Builders FirstSource: Under Construction (NYSE:BLDR)

It was 2015 when Builders FirstSource (NYSE:BLDR) announced a huge deal to acquire Probuild, which was a strange acquisition as it involved the purchase of a business which was three times as large as its own business.

With a lower acquisition multiple and synergies being anticipated, the promise of the acquisition was huge, yet the size of the deal made that leverage risks would be very large as well.

A Quick Recap

Shares of Builders FirstSource rose from $7 to $14 in 2015 as the company announced the $1.6 billion purchase of another homebuilding materials company, Probuild. The deal meant that the business would grow sales from $1.6 billion to $6.1 billion, marking a truly transformative deal.

Ahead of the deal the company had 100 million shares outstanding, trading at $7 per share, or $700 million, as the enterprise valuation rose to $900 million after factoring in net debt of $200 million. A $1.6 billion deal (or $1.8 billion if we add back the valuation of tax credits) made that Probuild was valued at just 0.4 times sales, partially as EBITDA of $190 million implied lower margins as well.

Factoring in the contribution of both businesses and an anticipated $100+ million in synergies through year two, and we would have a combination with $6.1 billion in sales and $367 million in EBITDA. The 100 million shares rose to $14 per share, or $1.4 billion as net debt would increase to $2.0 billion, a huge amount given the pro forma EBITDA contribution, certainly as a great deal of the pro forma EBITDA performance was based on realization of costs synergies.

Based on all of this and a cyclical element of the business, the risks would clearly be very high, certainly if the housing market would not recover, as the question was what earnings power could look like, as the excess leverage meant that shares could either see huge upside or downside down the road.

Stagnation, Then Unleashed

Since announcing the deal in 2014, shares have been trading range bound between $10 and $20 per share all the way up to early 2020. After an initial setback at the outset of the pandemic, shares rallied to a high of around $85 per share late in 2021, as shares have been trading stagnant thereafter, now exchanging hands at $65 per share. This follows the observation that the housing market has cooled down significantly amidst higher interest rates hurting the housing and construction market, and subsequently the materials business as well.

In the summer of 2020, Builders FirstSource announced a merger with BMC Stock Holdings, an all-stock deal in order to gain a further foothold, as that deal was incredibly well-timed. In March of this year, Builders posted its 2021 results as a 132% increase in sales to $19.9 billion was not just the result of a very strong housing market, yet growth was largely based on the merger with BMC.

The deal and very strong 2021 created a profit explosion as EBITDA more than four-folded to $3.0 billion amidst a spectacular increase in sales and the fact that EBITDA margins essentially doubled to 15% of sales. With the company announcing adjusted earnings of $2.1 billion in 2021, earnings came in close to $10 per share. Net debt of $2.9 billion is substantial, but given the EBITDA being generated, results in a very modest leverage ratio around 1 times.

The company was targeting more growth in 2022 as the company closed on the acquisition of National Lumber at the start of this year, a deal set to add $440 million in sales, or about 2% to pro forma revenues.

This spring the company posted first quarter sales of $5.7 billion, driven by a 15% organic growth rate as strong cash flow generating made that the company was aggressively pursuing bolt-on acquisitions, pushing up earnings per share even more, with first quarter adjusted earnings reported at $3.90 per share.

In August, second quarter sales rose to $6.9 billion, as organic growth slowed down to 12%, with adjusted earnings coming in as high at $6.26 per share. In September, the company announced its next bolt-on deal with the acquisition of prefabricated roof and floor trusses Trussway, a deal set to add $340 million in sales, little over a percent of sales at this point in time.

Early in November, third quarter sales rose just 5% to $5.8 billion, amidst commodity deflation, as the company actually announced quite a few more bolt-on deals during the quarter. For the first three quarters of the year the company grew sales to $18.4 billion, as EBITDA grew further to $3.7 billion, for margins around 20%. Earnings per share through the first three quarters have risen to more than $15 per share, marking huge earnings power.

Aggressive buybacks have reduced the float to 156 million shares, for a $10 billion equity valuation at $65 per share, as net debt comes in at $3.2 billion here, far less than 1 times EBITDA, albeit that this EBITDA performance likely cannot be maintained going forward.

Concluding Remark

The truth is that the 2014 deal for Probuild has unleashed a great acquisition machine, because that is how we can describe Builders FirstSource here. With earnings power trending at nearly $20 per share, the current multiples are very modest at 3-4 times earnings, and while weakness is not yet seen in the actual results, it is seen in the guidance for the fourth quarter.

Of course the big risk is that the company might see sales fall significantly. I believe we could see a 30-50% fall in sales amidst lower activity levels and price deflation. On top of that, margins could take a huge beating as well in such a scenario.

That could make that earnings power of $20 per share might come in closer to $5 per share down the road, as that increase the current low 3-4 times earnings multiple to much higher multiples as leverage will increase quite a bit as well. That might be a bit too short-sighted as well, as the company has been making many bolt-on acquisitions which diversify and grow the business, creating a bit more diversification as well.

If we zoom into the fourth quarter outlook, the company guides for sales around $4.4 billion and sees $600 million in EBITDA. This compares to a $4.6 billion revenue number in the final quarter of 2021 on which $793 million in EBITDA was reported. This already suggests a 25% fall in profitability, despite the impact of some tuck-on acquisition this year, revealing that earnings might be down 30% already, although we of course see a tough time already in the building industry.

Wishing management is a bit more conservative with leverage in such a situation, I am appealed to the name and the situation, as shares have held up quite well amidst continued share buybacks. This makes that I am happy to keep a close eye on the situation, but I am not yet pulling the buy trigger.