Quick note before reading: I wrote about Builders FirstSource (NYSE:BLDR) in March 2022 in my article “Builders FirstSource: Management Guidance Suggests 46% Upside“Since then, the stock is up 154% (outperforming the S&P 500 by about 134%). It could It makes sense to read that first and then move on to this article to give a comprehensive overview of my thoughts a few years ago versus what I think of the business today.
Investment Thesis/Business Overview
Builders FirstSource manufactures and supplies building materials to homes throughout the United States. The company also provides professional installation services to homeowners wishing to carry out renovations, additions or build new homes. To put it more broadly, the company supports house construction projects.
And that’s where the opportunity lies, in my opinion. The United States needs more housing construction projects to address the housing shortage 4 million households in the United States (according to The hill). Builders FirstSource is a direct beneficiary.
Additionally, the company has already benefited from the recent decline in mortgage rates, with single-family home starts increasing in recent months. A dovish Fed this year will also lead to lower interest rates, which in turn will create more real estate activity – with BLDR being the biggest beneficiary.
Due to the factors mentioned above, I expect strong revenue, EBITDA, and free cash flow growth over the next 5 years, and my DCF model currently shows the stock has 22% upside potential. % from current levels.
Revenue Growth Factors
As I mentioned in my first paragraph, the United States currently has a housing shortage of 4 million, and with the recent influx of immigration, that number is likely to increase. So simply put, we need to build more housing. And that’s where Builders FirstSource benefits. The company builds homes, completes additions and generally supports construction projects.
I think this slide from Builders FirstSource’s investor day presentation illustrates very well the structural demand I’m talking about.
While “The Hill” reports that the United States is short 4 million homes and Builders FirstSource reports that it is between 1.7 million and 3.5 million homes short, the point is still relevant: States -United States needs more housing.
Another tailwind I foresee this year is a dovish Fed. Interest rates have surged in recent years, dampening U.S. real estate activity.
Take a look at the NAHB US Housing Market Index indicator above, which is well below its peak of around 80 in mid-2020.
Nevertheless, Builders FirstSource was able to significantly increase its revenues and profits.
The 5-year CAGR of the following line items is below:
- Revenue: 26%
- EBITDA: 62%
- Net income: 134%
- Free cash flow: 95%
Construction starts are also starting to pick up for single-family units. Take a look at the table below.
Single-family homes are one of Builders FirstSource’s largest sources of revenue. Take a look at the slide below from the company’s investor presentation.
The company says it is well positioned for above-market growth and is looking to capture more market share within the U.S. building materials industry for new single-family construction.
Considering the revenue growth factors I mentioned above, here are my revenue, EBITDA, revenue, and free cash flow forecasts for the next 5 years.
I expect revenues to grow at a CAGR of 6% over the next 5 years due to strong tailwinds in single-family unit construction, falling mortgage rates driving housing demand, and a More accommodating Fed which will ultimately lead to more activity in the real estate market.
I forecast EBITDA growth of 8% over the next 5 years due to the company’s resilient margins (which I will describe later in this article).
And this will lend itself, in my opinion, to strong free cash flow growth over the next 5 years (I expect 8% growth over 5 years).
In terms of profitability, 5 of the 6 key profitability indicators that I track are currently respectively above their 5-year averages. The 6 metrics are ROIC, ROA, ROE, Net Margin, EBITDA Margin and EBIT Margin.
Among these 6 key indicators, the only one that has deteriorated is ROE. The company was able to improve the other 5 indicators, which shows its ability to generate profits even in an uncertain economic period (Covid-19 + recent inflationary period).
One item I want to highlight is the net margin, which has doubled from 6.0% (5-year average) to 12.1% currently. This is explosive growth, and I see no reason why the company wouldn’t be able to continue to maintain these margins, especially as inflation continues to fall and commodities become less expensive.
In terms of valuation, my DCF model can be found below.
I assume strong free cash flow growth, EBITDA growth, WACC of 12.7% and a conservative exit multiple on Year 5 EBITDA of 6.5 (below EV /median EBITDA of its reference group).
After properly discounting free cash flow, terminal value, and normalizing net debt, I arrive at a fair share price of $226.41. That’s 22.2% higher than the current stock price of $185.33.
And given this strong expected growth, you might think the stock is expensive.
This is not the case. Take a look below at BLDR compared to its peer group. The company trades on the low end of its peer group in terms of NTM PE ratio, despite its ability to capitalize on secular tailwinds in the real estate market.
And compared to its peers, the company leads in free cash flow growth (491% over the last 5 years).
This strong growth and low valuation relative to its peers are the two main reasons why I am partial to BLDR.
BLDR has a strong balance sheet. Below, I’ve included some of the key elements of the company’s balance sheet.
The main areas I want to highlight are short-term debt, current ratio and current ratio.
- Short-term debt: The company’s short-term debt is 0, meaning that all of its debt is grouped into long-term debt (easier to manage for a company like BLDR whose earnings are particularly cyclical, and positive for me).
- Current Ratio: >1 is always good to see, and BLDR has a current ratio of 1.76.
- Quick report: also >1, which is positive.
The biggest risks
The biggest risk I see for BLDR would be a “higher for longer” Fed. This would change the trajectory of mortgage rates upward and could potentially slow BLDR’s business. Additionally, a risk to my thesis would be that the economy falls into a recession, but given that inflation is slowing rapidly and real GDP became stronger than expected in the fourth quarter, I don’t see a recession going forward. ‘horizon.
Overall, I view BLDR as a great long-term play as it takes advantage of the structural housing shortage in the United States. The company is well capitalized, a free cash flow machine, and continues to execute despite the underlying macroeconomic environment. It is also not “expensive” compared to its peers from a relative valuation perspective. For these reasons, I recommend the stock as a Strong Buy and see 22% upside potential for the stock over the next year, given my DCF model which is based on strong revenue, flow free cash flow and EBITDA growth.