GMS Effectively Paddles Through Industry Challenges

seekingalpha09-10

GMS Inc. employs a growth strategy through M&A and cost-reduction measures despite a challenging housing market and high leverage.The company’s diversified revenue mix and stable pricing help maintain...

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(NYSE:GMS) provides wallboard, ceilings, steel framing, and complementary construction products through approximately 300 distribution centers in the US and Canada. Residential and commercial contractor customers use these building products and solutions. In addition to core organic sales, the company complements its growth through M&A, including three acquisitions and five new distribution centers in FY2024 alone. It has continued to indulge in these activities in FY2025, too. I think the housing market can see a modest improvement in the near term. However, I do not see much traction in the industry. In this environment, GMS's inorganic growth strategy can become a handful. It made several acquisitions in FY2024 and has so far strengthened its offerings in Canada and Florida in FY2025. Sales mix can become an important strategy as single-family units may continue to grow while multi-family and commercial units can decelerate. The company has initiated cost-reduction measures that can stabilize the margin. The company's high leverage and negative cash flows can concern the investors. The stock is reasonably valued compared to its peers. I recommend investors \"hold\" the stock with an expectation of a higher return in the medium term. Industry Outlook And Pricing FRED Economic Data GMS estimates that home sales have increased by low single digit in 2024 so far. A change in home sales partially depends on the change in interest rates - one of the key factors influencing the housing market. According to FRED Economic Data, the ratio of new houses for sale to new houses sold (MSACSR index) in the US has remained nearly unchanged in the past year. Over the medium term, I expect the housing development to recover. Easing interest rates will ease constraints over the company's end markets. GMS's management expects a reduction in interest rates in September, initially benefiting the single-family market, followed by commercial and multi-family. At this point, GMS's management typically checks out the Architectural Billings Index (or ABI) and the Dodge Momentum Index (or DMI) to understand the extent of single-family recovery. In July, ABI clocked a score of 48.2 as billings in July decreased compared to May, and the value of newly signed design contracts decreased. However, the DMI increased 7.9% in July from June. An expected Fed rate cut in September, slower inflation, and weaker labor market conditions will affect buyers' sentiment as we advance. In the multi-family market, investors might want to be patient until mid-2025 and into 2026 for a bottom and subsequent recovery. Strategies And M&As GMS Investor Review September 2024 The company aims to strike a revenue mix that is equally weighted between commercial and residential and will have a diversified mix of customers. The industry sees a modest improvement in demand while capacity conditions remain tight. The resilience in wallboard pricing is an encouraging trend, given that price increases can be challenging to capture in a softening market. It also continues to pass through manufacturer price hikes to customers. In July, GMS acquired Yvon in Canada. Yvon provides building supplies, including drywall, insulation, steel, ceilings, and other complementary products and related services. The acquisition is expected to be margin-accretive to GMS. In August, it announced the acquisition of R. S. Elliott, which distributes exterior cladding building products, including stucco, plaster, siding, and EIFS. These acquisitions strengthened the exterior business in Florida and expanded its platform by growing its complementary product offerings. R. S. Elliott's TTM revenues were $70 million, while its EBITDA margins will likely be accretive to GMC's brands. Segment Outlook In the Wallboard segment, GMS's management expects single-family volumes to grow by \"mid-single digits\" in Q2. Multi-family volumes, on the other hand, can decrease by \"low double digits,\" while commercial volumes can be down by \"high single digits.\" The overall wallboard volumes will likely remain \"flat or can go down by low single digit.\" The average realized wallboard price was $4.77 per thousand square feet in Q1, up from $4.75 in Q4 2024. In the Ceiling segment, Q2 2025 volumes can increase by \"low single digit\" compared to Q2 2024. Revenues, too, can grow similarly due to a low-single-digit improvement in price and a better sales mix. In Steel Framing, volumes can decrease by \"mid-to-high single digits\" following a slowdown in many active projects. Pricing in this segment softened by ~2% sequentially and can decline by \"low teens\" year-over-year in Q2. Challenges And Cost Reductions Seeking Alpha Inflationary costs on wallboard manufacturing have kept its pricing dynamic and resilient. Although higher costs impacted manufacturers and distributors, the company kept pricing stable. Management believes pricing will rise when demand rises in the single-family market. The pricing pressure can be sustained over the next several quarters. To mitigate this, GMS would implement a $25 million annualized cost reduction program, including a reduced backup house overhead. Other cost-saving programs include streamlined picking and loading processes, improving routing efficiency, and location consolidation. Simplification and efficiency optimization through technological improvement can achieve the desired savings. My Estimates Over the past ten quarters, the company's adjusted EBITDA increased by 2%. I expect the US residential index to remain weak in the next few quarters. Given the company's cost reduction initiatives and the effect of the acquisitions, its margin pressure should be partially mitigated. So, I expect its adjusted EBITDA should increase moderately, by 2% to 4%, in the next four quarters. Looking Through Q1 Results GMS's Filings In Q1 2025, GMS's Ceilings segment saw the most remarkable revenue growth (18% up) year-over-year, as announced in the Q1 earnings press release on August 29. Revenues from Wallboard increased by 3% in Q1, while Steel framing declined steeply (11.4% down) in Q1. Gross margin was 31.2% in Q1, down 80 basis points from a year ago. Although single-family demand grew, softening demand in multi-family and commercial end markets affected the company's performance in Q1. In commercial activity, healthcare, education, and data centers performed better than other subsectors. However, high interest rates kept the financing environment challenging. Also, during Q1, several sizable projects were postponed or canceled, particularly in July. Even for the new single-family units, builders have pulled back activity from a year earlier. Cash Flows And Debt Level In Q1 2025, despite steady revenues, GMS's cash flow from operations (or CFO) turned negative compared to a positive CFO a year ago. Free cash flow (or FCF), excluding acquisitions, also deteriorated. Its spending on acquisitions increased by $79.5 million. GMS's leverage (debt-to-equity) was 0.94x and deteriorated compared to FY2023. As of July 31, 2024, its liquidity was $619 million. It repurchased shares worth $46 million in Q1. Although the balance sheet holds strong liquidity, the company's already high leverage would make it more vulnerable to liquidity trouble if it indulges in more M&A activities with debt financing in the coming quarters. Relative Valuation And Price Forecast Author Created and Seeking Alpha GMS's forward EV/EBITDA multiple contraction versus the current EV/EBITDA is less steep than its peers. This should typically result in a lower EV/EBITDA multiple. Its current EV/EBITDA multiple (8.9x) is lower than its peers' (ALTG, DSGR, and DNOW) average. So, the stock is reasonably valued with a positive bias. GMS's average EV/EBITDA multiple for the past five years was 16.8x. If the stock trades at the past average, it can increase by 137% from the current level. The average EV/EBITDA multiple for GMS's peers (ALTG, DGSR, DNOW) is 11.5x. If the stock trades at this average, the stock price can increase by 50% from the current level. As I discussed earlier in the article, I expect 2%- 4% adjusted EBITDA growth in the next four quarters. Feeding these values in the EV calculation and assuming the sell-side current EV/EBITDA multiple of 8.9x, I think the stock should trade between $91 and $93, implying a 9%- 12% upside. Wall Street Rating Seeking Alpha Four analysts rated GMS a \"buy\" in the past 90 days (including \"Strong Buy.\") None rated it a \"sell,\" while four rated it a \"hold.\" The consensus target price is $91.8, suggesting an 11% upside at the current price. Given the current value drivers, Wall Street analysts are reasonably close to a fair return estimate. Risk Factors FreddieMac As I discussed earlier in the article, the residential market represents a significant portion of GEOS's business. Rest and Recuperation (or R&R) activities account for most of the consumers' spending in this business, while wallboard demand correlates with housing starts. Also, rises in mortgage rates, foreclosure rates, and the mix between single- and multi-family homes can affect demand. While mortgage rates decreased over the past year, they more than doubled over the past five years until September 2024. Housing and mortgage rates correlate with commercial and residential construction, which, in turn, depend on the financial market and economic conditions. Given the possibility of a recessionary condition in the US and a potential global economic slowdown, the company can see hurdles ahead of consumers' sentiment and purchasing power. What's The Take On GMS? Seeking Alpha Deterioration in multi-family home sales and commercial home sales volumes are the primary challenges that GMS will face in the current environment. The housing and R&R markets have had a quite ordinary run over the past few quarters. The US economy and global economic factors have not been showing exuberance either. The US economy, in particular, faces the possibility of a depression in the near-to-medium term.  Still, GMS managed to consistently keep its revenue and operating margin steady due to solid single-family home sales volumes, its M&A strategies that complemented core growth, and a discreet mix of commercial and residential customers. Relatively steady pricing and cost-saving measures will help stabilize its margins. So, the stock outperformed the SPDR S&P 500 ETF (SPY) in the past year. Cash flows remain problematic despite strong liquidity, especially with a leveraged balance sheet. Given the relative valuation multiples, I think returns from the stock can improve in the medium term when the borrowing costs fall. So, I rate this stock as a \"hold\" for now.","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":"analysis","news_rank":0,"symbols":[],"gpt_button":0},"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":"4.29.3","shortVersion":"4.29.3","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/2466459732"}