Melena-Nsk/iStock via Getty Images
investment work
I am reviewing Builders FirstSource (NYSE:BLDR), the leading building materials supplier in the US, a strong buy on resilient underlying demand for housing, increased market share through strategic M&A and a forecast housing market to stay strong into FY23. Driven by multiple tailwinds, the building materials industry had a very strong year in 2021. Demand for building materials remained robust, primarily due to the severe housing shortage in the United States. To the detriment of home buyers, the ongoing housing deficit will continue to act as a catalyst for the company’s revenue growth. BLDR’s share price has recently been driven lower by interest rate concerns and falling lumber prices, which I believe is unfair and represents a buying opportunity.
Security information for BLDR (Excel)
Robust underlying demand
Many investors believed that FY22 rate hikes would reduce housing demand due to expensive borrowing to start construction and renovations. Despite interest rate increases, demand remains robust due to the severe housing shortage in the United States. Since 2018, the housing shortage has risen rapidly by 52%. This rapid increase has left the United States short of 5.8 million homes as of March 2022 to meet demand.
Housing shortages are forecast to persist due to ongoing supply chain disruptions, labor shortages and a high rate of household formation among millennials (44% of homebuyers in March 2022). Single-family home revenue accounted for 75% of BLDR’s total revenue in FY21, positioning the company to capitalize on pent-up demand driven by the housing shortage.
Presentation of the housing deficit (real investment advice)
Aggressive acquisition strategy
BLDR’s aggressive M&A strategy has enabled them to gain significant market share in the building materials industry. The company has a liquid balance sheet that allows it to continue to make strategic, value-added acquisitions. Following their blockbuster merger with BMC in 2020, BLDR became the nation’s leading supplier of building materials with combined sales of more than $11 billion. Their M&A strategy has expanded delivery capacity and created additional cross-selling opportunities that have been essential to gaining market share.
BLDR’s steady M&A streak has significantly increased the company’s capacity to meet robust demand driven by the current housing crisis. The company has made major capital investments to expand its geographic footprint in the United States, specifically targeting the country’s fastest growing markets.
As of March 2022, BLDR has a presence in 85 of the country’s top 100 metro areas. Management expects ambitious acquisition activity to continue into FY22 and cites a robust M&A pipeline. Further acquisitions will allow BLDR to continue leveraging its post-merger market share to drive outsized revenue growth.
Strong economic indicators for housing
Economic indicators for the housing market (Bloomberg)
construction expenses
Major economic indicators are currently working significantly in BLDR’s favor. Construction spending in the United States has increased by over 100% over the past decade. In FY21 alone, construction spending rose 8%, largely driven by a 23% increase in the housing sector (see below). In contrast, spending in the commercial sector has stagnated over the past 7 years.
The sharp increase in housing spending is attributed to the housing deficit, which will persist for the foreseeable future. Economists forecast that construction spending will increase at a CAGR of 3.7% from FY22 to FY24. Reports over the past few years suggest that increased construction spending will be mostly driven by the housing sector, which will benefit BLDR as it relies on single-family homes for sales growth.
Construction spending by sector (ING Think)
living begins
Housing starts have been rising steadily over the past decade, rising from 609,000 in 2011 to 1.6 million in 2021 (see below). The boom in housing starts in 2021 was a boost to BLDR’s revenue growth. As of April 1, economists polled by Reuters are forecasting 1.745 million new housing starts in 2022. In a tight housing market, builders will keep building in the knowledge that projects won’t be vacant long after completion, boding well for BLDR in FY22 is.
Historic Housing Starts/Permits/Completions (US Census Bureau)
timber prices
Given that 39% of its core business is commodity-exposed, BLDR was the beneficiary of record high timber prices in FY21 (see below). High timber prices in FY21 are being attributed to the recent construction boom, supply chain disruptions, inflation and strong demand for housing. All four of these drivers are expected to continue into FY22 (assuming the Fed doesn’t hike rates fast enough to dampen inflation).
Historical Lumber Prices (Fortune)
There is a revenue difference of up to $6 billion between assumed FY22 lumber prices of $600 and $1000 (see below). Additionally, there is a $1 billion difference in adj. EBITDA. According to David Logan, a senior economist at the National Association of Homebuilders, futures markets are suggesting that wood will remain above $1000 through September 2022. EBITDA, which encourages free cash flow to reward shareholders.
Lumber Prices vs Revenue/EBITDA (BLDR Investor Day Presentation)
Discounted cash flow model
For my discounted cash flow model, I’ve made assumptions of a 5% CAGR in FY22-FY25 revenue, which assumes $600-$700 in lumber in FY22. That assumption is fairly conservative compared to management’s projections of 8% to 12% for revenue growth in FY21. After feeding these assumptions into my DCF analysis, I came up with an intrinsic value of $97.45 per share (up 52.33% from the current price of $63.97). For the cost and expense assumptions, I used the historical 3-year averages as a percentage of sales.
Over the past three years, BLDR’s average cost of sales has been 72% of sales. Their 3-year average of operating expenses was 19% of sales. Non-operating expenses were 1.25% of sales. Investments amounted to 1.3% of sales. Finally, the change in net working capital was 0.84% of sales. In terms of terminal value, I used the 10-year treasury note as the perpetual growth rate. After incorporating these assumptions into my DCF model, I came up with the following cash flows for FY22 through FY25:
Projected Cash Flows (Excel)
For my discount rate, I calculated BLDR’s discount rate to be 8.74% using their current market cap and the current market value of the debt (see below). To calculate BLDR’s cost of equity, I arrived at a 4.23% market risk premium for their cost of equity by taking the difference between a 7% expected market rate of return and a 2.77% risk-free rate (US Treasury 10Y). To calculate the market value of the debt I used the interest expense from 2021, the total debt (book value) from YE21 and a 4 year period.
WAAC/Discount Rate Calculation (Excel)
After applying a discount rate of 8.74% to my projected future cash flows for BLDR, I came up with an intrinsic value of $97.45 per share (see image below). This represents a 52.33% increase from the current share price of $97.45. My price target falls at the median of Wall Street’s 12-month price targets, which range from $71 to $125 per share.
BLDR EV & intrinsic value (Excel)
investment risks
There are a number of risks that you should consider before investing in BLDR. The risk of a recession is steadily increasing and may come sooner rather than later. Despite healthy consumption balances among the US population, Goldman Sachs sees the risk of a recession at 35% next year. This is entirely possible given the geopolitical turmoil, inflationary environment, high oil prices and possible corporate tax hikes in the near future. Hopefully, given the healthy consumer balance sheet, the next recession won’t be as bad as the dot-com bubble or the subprime mortgage crisis.
Another risk is the supply chain disruptions that continue to plague global business. These disruptions were caused by the current geopolitical strife, high commodity costs and Brent crude above $100 a barrel. Businesses in the United States are grappling with shortages of inventory due to rising material costs, while others are unable to meet demand. A significant disruption in the supply chain for BLDR could pose a risk of opportunity cost from lost revenue.
A third risk for BLDR investors is more modest housing starts and lower than forecast lumber prices. A slowdown in housing starts would dampen BLDR’s sales volume. Additionally, weaker oil prices will have a noticeable impact on its top line, as 39% of its top line is invested in commodities. Record high timber prices drove profitability in FY22. If lumber prices come in well below futures market forecasts of $1000, BLDR could lose up to $3 billion in incremental revenue and $1 billion in adjusted revenue. EBITDA.
closing remarks
BLDR is a cyclical stock exposed to the winds of the housing market, but most economists believe the housing market will remain rock solid well into FY23. Lumber prices are forecast to remain high through September, resulting in significant cash flow for BLDR in the near term. In addition, the company has aggressively expanded its operations to meet pent-up demand caused by the housing shortage. With many secular and non-secular tailwinds in its favor, BLDR has tremendous upside potential. I own BLDR and recently bought it. I will add to my position if the current economic uncertainty drives the price further lower. Long BLDR.
Comments are closed.