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Beacon Roofing Supply(NASDAQ: BECN)
gave results recently and served notice that its near term upside
drivers from a housing market recovery are in place for 2013. Meanwhile,
its long term objective of consolidating the roofing supply industry in
the US continues apace. In summary, I like the company and the stock,
but it doesn't look cheap. If you are aggressively seeking exposure to
US housing then the stock is compelling. However, if you are like me and
don’t like buying stocks without a margin of safety then you might want
to try to get a better entry point.
Beacon Roofing’s Exposure to New House Building?
Firstly I want to clarify a key point. Traditionally BECN’s exposure
to new housing is only 20%, but in recent years (with the slowdown in
construction) that has fallen to around 10-15%. So why is BECN a play on
new housing construction?
The answer to this is twofold. First the marginal contribution from
an increase in new build will have its affect on the bottom line.
Second, if new build comes back then the demand pull is likely to drag
up pricing for the whole roofing industry.
Lumpiness in Revenues
With that said, this isn’t a linear process. BECN’s top line is
always subject to a certain amount of lumpiness thanks to weather
uncertainty. Indeed, last year was a classic example with a lot of
activity in the sector being pulled forwards at the start of the year
thanks to seasonally clement weather.
Both Home Depot(NYSE: HD) and Lowes Companies(NYSE: LOW)
reported the pull forward effect in their results, and some investors
were disappointed when their mid year results didn’t match expectations,
which were artificially high thanks to this effect. No matter, things
got better from the autumn onwards as the underlying strength in housing
started to kick in. It is particularly noticeable that Home Depot is
talking about strength in categories that are more discretionary in
nature. In addition, Lowes is achieving a lot of success in its program
to restructure and simplify its product lines. I don’t believe in
coincidences and I suspect Lowes is able to do this because it now has
favorable end markets.
All About Pricing
In common with the home goods stores BECN is seeing signs of strength
in some of the more discretionary elements of sales. For example
Complimentary Building Products pricing was up 3-4% in the quarter and
this helped sales in existing markets to be up 2.9% in this segment.
It’s a good early indicator of some cyclical strength.
However, Complimentary only makes up 14.6% of sales at present with
Residential Roofing providing 47.2% and Commercial Roofing at 38.2%.
Commercial Roofing saw pricing flat and I think it’s fair to argue that
its growth tends to lag residential growth. The main driver to upside in
2013 will be from the residential market. As such, it was easy to be
disappointed by the 3% decline in Residential pricing in the quarter.
Throw in the 5.4% fall in existing market sales and disappointment might
start turning into despondency.
If so, it would be a mistake! Pricing and sales may be down on a
yearly basis but they are up against some very tough comparisons
(remember the pull forward effect and the re-roofing activity created by
Katrina?) last year. BECN’s management argued that sequential pricing
was up sequentially, and by my reckoning that is three quarters in a
row. Another good sign.
Where Next for Beacon Roofing Supply?
Analyst estimates are for $1.81 in earnings, and management declared
that they were comfortable with these numbers. The game changer will be
if BECN manages to get the planned price rises in Residential to stick.
Indeed, the company spent significant sums on inventory in order to take
advantage before industry prices rise. BECN reported that January was a
good month with its order backlog growing, and there is a real sense
that any weakness in the winter was temporary.
With a current stock price of $37, the forward PE is over 20.4, which
looks a bit pricey to me. It isn’t ‘pricey’ if you start baking in some
increased pricing in Residential Roofing pricing. I’m willing to do
this but not without some margin of safety. Another one for the monitor
list.
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