Builders FirstSource Stock: Cautious Approach Due To Housing Challenges (NYSE:BLDR)

Synopsis

Builders FirstSource (NYSE:BLDR) is the largest supplier of building materials, prefabricated components, and value-added services in the US. In 2023, BLDR’s net sales declined due to a slowdown in single-family housing starts, and margins also contracted. In the most recent quarter, the company continued to experience softer-than-anticipated single-family and multifamily starts, along with housing affordability issues. The near-term outlook remains challenged by these affordability concerns. Despite the housing gap and acquisition opportunities driving its long-term growth potential, I believe we should take a cautious approach given the current and near-term challenges. Coupled with the lack of a margin of safety in its share price, I am recommending a hold rating for now.

Historical Financial Analysis

Over the past three years, BLDR’s net sales have been volatile. In 2022, net sales grew 14.2% to $22.7 billion from 2021’s $19.9 billion. This growth was driven by acquisition and core organic sales growth of 7.3% and 6.6%, respectively. In 2022, all product categories except lumber and lumber sheet goods increased year-over-year. The decline in lumber and lumber sheet goods was due to a decrease in housing starts in the second half of 2022.

In 2023, net sales fell 24.8% year-over-year to $17.1 billion from 2022’s $22.7 billion. The decrease in net sales was driven by a decline in core organic sales of 17.3% and commodity price deflation decrease of 11.1%. The decline was partially offset by a 3.6% sales growth from acquisitions. In 2023, all product categories fell year-over-year, and this was caused by a slowdown in single-family housing starts. The housing industry’s near-term demand was dampened by the uncertainty surrounding inflation and interest rates, as homes are becoming less affordable.

Moving on to margins, BLDR reported modest contraction in 2023 after an increase in 2022. In 2023, the company’s adjusted EBITDA fell 33.8% year-over-year to around $2.9 billion. This decline in adjusted EBITDA was mainly driven by the decline in 2023’s net sales. Its adjusted EBITDA margin contracted 2.3% to 17% due to the decrease in net sales and lower operating leverage. Its 2023 adjusted net income margin fell 2.5% to 11%, driven by the decrease in net sales. Lastly, its diluted adjusted EPS fell 22% year-over-year to $14.59 from $18.71.

Second Quarter 2024 Earnings Analysis

For 2Q24, net sales were down a modest 1.6% year-over-year to approximately $4.5 billion. The reason for the decline was due to the downward trend in multifamily offsetting growth from single-family, repair and remodel, and acquisition.

Onto core organic net sales, the company reported a 3.8% decline, mainly driven by softness in multifamily. Single-family was up 1.1% while repair and remodel increased 1.5%, but they were offset by a 31.3% decrease in multifamily. However, if adjusted for their weightage, single-family increased BLDR’s net sales by 0.7%, repair and remodel increased by 0.3%, and multifamily reduced it by 4.8%.

Overall for the quarter, BLDR continues to see and experience softer than anticipated single-family and multifamily starts as well as housing affordability issues. As a result, these factors affected their quarterly results.

Moving on to margins, both adjusted EBITDA margin and adjusted net income margin contracted but modestly. The company’s adjusted EBITDA margin decreased approximately 2% to 15%. This was caused by a decrease in adjusted EBITDA. For the quarter, adjusted EBITDA decreased 12.9%, attributed to lower gross profit. Gross profit margin for the quarter fell 2.4% to 32.8% due to normalisation, especially in multifamily. As a result, adjusted net income contracted to 9.4%. BLDR’s 2Q24 diluted adjusted EPS fell approximately 10% from $3.89 to $3.50.

Gain Market Share Through Acquisitions

BLDR is the largest supplier of building materials, prefabricated components, and value-added services in the US. The company operates within the pro segment of the US residential building products market. This market is fragmented, and competitions are mainly from national dealers, specialty suppliers, retailers, and smaller local businesses. Therefore, this fragmented nature provides the company with growth and acquisition opportunities.

Looking at the above total addressable market [TAM] chart, the TAM for single-family is approximately $110 billion. Currently, the company’s market share is only about 11%. Do note that the single-family end market forms the largest share of BLDR’s 2023 net sales at 69%. For the multi-family end market, the company’s penetration is only 2%, while repair & remodel is only 1%. Therefore, this implies that there are still substantial opportunities for BLDR to grow and expand.

In the first two quarters of 2024, the company has already completed five acquisitions, which are Quality Door, Hanson Truss, RPM, Schoeneman, and TRSMI. These acquisitions are expected to expand its market presence, market reach, manufacturing capabilities, and service offerings. Thus, further extending its competitive advantage.

As a result of these acquisitions, it also improved the company’s product mix. In 4Q21, value-added product mix accounts for approximately 45% of net sales. In 2Q24, value-added product mix increased 4% to 49%. Value-added products refer to products with higher margins, which include trusses, wall panels, and mill work.

Positive Long-Term Housing Outlook

Based on 2023 net sales, 69% of net sales are from single-family, 14% are from multifamily, and 17% are from repair & remodel/others. Therefore, the company’s performance is dependent on factors such as US residential new construction and remodelling.

According to realtor, the US housing gap has been widening. In 2023, approximately 1.7 million additional households were formed. As a result, the total number of new households between 2012 and 2023 is approximately 17.2 million. For house construction starts in 2023, there were approximately 947,200 single-family homes and 472,700 multifamily homes. Therefore, overall housing starts between 2012 and 2023 are approximately 14.7 million. Due to housing starts lagging household formation, this resulted in a cumulative gap of 2.5 million units between 2012 and 2023.

Therefore, this housing gap situation is expected to create long-term tailwinds as the under-building of houses and consistent growth in household formation combined with low home inventories is expected to create demand for more homes to be built.

Relative Valuation Model

BLDR manufactures and supplies building products in the US. In my relative valuation model, I will be comparing BLDR against its peers’ in terms of growth outlook and profitability margins trailing twelve months [TTM]. For growth outlook, I will compare their forward revenue growth rate, which is considered forward-looking. For profitability margins, I will compare their EBITDA margin TTM and net income margin TTM. These metrics will give us a better insight into their core business performance.

Starting with growth outlook, BLDR underperformed its peers as it has a forward revenue growth rate of -7.96% while its peers’ median is -1.92%. Overall, I do note that the industry outlook is soft. Moving on to profitability margins, BLDR underperformed in both EBITDA margin TTM and net income margin TTM. BLDR reported EBITDA margin TTM of 15.04%, which is lower than peers’ median of 19.88%. For net income margin TTM, BLDR reported 8.25%, while peers’ median is 11.59%.

Currently, BLDR’s non-GAAP forward P/E ratio is 14.61x, lower than peers’ median of 17.05x. Given that BLDR underperformed its peers’ in both growth outlook and profitability margins, I argue that it is fair for BLDR to have a lower P/E to reflect the underperformance.

For 2024, the market revenue estimate for BLDR is approximately $16.86 billion, while EPS is $11.53. For 2025, the market revenue estimate is $17.72 billion, while EPS is $12.39.

While analysing the company’s most recent quarter financial results, the company did provide guidance and outlook for full year 2024. Starting with net sales, it is forecasted to be between $16.4 billion and $17.2 billion. The gross profit margin is expected to be between 31.5% and 32.5%. For adjusted EBITDA and EBITDA margin, it is guided to be between $2.2 billion and $2.4 billion and 13.4% to 14.0%, respectively.

Considering the FY2024 guidance and my key growth drivers as discussed, the market’s estimates appear well-founded and aligned with the company’s projected performance. Therefore, by applying my 2025 target P/E for BLDR to its 2025 EPS estimate, my target share price is $181.02. My target price is also in line with the market’s average target price, thus ensuring that my valuation is conservative.

Risk and Conclusion

Before we conclude, I would like to highlight two risk factors associated with BLDR. First, the industry it operates in is highly dependent on new homes, multifamily construction, and repair and remodelling activities. These activities are influenced by factors such as interest rates, consumer confidence, and housing demand. Therefore, any negative shift, like increasing mortgage rates and inflation, can affect demand. In addition, BLDR has a significant fixed cost. Therefore, any decline in demand will have an immediate impact on its financial performance.

The second risk is in regard to the highly fragmented and competitive nature of the industry. Currently, the company faces strong competition from large national dealers and small local businesses. In addition, the industry’s low barriers to entry pose a threat from new entrants. Therefore, the company faces a lot of competition, such as competitors having better products or lower costs. Additionally, home centre retailers, which traditionally targeted retail consumers and small contractors, have started to target professional homebuilders, thus bringing in another set of competitions.

BLDR’s top line declined in 2023 because of a slowdown in single-family housing starts. Additionally, its margins also contracted. For 2Q24, it continues to experience softer-than-anticipated single-family and multifamily starts and housing affordability were an issue. Furthermore, the near-term outlook for the company remained challenged due to the affordability concerns.

Despite the housing gap and acquisition initiatives bolstering its longer-term growth outlook, I believe we should remain cautious given the current and near-term challenges BLDR is facing. Coupled with a lack of a margin of safety in its share price, I am recommending a hold rating.