The Thesis
Moving into 2024, topline weakness across DXP Enterprises (NASDAQ:DXPE) Service Centers and Supply Chain Services segments continues. However, I expect this to improve in the coming quarter as the demand environment for the company's solutions in the Oil & Gas end market remains healthy, which along with strong pricing in the industrial end market and backlog growth should drive the company's topline in 2024. Long-term term, on the other hand, should benefit from the company's investment in expanding its product offerings and strategic M&As. The margin for FY2024, on the other hand, looks weak due to lower sales in the first half of the year, however, anticipated volume growth and benefits from price increases and improved efficiency should drive margin expansion beyond 2024. The company's stock valuation looks attractively priced versus its historical averages, which along with a good long-term outlook makes this stock a decent buy at the current level.
Business Overview
DXPE is among the leading players in the industrial distribution and services market. Through its subsidiaries, it distributes maintenance, repair, and operating (MRO) products and equipment across the United States and Canada. The company mainly operates under three segments:
Service Centers (SC): This segment primarily offers MRO products, equipment, and related services and includes the distribution of industrial supplies such as bearings, pumps, power transmission, and other industrial equipment across various industries including Oil & Gas, food & beverage, petrochemical, and transportation. This segment accounts for approximately 70% of the total sales as of the first quarter of 2024.
Supply Chain Services (SCS): This segment provides supply chain solutions and is involved in managing inventory, procurement, storeroom management, transaction consolidation, and all the other aspects of procurement and logistics for customers that are designed to reduce costs and improve efficiency for customers.
Innovative Pumping Solutions (IPS): The IPS segment specializes in custom pumping solutions including design, engineering, assembly, and installation, and also offers technical support and maintenance for the pumping equipment.
Last Quarter Performance
Entering 2024, the year started with a slight single-digit topline decline after a decent 2023. During the first quarter of 2024, the company’s sales declined 2.7% year-on-year to $413 million as the weakness across both the SC and SCS segments continued more than offsetting the strong double-digit growth in the IPS segment. In the SCS segment, the company faced significant headwinds from facility closures with its existing customers, leading to a year-on-year decline of 7.5% during the quarter.
The SC segment was also down in mid-single digits despite positive growth in the South Atlantic and North Central regions during the quarter. The IPS segment on the other hand was strong with double-digit growth as the booking remains strong for the company’s pumping solutions, which also resulted in sequential backlog growth.
The topline contraction also negatively impacted the company’s margin, as the adjusted EBITDA margin contracted 40 bps during the quarter to 9.8% versus the prior year, going below the stated goal of 10% plus. This was mainly due to the impact of lower sales and approximately 180 bps higher SG&A as a percentage of sales during the quarter. Reduced EBITDA also impacted the company's bottom line. The company’s adjusted diluted EPS reduced to $0.74 during the quarter versus $0.95 a year ago, however, beat the consensus estimates by $0.03.
Outlook
After a strong 2023, the company experienced headwinds across most of its business as it entered 2024. However, I expect the company should continue to benefit from strength in the Oil and gas end market in the quarter ahead, which accounts for approximately a quarter of DXP’s revenue. In addition to this, pricing strength from the recent increases in the company’s industrial end market as well as the contribution from recent acquisitions should further support the company’s topline growth in the coming quarters. The backlog levels primarily related to the energy and water industries are also good and increased significantly in the last few quarters, reaching a total of approximately $138.4 million by year-end 2023, which should further provide visibility for the company’s sales in 2024. The backlog growth in the IPS segment was the strongest, which climbed 11.8% over the fourth quarter of 2023.
While the outlook for the near term looks decent, the company remained focused on the strategy of growing its business both organically and inorganically in 2024 and beyond and is focused on capturing additional market share in the coming years to further diversify and grow in recession-resistant end markets with quality customer base. As a part of its strategy, DXP continues to make investments in expanding its business, as well as to improve efficiency for its customers to retain them and acquire new customers in the future. Apart from this, to grow inorganically, the DXP is strategically investing to fuel growth and diversity through acquisition and also closed three acquisitions in the last quarter as well, including Pro-Seal, DXP’s Water acquisition, Hennesy Mechanical, and Kappa Associates.
In my opinion, as the company continues to look for potential M&As that are aligned with its focus on diversifying its end markets and customers as well as consolidating fragmented markets, the company’s topline should benefit in the longer term. The company also holds a strong financial position with a liquidity of approximately $272 million as of the first quarter of 2024 and a decent leverage ratio of 2.3x. While the total debt has increased versus the prior year, I believe the company’s ability to generate decent free cash flow should help in debt repayments in the future and support the company’s strategic M&As in the coming years.
Overall, the near term looks promising, with healthy demand in the oil and gas end market and backlog growth. On the other hand, the company’s strong position and continued investment in product offerings and strategic M&As as well as its exposure to sustainable secular trends that include water and waste water and energy markets should drive the company’s sales in the longer term.
Valuation
In the past year, DXP's stock has given approximately 21% returns to its investors due to decent bottom-line performance in the recent quarter, which saw notable growth as compared to a year ago figures. Currently, the company's stock is trading at a forward P/E ratio of 14.21, based on the FY24 EPS estimate of $3.21 representing a significant discount to its five-year average P/E of 22.13.
I am expecting the company's topline to continue to grow further as the demand environment primarily in the Oil & Gas end market remains strong. Pricing is also showing strength, primarily in the industrial end market, which should benefit the company's margin going forward. Backlog levels are also good, thanks to strong booking for the company's pumping solution in the last quarter, which should further leverage the company's margin as volume grows. As we can see in the chart below, the company's forward EBITDA is anticipated to grow 13.01% as compared to the single-digit topline growth. This should result in bottom-line expansion in the coming quarter.
While the company's FY24 EPS estimate represents a decline in double digits, I believe the company's focus on improving efficiency and benefits from higher sales should help the company improve its margin in the future. Considering the company's promising long-term prospects, I believe the company's stock to be attractively valued at the moment and should improve further with margin expansion in the coming years.
Risk
Except for the first quarter of 2024, the company has shown notable growth in its bottom line in recent quarters as the company's adjusted EBITDA margin sustained above the 10% goal throughout 2023. While the bottom-line saw a year-on-year decline in the first quarter of 2024, I expect this to improve in the coming quarter as the company sales improve. My thesis is built upon the expectation that the anticipated revenue growth and benefits from price increase and efficiency improvement should drive the company's margin going forward. This margin growth should result in bottom-line expansion, further making the stock valuation more reasonable. However, if the weakness in the company's SC and SCS topline continues, the company's profitability might be impacted negatively, leading to bottom-line contraction and poor stock performance in the future.
Conclusion
As we discussed earlier, the company's stock is trading at a significant discount to its historical averages. I expect the company's top line should grow in the coming quarters as demand is showing strength in the Oil & Gas end market. This along with positive pricing and backlog growth should drive revenue growth in the coming quarters. Expected volume growth should lead to improved margins in the quarters ahead, which along with the benefits from pricing mainly in the industrial end market and focus on improving efficiency should support the company in bottom-line growth in the coming years. The long term also remains good as the company is focusing on strategic acquisition. The DXPE's stock is currently priced attractively and considering its growth prospects, I would recommend to "BUY" this stock at the current levels.