Here’s Why You Should Invest in Beacon Roofing Supply (BECN)

·6 min read

Fiduciary Management, an investment management firm, published its “Small Cap Equity Fund” third quarter 2021 investor letter – a copy of which can be downloaded here. The FMI Small Cap portfolios gained approximately 0.6% in the September quarter compared to declines of 4.36% for the Russell 2000 Index and 2.98% for the Russell 2000 Value Index. You can take a look at the fund’s top 5 holdings to have an idea about their best picks for 2021.

Fiduciary Management, in its Q3 2021 investor letter, mentioned Beacon Roofing Supply, Inc. (NASDAQ: BECN) and discussed its stance on the firm. Beacon Roofing Supply, Inc. is a Herndon, Virginia-based commercial and residential roofing products distributor with a $3.7 billion market capitalization. BECN delivered a 32.87% return since the beginning of the year, while its 12-month returns are up by 51.49%. The stock closed at $53.40 per share on October 18, 2021.

Here is what Fiduciary Management has to say about Beacon Roofing Supply, Inc. in its Q3 2021 investor letter:

"Beacon is the largest publicly traded (#2 overall) distributor of roofing materials and complementary building products in the U.S. and Canada. Beacon serves greater than 90,000 customers and offers 140,000 SKUs from over 400 branches throughout all 50 states (97% of sales) and 6 Canadian provinces (3% of sales). Beacon makes 1.7 million annual deliveries (within a two-hour radius) using its fleet of specialized trucks. Since the sale of the non-core Interiors division (2021), their run-rate sales have been 53% Residential Roofing; 25% Commercial Roofing; and 22% Complementary Building Products (siding, windows, specialty exterior building products, insulation, and waterproofing systems).

Good Business

• Manufacturers and distributors operate in a rational and consolidated market, with the top three distributors accounting for 54% of a $28 billion industry (almost two times what they had ten years ago). • The industry is led by ABC Supply Co. Inc. (24% share), Beacon Roofing (20% share), and SRS (10% share), with the remaining 46% held by 1,500 smaller distributors. • It is estimated that roughly 80% of roofing sales are replacement, and that the U.S. housing stock is now over 40 years old on average. Ninety-four percent of U.S. re-roofing demand is thought to be non-discretionary. • With management’s focus on organic growth and maintaining discipline, rising returns should follow. • Aided by the Interiors divestiture, the fiscal third quarter 2021 net debt-to-EBITDA ratio dropped to 2.4 times, providing financial flexibility and likely the ability to buy back stock and issue dividends. • Beacon is a simple scale business, and roofing distribution is unlikely to undergo major change.

Valuation

• Despite newfound financial health and flexibility, and strong fundamentals, Beacon’s shares have receded from $60 in May to $50 in August (-17%), and the stock trades at a discount to its 10-year average for the next twelve months P/E (11 times), enterprise value-to-EBITDA (9 times), and enterprise value-to-sales (0.85 times). With steady execution, we think there is scope for Beacon to trade at a premium to 10-year averages and north of 1 times EV/Sales. • If Beacon were to grow 4.5% and reach the low end of their EBITDA margin target by fiscal year 2026 (9%-11%) and were ascribed a 15 P/E ratio, the compound return would be approximately 15%.

Management

• New CEO Julian Francis has refocused the company on its core Roofing/Exteriors business (divesting Interiors and substantially de-risking the balance sheet), and inward on branch productivity, margin improvement, organic growth, and realizing the benefits of scale. • Frank Lonegro, CFO, recently joined Beacon from CSX Corporation, where he was the CFO and Executive VP.

Investment Thesis

Beacon is a simple business driven by largely non-cyclical, non-discretionary demand. While Beacon has achieved scale in an industry that has consolidated substantially over the last decade, under prior management they were saddled with (1) a challenging and costly integration (2) substantial debt and interest costs, and (3) a separate Interiors business. Under their new CEO they sold Interiors, and are progressing on strategic initiatives. Strong industry fundamentals have led to rapid restoration of financial flexibility and Beacon’s future now looks solid. While expecting a sequential slowdown in growth (in part due to lower y/y storm activity) and a decline in margin, we think enhanced focus on organic growth and structural margin improvement should help reaccelerate future earnings, particularly as replacement demand will likely benefit from the strong build period from 2000-2006."

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Based on our calculations, Beacon Roofing Supply, Inc. (NASDAQ: BECN) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. BECN was in 20 hedge fund portfolios at the end of the first half of 2021, compared to 21 funds in the previous quarter. Beacon Roofing Supply, Inc. (NASDAQ: BECN) delivered a -2.08% return in the past 3 months.

Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.

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Disclosure: None. This article is originally published at Insider Monkey.

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