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UFP Industries, Inc. (UFPI) “Universal Forest Products” is a commercial distributor of lumber and treated wood products. The company’s main business includes retail, industrial, and construction markets each with leading specialized brands. While there were some concerns during the early stages of the pandemic regarding the operating outlook, surprising strength in the retail segment with consumers pursuing home improvement projects supported better than expected Q2 earnings. We see UFPI continuing to benefit from strong trends in the U.S. housing market driving operational and financial momentum for the remainder of the year. Beyond uncertainties regarding the strength of the economic recovery, we like UFPI given its overall strong fundamentals and see value in shares at the current level.
UFPI Financials Recap
UFPI last reported its Q2 earnings on July 22nd with GAAP EPS of $1.08 which beat expectations by $0.48. Revenue of $1.24B billion was flat on a year over year basis but ahead of market estimates. The story here was exceptional trends in its retail segment where revenues climbed 22% y/y. The result helped balance a 27% y/y decline in its industrial business and 16% construction market which were more impacted by the COVID-19 pandemic.
(Source: Company IR)
It’s worth noting that UFPI counts on home-improvement retailers like Home Depot (HD) as major customers and these businesses were deemed essential during the pandemic allowing them to remain open. This is in contrast to the construction and industrial segment where customers shut down temporarily amid stay at home orders. Management highlights that the operating environment improved sequentially over the quarter through June setting up a stronger Q3 outlook.
(Source: Company IR)
In terms of financials, a higher gross margin at 16.5% compared to 15.1% in the period last year drove a higher operating income. While the company sources lumber and wood from mills as a major cost component, management explains that it’s variable pricing to customers allows it to pass on some of that impact. Indeed, a development in the lumber industry this year was significant supply chain disruptions as supplier mill facilities were forced to temporarily suspend operations resulting in tighter industry supplies. Lumber prices are up significantly since the start of the year but UFPI has been able to benefit from the pricing mix.
Company-wide cost-savings efforts helped EBITDA increase 21.6% year over year continuing a trend of firming profitability in recent years. Year to date, EPS is up 18.5% compared to the first six months of 2019 highlighting the earnings momentum.
A Strong Balance Sheet Position with No Net Debt
The other important point here is that the company maintains a strong balance sheet position with a net cash position. UFPI ended the quarter with $201 million in cash against $163 million in gross debt. Considering an additional $361 million available under a revolving credit facility, management believes liquidity is more than sufficient to navigate the current environment and potentially take advantage of investment opportunities.
(Source: Company IR)
The company pays a small quarterly dividend that yields 1.1% representing a $27 million distribution and an approximately 15% payout ratio. Separately, UFPI has continued with its share repurchasing program, buying back $29 million over a year to date. Overall, we believe the dividend is well supported and the policies are shareholder-friendly.
Management Guidance and Consensus Estimates
While UFPI does not issue formal earnings guidance, management is optimistic that the current momentum can continue. During the earnings conference call, it was questioned by an analyst up if these trends represent a fundamental improvement or simply a “pull-forward” of demand in the DIY home improvement market, presumably with consumers taking advantage of the stimulus checks. CEO Matt Missad explained that the company sees strong demand at least through the next few months.
I think as we look at it, I would say that from a high level view the demand profile is still very strong and you can kind of look at lumber market and see that the demand for that product continues to remain strong, so that’s a good indicator from our standpoint, I think there’s a lot of people who have projects that have not been able to get the materials, they need. So, we expect that demand to continue. As I mentioned before, at least the next 30 days to 60 days and could very well continue beyond that. But it seems to be strong at this point.
Keep in mind that the last comments from management from the Q2 earnings release was back in July. In the period since a case can be made that the outlook as it relates to consumer spending and construction improved considering strong housing market data during the summer. Recent data like the Case-Shiller home price index up 4.8% year over year for July along with existing home sales up 10.5% year over year for August highlight the ongoing dynamic.
The setup here suggests some upside to Q3 earnings estimates in our opinion. UFPI is scheduled to release its Q3 earnings on October 21st. According to current consensus estimates, the company is expected to deliver EPS of $0.89, which if confirmed, would represent an increase of 6% compared to the period last year. Similarly, the market is forecasting revenue growth of 9% which would be the strongest for the company since Q3 2018.
(Source: Seeking Alpha)
For the full-year 2020 UFPI is on track to reach EPS of $3.22 representing an 11% increase compared to 2019. Firming earnings are seeing continuing through 2021 with a market EPS forecast of $3.62 next year. On the other hand, single-digit revenue growth reflects the uneven results across the stronger retail segment and weaker industrial markets.
(Source: Seeking Alpha)
Analysis and Forward-Looking Commentary
We believe UFPI is well-positioned to benefit from the strong housing market and trends in consumer spending through its related retail segment products like preserved lumber, composite decking, and railings materials, premium house siding, accent pieces, along with landscaping solutions. By next year, the possibility that the industrial and construction market segments stabilize would further improve the outlook. Fundamentally, beyond what could be temporary factors, the underlying earnings profile and solid fundamentals support a bullish view.
(Source: Company IR)
Taking a look at valuations, the stock currently trading at a P/E of 17x based on current 2020 consensus EPS. Across several metrics, it appears current multiples are within a few percentage points of the 5-year average for the company. By this measure, UFPI is near fair value.
(Source: data by YCharts/ table BOOX Research)
On the other hand, the ratio that stands out is the price to free cash flow of at just 9.7x over the trailing twelve months. In the context of what is expected to be double-digit earnings growth through 2021 and an improving outlook, we believe the valuation is attractive and should even be at a premium compared to the average. Accelerating earnings should support even high free cash flow and potentially provide room for a dividend increase or expanded share repurchase program.
We rate shares of UFPI as a buy and have a price target on shares at $66.00 per share for the next year. Our price target implies approximately 18% upside from the current level and a 17.5x multiple on the current 2021 consensus EPS.
The main risks to watch for would be a deterioration of the broader macro outlook driving a significant slowdown to economic growth and the housing market. Monitoring points going forward include the evolution of financial margins the performance of UFPI’s industrial and construction which should begin to at least stabilize. Weaker than expected result may require revisions lower to earnings estimates pressure the stock through weaker sentiment.
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Disclosure: I am/we are long UFPI. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.