adminIn March, I believed that shares of TopBuild (NYSE:BLD), a premium insulation play, had warmed up. I see TopBuild as a strong operator, which benefits from secular tailwinds in the housing market, driving increased demand for insulation and adjacent products.
The company has been combining organic growth with bolt-on acquisitions, driving impressive sales and margin pressure. Unfortunately, price expectations have increased quite a bit, too much to get back involved here.
TopBuild – A Big Performer
Originally part of Masco Corporation (MAS), TopBuild was spun-out of the company back in 2015, at the time just a $1.7 billion buyer, installer and distributor of insulation products. A $20 stock was set to enjoy a huge boom, amidst increasing environmental concerns, as well as higher utility bills driving the need and economic sense to install better insulation.
Fast forwarding seven years in time, the company had essentially tripled sales to $5 billion in 2022, while growing EBITDA margins to the high-teens, close to a billion in dollar terms. That was all about to change, as higher interest rates caused a downer on the 2023 outlook with the company originally seeing sales down towards $4.8 billion, with EBITDA seen around $865 million. This could weigh on the earnings power of the business to the tune of $2-3 per share.
Nonetheless, earnings close to $20 per share could be expected in 2023, which looks quite interesting with shares trading in a $150-$200 range early in 2023.
The combination of organic growth and continued bolt-on deals has created a huge business, now surpassing 400 branches and 13,000 workers. The vast majority of sales are generated from insulation, geared towards residential markets. That said, the company offers other adjacent products such as gutters and accessories, while catering to commercial and industrial markets as well.
Picking Up The Performance
Through 2023, the impact of higher interest rates on the housing market was less than initially feared. In the end, 2023 sales actually rose by 4% to $5.19 billion, although aided by continued bolt-on dealmaking. EBITDA came in at $1.05 billion as net earnings were reported at $19.33 per share, in line with initial estimates for the year.
Amidst relatively fewer deals made during 2023, I found the 2024 outlook comforting, with the company seeing sales up modesty to $5.46 billion with EBITDA seen advancing to $1.085 billion. The issue was that shares went on a huge run, having risen from $230 per share in October of last year to the low $400s in March.
With earnings power seen around $20 per share, multiples expanded to 20 times earnings amidst modest leverage, but the screaming appeal was gone.
While I liked the performance of the business and its prospects, I was fearful about a potential pullback in margins as well, with margins coming in far above the long-term averages, and quite high percentages in absolute terms.
Trading Stagnant
Since March, shares of TopBuild have traded in a $380-$440 trading range, although that shares rose in a spectacular fashion to $440 in recent trading, aided by the recent inflation report indicating that a rate cut might be around the corner.
In April, the company terminated the deal to acquire Specialty Products and Insulation, a substantial deal announced in the summer of 2023. The deal did not close due to concerns in obtaining regulatory approval, making that TopBuild needed to pay a $23 million termination fee.
This deal did not withhold TopBuild from continuing its role as consolidator. In May, the company acquired Insulation Works, an Arkansas-based insulation business which generates about $28 million in annual sales, adding about half a percent to overall sales.
In the same month, TopBuild posted first quarter results which were relatively modest. First quarter sales rose by a modest 1.1% to $1.28 billion, although the company demonstrated on strong operating leverage, with adjusted earnings up more than 10% to $4.81 per share.
Net debt ticked down to $439 million, resulting in very modest leverage of around 0.4 times. Despite reporting on modest growth, the company upped the midpoint of the full-year guidance by a hundred million to $5.5 billion, with EBITDA now seen at a midpoint of $1.11 billion.
In June, the company announced its next deal, as it acquired Texas Insulation, a Texas-based insulation business which generates about $39 million in revenues, adding nearly a percent to overall sales.
What Now?
With the business posting steady growth, earnings should surpass the $20 per share mark this year while the balance sheet remains incredibly strong. The challenge of the business is to find enough and sufficiently scaled acquisition targets here, in its quest to play the role of consolidator in a near $20 billion addressable market.
The company keeps doing this, but amidst low leverage, there is still room for continued buybacks. The problem at this point in time, if you will, is that shares rose from $390 to $440 in the time span of just two days, as a lower inflation report ignites dreams for a quicker recovery in construction markets and housing markets. This seems some kind of overreaction in response to anticipated interest rate declines.
All in all, I see no reason why earnings might not improve further to a run rate in the mid-twenties in terms of earnings per share in a year or two, but trading near all-time highs, I am performing some restraint here. Right now, operating margins come in the high teens, compared to margins of just high single digits pre-pandemic.
This makes that balancing act is to be performed. If the company can continue to grow sales and sustain margins, shares likely are appealing for those with a long-term horizon.
On the other hand, we might as well see modest growth from here, but accompanied by some margins pressure, as such a scenario is within the realm of possibilities. Given that lots has to continue to go right to drive long-term appeal here, after shares have seen a decent run over the past year, I am leaning cautious, approaching shares with a neutral stance.
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