Friday, January 20, 2017

An AIM Equity Holding: Beacon Roofing Supply (BECN) by Sarah Hillegass. “Heathy growth ahead? We think so"

Beacon Roofing Supply, Inc. (BECN, $44.00): “Who you gonna call? Beacon Roofing!”
By: Sarah Hillegass, AIM Student at Marquette University



 Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Summary
·         Beacon Roofing Supply, Inc. (NASDAQ: BECN), headquartered in Herndon, VA, is the second largest distributor of residential and non-residential roofing materials in the United States. Beacon reports sales via three segments: residential roofing products (53% sales), non-residential roofing products (32%), and complementary products (15%).
·         The residential roofing industry derives nearly 80% of its demand from re-roofing, which is primarily non-discretionary. Leak damage, storm damage, and old age are the main causes of such demand. Thus, the storms in Texas last summer will continue to cause spillover demand in roofing until April, 2017.
·         BECN operates through a branch based operating model. This allows BECN to use its scale as a national distributor while providing local, customer service. The acquisition of Roofing Supply Group (RSG) in October, 2015 added 85 U.S. branches to make FY16 total to 368 branches.
·         BECN has struggled to breach the $50 mark throughout the last year. Therefore, our original price target of $49 is still within reach and attainable.
·         Due to BECN’s trajectory for continued growth, supported by a historical 12-year sales CAGR of 16.6%, I would recommend a HOLD until the next roofing season.

Key Points: BECN’s fiscal year 2016 ended September 30, 2016 with record results. BECN ended the year operating 368 branches in 46 U.S. states and 6 Canadian provinces, solidifying its position as the 2nd largest distributor of residential and non-residential roofing materials in the US. Their catalog includes 46,000 products with SKU’s to serve roughly 67,000 customers. 4Q16 net sales were 49.1% above the previous year. BECN reached just over $4B in annual sales for the first time and improved gross margins by 140 bps to 25.7%. BECN’s growth was led by 2.4% existing residential market growth, primarily in the Southwest, successful execution of its RSG acquisition integration, as well as strengthening of its balance sheet through incremental paydowns to affect its debt leverage ratio.

BECN wins the re-roof business for the residential and non-residential segments by differentiating itself to bring more value-added services apart from just providing roofing materials, such as installation, design, and layout services. In 4Q16, the residential roofing segment was the standout performer. This segment is projected to have 2017 organic growth of nearly 2-5%. Organic growth includes all owned branches held for four quarters or more. The organic growth is projected to come from continued storm repair from last summer, future weather related fixtures, and existing home sales. The residential roofing segment has a total addressable market of nearly $15 billion with the four largest distributors having 50% of the market share. 

With further consolidation in the industry through acquisitions, BECN should see stable growth in this segment. Additionally, the non-residential market has long term growth rates of 2-3%, which will be won by providing additional services and cross-selling of products. Per the National Association of Home Builders, approximately 94% of re-roofing demand is non-discretionary, which means when roofs need re-roofing, the wait time is minimal and the price is inelastic. The complementary products segment will be a growth driver in adding more value to roofing projects with siding, insulation, and window installation.

BECN’s Roofing Supply Group acquisition will also contribute to this growth in cross-selling of products, as well as geographic diversification of branches. FY16 saw exceeded cost synergies expectations from the acquisition with an additional $55 million of cost synergies expected for 2017. The cost savings have been the primary contributor to improved margin performance. For example, purchasing synergies led to a 3% product cost decline. Additionally, the acquisition expanded BECN’s geographic capabilities with 85 locations, primarily in key Western and Southern markets, which have the highest growth potential. Furthermore, the expansion into these key markets will allow seasonality to become less harsh as both regions have milder 2Q’s.

Lastly, BECN has benefitted from and will continue to benefit from its initiative to strengthen its balance sheet. BECN’s 2018 goal is to have a debt to leverage ratio of 2x. They have decreased the ratio from 4.3x in October, 2015 because of the RSG acquisition, to 3.3x currently. Further cash generation will be used to decrease this further. Any potential tax reform will most likely benefit BECN’s tax rate as it is currently one of the highest taxpayers at nearly 40%. BECN indicated that any excess cash they could use from lower taxes would be driven right back into the business for future growth, rather than a one-time dividend or stock buyback.

What has the stock done lately?
BECN has volleyed between $40-$50 throughout the last three months, finding resistance near $50. Since the release of FY16 results, BECN has announced three new acquisitions to add to its branch portfolio. In December, BECN announced the acquisition of BJ Supply of Bristol, PA to add complementary branches to the Philadelphia and New Jersey markets. In January, BECN announced one acquisition related to seven branches in the Seattle market and one acquisition, which is an insulation distributor, to add-on to its complementary products segment. Neither of these three most recent acquisitions has made the stock pop however. What may be guiding the stock through these winter months is the seasonal climate. Harsh winter weather crowds the competitive landscape, while mild winter weather will provide for easy year-over-year comps.

Past Year Performance: BECN has substantially outperformed the Russell 2000 index over the last two years. The primary growth driver has been through continued stable market demand and consolidation within the industry. The more accretive acquisitions BECN can undergo, the better its sales and performance will be. The market is highly fragmented with nearly 1,500 players to act as potential acquisitions and room for future growth. Additionally, the continued synergies in cost through the RSG acquisition have been and will continue to be beneficial for margin expansion.



My Takeaway
BECN has a proven track record of successful, accretive acquisitions. In this industry, stable market growth in re-roofing demand and industry consolidation will be key to future growth. The RSG acquisition is a great example of an acquisition executed properly to yield significant cost savings and in turn enhanced margin performance. With the January announcement of the retirement of the longest serving director on BECN’s Board of Directors, Peter Gotsch, there is a slight risk that future growth and expansion opportunities will have different management advice. However, due to BECN’s expertise in acquisitive growth, complemented by organic growth and the development of greenfields, BECN seems poised to continue its healthy growth charge. Therefore, I recommend holding BECN until the next roofing season when future demand can be foretasted.




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