Patrick Industries: An Acquisitions Masterclass For Long-Term Growth

seekingalpha05-04

Patrick Industries is a leading provider of components to recreational vehicles, marine, manufactured housing and various industrial markets.The company has achieved outstanding growth in the past 10 ...

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And I certainly got intrigued by Patrick Industries, Inc. (NASDAQ:PATK)’s share price appreciation of 50% in the last twelve months. But the good performance goes back in time, surpassing that of the S&P 500 (SPY) in the last ten years. When such thing happens, most of the times it is a phenomenal business’ fault: Data by YCharts Patrick Industries seems to own and maintain solid competitive advantages, as shown by the company’s Return on Invested Capital (ROIC) values above 10% in each of those ten years. And that was probably the major reason why the company grew revenues, EPS, equity and FCF above 19% CAGR each in that period. Impressive enough, all that growth has been achieved under comfortable short-term liquidity levels, since PATK’s current ratio has been between 2 and 3 every year in the last decade. Any company with these credentials is certainly worth spending time on a deeper look. Under the microscope Patrick Industries is a component solutions provider for the recreational vehicle, marine, manufactured housing and various industrial markets, including single and multi-family housing, hospitality, institutional and commercial markets. The company was founded in 1959 and is located in Elkhart, Indiana, home to several RV manufacturers. As a matter of fact, revenues from the RV market include sales to two major manufacturers of RVs that each account for over 10% of the Company's net sales, Forest River and THOR Industries (THO), as reported in the company’s last 10-K filing. As shown in PATK’s latest Investor Presentation, 70% of PATK’s 2023 revenues came from the RV and Marine markets. That means the Marine segment is now second in size within the company’s revenues, outpacing the Housing market: Patrick Industries Sales by End Markets (Patrick Industries March 2024 Investor Presentation) The mix by end markets slightly changed in the recently finished quarter. As shown in the Q1 2024 earnings presentation, RV revenues increased 15% YoY to $421 million (45% of Q1 revenues), marine revenues were up 35% YoY to $155 million (17% of Q1 revenues), housing revenue was up 5% YoY to $275 million (29% of Q1 sales) and Powersport revenues were $83 million, representing 9% of the quarterly sales. Let's take a look at how each reportable business segment (Distribution and Manufacturing) performed in the last decade. Both of them grew Gross Profits and Operating Income above 20% CAGR. The only exception is the Manufacturing sales with an 18.7%, which is nothing to sneeze at either. Sales in the Distribution business grew at an outstanding 20.39% CAGR in the last ten fiscal years: PATK's 10-K filings We can also notice that the Manufacturing segment is the biggest contributor of the two to the company’s earnings. However, the Distribution business has been growing all three lines at a slightly faster pace: 2.45% CAGR on average faster than Manufacturing sales. So it is good news that a segment contributing 25% of the company’s sales ‘only’ is not lagging behind in growth and therefore does not seem to be a problem moving forward, should this segment continue performing as it has. The line chart above might give the impression that the distance between sales and gross profits has been increasing over the years. But nothing further from the truth, since sales and gross profits have been growing at 20.39% CAGR and 23.83% CAGR in the Distribution business and at 18.7% and 23.46% in the Manufacturing business, respectively. This means that sales have been increasing faster than the costs of goods sold (COGS), which indicates that the company is doing a fantastic job at controlling costs over time. A solid ground paved with acquisitions When assessing any company’s competitive advantage, analyzing its ROIC values in past years is an important step of the process. This metric provides a quantitative -and therefore straightforward- way to figure how strong the company’s ‘moat’ is and compare it with that of others’. If we calculate PATK’s ROIC in each of the last ten fiscal years and do the same with some of its peers, such as American Axle & Manufacturing Holdings, Inc. (AXL), LCI Industries (LCII), Modine Manufacturing Company (MOD), Gentherm Incorporated (THRM) and XPEL, Inc. (XPEL) we will see some interesting facts: PATK's ROIC vs Peers (Data from SEC 10-K filings. ROIC values calculated as in Investopedia) It stands out that all of these companies have achieved high ROIC values on average through the past ten years. All in double digits except for AXL at 8.72%. Although the Automobiles Component industry is a large one, with an estimated size of $39 Bn by revenue in 2023, it is a very fragmented industry. Due to the high number, complexity and specificity of the components assembled into RVs, motor-propelled marine boats and even homes, the companies in the sector generally compete only over an overlap of all their products. This allows them to strive by having different areas of expertise if these companies develop an efficient and high-quality business model, measured by their ROIC among other metrics. It can also be seen from the figure above that PATK’s ROIC values have remained stable between 10-20% in the past decade. These numbers point to an unharmed competitive advantage and also to a robust business model and a skilled management team, capable of achieving high returns in different market conditions. Maybe with the exception of XPEL, I’d rather see a somewhat straight (or increasing) ROIC line than huge spikes up and down. An important component of PATK’s historical success must be found in its strategy of acquisitions. Throughout the years, the company has been meticulously choosing targets and timepoints for the takeovers very accretive. This can be seen by comparing the total consideration paid by PATK in acquisitions with the revenue pertaining to the businesses acquired in each such respective year (‘Acquired Revenue’ below): PATK's 10-K filings As we can see, PATK has reported a very high percentage of acquired revenue relative to the total consideration paid each year. These percentage values range from 16% in 2019 to a whopping 78% in 2014. Except for 2019 and 2020, the acquired companies contributed to PATK’s revenues above 40% of their cost of purchase, in the same year they were acquired. But all this income must not come with an unmanageable amount of debt for the company, if we want to qualify the acquisitions as successes. As the results show, the net leverage values were on an upward trend from 2013 and peaked in 2020 at 3.8. Since then, the net leverage values have been ticking lower until they increased to 2.39 in FY 2023. The ratio moved to approximately 2.9 with the $315 million acquisition of Sportech in January 2024. Matthew Filer, SVP Finance, said in the Q4 2023 Earnings Call that the company expected to reduce this ratio to their target range of 2.25 to 2.5x within the next 2 to 3 quarters. In Matthew Filer’s own words at the aforementioned earnings call: We will continue to utilize the appropriate levers to optimize our operations and maintain our strong financials, including maintaining a disciplined leverage position and prioritizing paying down debt after the Sportech acquisition while still having the opportunity and ability to grow the company through targeted acquisitions and capital investment. And it seems for now that the company is on track to keeping this promise, since net leverage slightly ticked down to 2.8x in Q1 this year. On a quick note about the Sportech acquisition -the largest ever in the company's history- it's two-month contribution to the company's revenues in Q1 helped the Powersports end-market sales to represent 9% of the quarterly sales. Jeffrey Rodino, President of the RV division, said at the Q1 2024 earnings call that these results outperformed the company's expectations. This end-market's portion of FY 2023 revenues was probably residual until now since it was not reported in either the Investor Presentation or the FY 2023 10-K filing. The results above show that the company has been able to keep leverage under control while executing multiple acquisitions every year. This is a demonstration of remarkable skills by PATK’s management team. Considering this strategy has been part of the company’s business model for decades, in my opinion there is no reason to think the company will do differently for years to come. Valuation The latest estimates for PATK’s end markets forecast moderate growth into the next decade. The Manufactured Housing market is expected to grow at a CAGR of 3.95% between 2024 and 2031, while the U.S. modular construction and the U.S. Residential Remodeling markets could grow at a CAGR of 7.8% (2023-2030) and 4.6% (2024-2030) respectively. Although 2024 is still expected to be impacted by the current high interest rates and low consumer spending at least in the first half of the year, forecasts seem to agree that the down cycle might have bottomed in 2023. Manufactured home production in 2024 is expected to resemble 2023 volumes. On the RV side, the RV Industry Association (RVIA) projects 2024 RV shipments to be around 350,000 in the midpoint of the range, which would mean an 11.75% growth from the 313,174 units shipped last year although still far from the 406,070 shipments in 2019. Although the estimates cited above point to a clearer horizon ahead, it was expected by the back half of 2024, with a considerable amount of uncertainty for the short term. In the words of Andy L. Nemeth, PATK’s CEO at the Q4 2023 earnings call: We believe the first half of 2024 will look similar to the last few months of 2023 in respect to industry and macro trends. With some promising upside potential in the second half of 2024, especially if there is interest rate relief for both retail and floor plan financing. But as we recently knew, the Federal Reserve might keep interest rates at current levels for the remainder of 2024 due to \"a lack of further progress\" towards its 2% inflation goal. However, PATK is solidly positioned with an unharmed competitive advantage and a long history of successfully expanding end markets while generating strong free cash flow growth: 38.8% CAGR in the last 10 years. We would be conservative by estimating PATK’s FCF to decrease 0.5% in FY 2024, to grow 10% in FY 2025 and to increase to 15% growth annually from FY 2026 until 2033. With these guidelines, the DCF analysis would yield the following results: Discounted Cash Flow (DCF) Analysis of PATK (PATK's 2023 10-K filing. Author's own estimations and calculations) The forecasted decrease in FCF for FY 2024 would be in line with the latest outlook provided by PATK’s management. At the Q4 2023 earnings call, Matthew Filer, then Interim CFO said the company expected operating cash flow (OCF) of $390 million to $400 million for the full year 2024, resulting in free cash flow of approximately $310 million or more. This outlook was revised slightly upwards at the Q1 2024 earnings call, with the new range provided for the OCF to be $390-$410 million. At the time of writing this article, PATK’s shares are trading at $110.35, which would imply a deep discount from the DCF-estimated fair price above. Therefore, I’m calling PATK a Buy. Not risk free, though We can all probably think of multiple reasons why not to invest in a company like Patrick Industries. There’s a high chance that the current inflation levels, high interest rates and lower consumer spending are among those reasons. And we should indeed be wary. As of today, there are no clear indications that any of those factors will ease any time soon. And businesses like PATK with roots in the consumer discretionary sector and the construction industry are especially hurt during down cycles. We have also witnessed how recent developments in ongoing geopolitical conflicts have sent crude oil prices higher. Should the conflicts remain, worsen or increase in number, oil prices might reach levels that deter outdoor enthusiasts from buying that RV they have been wishing for. Although the long-term estimations for the RV shipments and the housing market are positive, we can’t say for sure how much more the economy is going to be hurt before the down cycle ends. In its latest report, the RVIA notified a 9% increase YoY in RV wholesale shipments for the first quarter of 2024. This is certainly encouraging news but we should anyway keep a close eye on how the market conditions continue to unfold and how is PATK’s business going to be affected moving forward. Conclusions In the last decade, Patrick Industries continued its phenomenal long-term growth. So did both of its business segments, each at their own scale grew at nearly or above 20% CAGR even after a very operationally tough FY 2023. The company excelled at growing FCF in the last 10 years, aided by very low interest rates and the consumers’ increased interest in outdoor activities after the COVID pandemic. PATK has historically executed a very well-timed and accretive strategy of acquisitions, combined with a focus on leverage control, operational efficiency and increasing shareholder returns. All of which remain as pillars of the company’s capital allocation strategy moving forward. Therefore, assuming the company will grow FCF at a third of its past rate seems to be both achievable and conservative. The FCF estimates for PATK used in the model described here project an overall CAGR of 12.3% for the next ten years, hinting at a possible 30% undervaluation. Also, the fair price estimated for PATK’s shares gives investors a considerable margin of safety, which is always recommended to offset any overestimation in the model as well as the uncertainties that the future always holds.  It will remain to be seen how long it will take the company to get back to the growth pace achieved until FY 2022, considering the current market conditions and the uncertainty around interest rates and inflation. However, I think Patrick Industries’ historical results show that the company has performed exceptionally well. Its expertise, potential and strong competitive advantages will likely allow the company to thrive over the long term.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.28.0","shortVersion":"4.28.0","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2432116358"}