Hayward (HAYW) Stock: To Dive In After Short-Term Headwinds Pass

Overview

Hayward (NYSE:HAYW) has 13% potential upside. The market for pool equipment is substantial, growing, and stable, with growth driven by the aftermarket installed base, rising demand for pools, improved products, and higher prices. HAYW has a strong brand positioning and a wide variety of products, making it a popular choice for pool owners as they upgrade their pools over time. That said, there are very visible near-term headwinds that will crystalize in FY23. Hence, I believe it is wiser to delay any investments until there are visible signs of recovery.

Business description

HAYW is a leading developer, producer, and vendor of swimming pool automation systems worldwide. Products in the range include pumps, heaters, cleaners, lights, flow control valves, and more.

Outdoor products are on demand

There has been a rise in the demand for outdoor living products over the past decade as more people regard their backyards as an extension of their living space and work to make it more aesthetically pleasing. Spending on outdoor living repair and remodeling has recently outperformed more conventional repair and remodeling, providing concrete evidence of this trend.

Baby boomers entering retirement and picky millennials, in my opinion, are major factors in this expansion. Baby boomers are updating their homes in anticipation of a long retirement at home. Millennials, more than any other generation, place a premium on outdoor beauty and functionality. Research mentioned in the prospectus indicates that seventy percent of American homes have outdoor spaces that get used on a weekly basis. This pattern has been bolstered by homeowners’ responses to the COVID-19 pandemic.

One of the most costly additions to a backyard is a swimming pool, which serves as the centerpiece of the outdoor living space. Buyers are increasingly interested in properties with pools because of the social benefits associated with having one. In addition to making this backyard staple easier to care for and more fun to use, new pool items have made it easier to entertain guests and relax in.

Generally speaking, I think the market for pool equipment is substantial, growing, and quite stable. In the long run, the growth prospects for this market look good. Growth in the aftermarket installed base, rising demand for pools, improved products, and higher prices have all contributed to this market expansion.

Premium brand positioning

When it comes to pool builders, designers, and homeowners around the world, HAYW is unrivaled. Over a few thousand unique stock-keeping units are available from this provider. In my perspective, being able to provide a wide variety of products is a major asset in the marketplace. Whether it’s an above-ground or in-ground pool, HAYW has you covered with their full line of linked goods. There’s little doubt that HAYW’s extensive product catalog and ability to satisfy any kind of demand will make it a go-to for pool owners as they upgrade their pools over time. To put it another way, HAYW triumphs because it removes the reason (like having the product that as consumer seeks) that would cause a buyer to choose an alternative brand.

Large installed base that drives recurring revenue

Products sold by HAYW are typically reoccurring because of the necessity of repairing and replacing pool equipment in order for the pool to continue working. I believe that HAYW’s market dominance and the enormous number of above-ground pools already in use will generate substantial demand from the aftermarket (repairs, remodel, etc.).

Since the average lifespan of a pool is between 9 and 12 years, HAYW has several opportunities to replace its products throughout its lifetime, hence the “recurring” character of its business. In my opinion, pool owners will be less concerned with the equipment cost as a percentage of the total cost of the pool because of the functions that equipment provides. As a consumer, it only makes sense for me to purchase an identical replacement product from the same manufacturer to guarantee continuity of use. It follows that, when it comes time to replace, I think most pool owners would rather have a comparable Hayward product installed or, at the very least, an upgrade to something more recent. Moreover, the replacement cycle generates a lasting connection that last for a long time after installation as homeowners continually upgrade their pools.

Strong manufacturing capabilities

Over 20 countries are serviced by HAYW’s global network of factories, distribution hubs, and small-scale assembly facilities. I believe that HAYW’s vertically integrated manufacturing and distribution operations are what enable it to operate a cost-efficient production model with strong profits and excellent quality control. HAYW is able to grow and take advantage of operational leverage within its current footprint because of its enormous manufacturing and distribution capability.

HAYW’s robust supply chain is made possible by the company’s extensive production capabilities, allowing it to respond quickly and effectively to both demand spikes and unforeseen delays in shipping (COVID has clearly taught us the importance of having a strong in-house logistical network). On top of that, HAYW’s current production capacity is more than enough to sustain its projected growth over the next decade. This also suggests that HAYW will not be making any major CAPEX investments in production facilities in the near future, which bodes well for the company’s FCF. HAYW facilities are highly automated, so extending the work week and increasing output velocity require only modest increases in capacity.

Efficient go-to-market strategy

HAYW promotes itself through the wholesale, retail, and online markets. Typically, these businesses cater to other businesses by acting as distributors, contractors, buying groups, specialized online resellers, and service providers. These wholesalers and retailers offer HAYW products to individual pool owners and thereby contribute to the company’s overall revenue. Due to HAYW’s commanding market share, its trade customers are experts on the brand’s products and can advise homeowners on how best to utilize them. Given the time and effort required to become familiar with a new brand’s products and selling strategies, this is a significant competitive advantage among wholesale customers. This is evidenced by the company’s 20-year-plus standing with the top 20 wholesalers.

On a strategic level, HAYW uses a “push-pull” tactic. Marketers at HAYW “push” distributors to carry and promote the company’s wares, while those at retailers, service providers, and pool owners generate demand through their own marketing efforts. This synergy of factors makes it harder for new entrants to break into the market.

HAYW generates “pull” demand not only because of the high quality and novel aspects of its products, but also because of its customer loyalty programs. According to the S-1, pool owners are generally pleased with Hayward products and prefer to stick with the brand when shopping for replacement or upgraded equipment. HAYW’s strategic approach to product replacement allows retailers and service technicians to offer the same or similar Hayward brand to pool owners when replacing components from other manufacturers. As a result of this shift in consumer behavior, HAYW wholesalers are more likely to keep a steady supply of HAYW items in stock.

3Q22 results were not great with guidance lowered

3Q22 results were somewhat better than forecast for HAYW, with volumes falling dramatically as expected owing to continued channel de-stocking actions. HAYW has lowered its revenue and adjusted EBITDA forecasts for FY2022, as the pace of channel inventory correction seems to be faster than anticipated through the second half of the year. HAYW’s margins are under pressure from cost inflation and reduced operational leverage, and commentary has warned that demand in Europe could worsen.

I am keeping a careful eye on the continuing channel inventory adjustment. HAYW has announced that it is taking action to decrease costs and lower its own excessive inventory levels as a result of the ongoing channel inventory correction and declining demand. In particular, HAYW is working to reduce SG&A costs by 10% by 2023. This includes both production and administrative expenses. According to HAYW, the company’s inventory level has reached a maximum, and the following pool season will be dedicated to depleting that level.

Forecast

The underlying secular trends for HAYW are positive. However, I believe FY22 is going to be a down year due to management commentary and channel de-stocking activities. I also expect HAYW to see negative growth in FY23 in line with consensus.

HAYW is currently trading at 10 times forward EBITDA. I believe the market is already pricing the weak outlook in FY22 and FY33, hence valuation should sustain at this level until new catalyst appears. With these assumptions, I believe HAYW is worth around $10.61, or 13% more.

Key risks

Brand reputation could be hurt by trade customers

When it comes to selling its products to pool owners, HAYW relies on its distribution channels. The fact that HAYW has established a solid reputation with these retailers over time is no assurance that they would restrict themselves to selling exclusively HAYW goods. HAYW’s growth initiatives are hindered to some extent by the work of resellers.

Recession

In a period of economic downturn, consumers may be less inclined to spend money on luxuries like swimming pool equipment.

Seasonality

Sales and cash flow are typically more cyclical due to the seasonal nature of swimming pools, which see high usage, installation, and maintenance activity during the warmer summer months.

Conclusion

The pool equipment industry is sizable, expanding, and stable, with growth driven by the aftermarket installed base, increasing demand for pools, enhanced goods, and higher costs. HAYW has a solid reputation as a brand and a large selection of goods, making it a favorite among pool owners who often replace their equipment. However, a number of obvious short-term challenges will become more pronounced in FY23. Therefore, unless there are clear indicators of a turnaround, I think it’s best to hold off on making any investments.