growth and complementary agreements has created a large-scale company, which today has more than 400 branches and 13,000 employees. The vast majority of sales are generated by insulation, aimed at residential markets. That said, the company offers other related products such as gutters and accessories, while also catering to commercial and industrial markets.
Resume performance
In 2023, the impact of rising interest rates on the housing market was less than initially feared. In the end, 2023 sales actually increased by 4% to $5.19 billion, although they were helped by continued merger activity. EBITDA came in at $1.05 billion, while net income was reported at $19.33 per share, in line with initial estimates for the year.
Despite the relatively low number of deals in 2023, the outlook for 2024 looks reassuring to me, with the company reporting a slight increase in sales to $5.46 billion and an increase in EBITDA to $1.085 billion. The problem is that the stock has seen a sharp rally, from $230 per share in October last year to $400 in March.
With earnings power estimated at around $20 per share, multiples have increased to 20 times earnings in a context of modest debt, but the gaudy appeal has disappeared.
While I liked the company’s performance and its outlook, I was also concerned about a possible decline in margins, as these are well above long-term averages and reaching quite high percentages in absolute terms.
Trade stagnates
Since March, TopBuild shares have been trading in a range of $380 to $440, although the stock has risen dramatically to $440 in recent trading, helped by the recent inflation report indicating that a rate cut could be imminent.
In April, the company finished the agreement to acquire Specialty Products and Insulation, a substantial deal announced in the summer of 2023. The deal did not close due to concerns about obtaining regulatory approval, forcing TopBuild to pay a $23 million termination fee.
This operation did not prevent TopBuild from continuing its role as consolidator. In May, the company acquired Insulation Works, an Arkansas-based insulation company that generates about $28 million in annual sales, adding about half a percent to overall sales.
During the same month, TopBuild published First-quarter results remained relatively modest. First-quarter sales rose 1.1% to $1.28 billion, though the company demonstrated strong operating leverage, with adjusted earnings up more than 10% to $4.81 per share.
Net debt declined to $439 million, translating to a very modest leverage ratio of about 0.4 times. Despite modest growth, the company raised the midpoint of its full-year guidance by $100 million to $5.5 billion, with EBITDA now estimated at a midpoint of $1.11 billion.
In June, the company announcement its next deal, with the acquisition of Texas Insulation, a Texas-based insulation company that generates about $39 million in revenue, adding nearly 1 percent to overall sales.
And now?
The company is growing steadily and is expected to surpass $20 per share this year, while the balance sheet remains incredibly strong. The challenge for the company here is finding enough acquisition targets at a large enough scale, as it seeks to play the role of consolidator in a nearly $20 billion addressable market.
The company continues to do so, but in a low-debt environment, there is still room for continued buybacks. The problem at this point, if you will, is that the stock has gone from $390 to $440 in just two days, as a weaker inflation report has raised hopes of a faster recovery in the construction and housing markets. This seems like something of an overreaction in response to anticipated interest rate cuts.
Overall, I see no reason why earnings couldn’t improve further to a 25% EPS rate within a year or two, but with the stock trading near all-time highs, I’m holding back. Operating margins are currently in the high single digits, compared to pre-pandemic margins.
So it’s a matter of finding the right balance. If the company can continue to grow sales and maintain margins, the stock is likely to be attractive to those with a long-term horizon.
On the other hand, we could just as well see modest growth from here on out, but accompanied by some margin pressure, as such a scenario is within the realm of possibility. Given that things need to continue to go well to generate long-term appeal here, after the stocks have enjoyed a good run over the past year, I am rather cautious and approach the stocks with a neutral stance.
