Synopsis

In the US, BlueLinx (NYSE:BXC) is one of the top wholesale distributors of building products for residential and commercial building. In FY2023, BXC’s top line contracted due to a combination of price deflation and lower sales volumes, implying that the market conditions have started to normalise. As a result, profitability margins contracted as well. For its most recent 1Q24 results, consolidated net sales declined. On a brighter note, its profitability margins remained robust year-over-year. Looking ahead, the high interest rate environment due to persistent inflation is expected to continue creating headwinds for the housing market. In addition, annual spending for repairs and improvements to homes is expected to decrease. Given BXC’s mixed outlook and a lack of margin of safety in its share price, I am recommending a hold rating.

Historical Financial Analysis

In 2022, BXC’s consolidated net sales grew from $4.277 billion to $4.450 billion. This growth was attributed to net sales growth in its specialty products segment, which increased by $351 million to $2.871 billion. The increase in specialty products segment net sales was driven by the strategic pricing of its specialty products. On the other hand, in the structural products segment, net sales fell to $1.578 billion. This decline was caused by a decrease in wood-based commodity prices and modestly lower volume. In 2022, composite lumber prices fell 10% while composite panel prices declined 18% year-over-year.

Looking at the chart, it is clear that BXC faced headwinds in 2023 as net sales fell from $4.450 billion to $3.136 billion. The main drivers behind the decline in 2023 net sales were due to a combination of price deflation and lower sales volumes. This implies that the market conditions have started to normalise. For context, specialty products segment net sales fell 23.9%, while structural products segment net sales declined 39.7%. In 2023, composite lumber price fell 47%, while composite panel prices fell 32% year-over-year.

Moving onto profitability margins, it is clear that in 2023, all three margins faced contractions. Its gross profit margin contracted from 18.70% to 16.80%. The gross profit margin contraction was because of price deflation and lower sales volumes. These factors were due to the market returning to normalised levels.

In addition, in 2023, selling general and administrative [SG&A] expense as a percentage of net sales increased from 8.2% to 11.3%. As a result of gross profit margin contraction and increased SG&A expense as a percentage of net sales, operating income margin fell to 4.40%. The net income margin contracted from 6.70% to 1.50%. Additionally, in 2023, the accounting for the settlement of its frozen defined benefit pension plan of approximately $30.4 million also impacted its net income margin. The main drivers behind the decline were lower sales volume and pricing declines.

First Quarter 2024 Earnings Analysis

For BXC’s 1Q24, consolidated net sales fell by $71.7 million to $726.2 million. The decline in consolidated net sales was attributed to a decrease in both specialty products and structural products segments net sales. They fell by 11.3% and 3.3%, respectively. Looking at the following net sales breakdown, specialty products form the largest share of consolidated net sales, accounting for 69% of the quarter's net sales, while structural products account for 31%.

In January, the winter weather had an adverse impact on the volumes of both sales segments. As a result, approximately half of its branches were closed for one to five days. On a brighter note, volumes experienced an increase in February and March.

Regarding margins, BXC’s 1Q24 results performed well year-over-year. Its gross profit margin expanded from 16.70% to 17.60%. The gross profit margin expansion was due to a net benefit from import duties, and it added 0.9%. However, SG&A expense as a percentage of consolidated net sales for the quarter increased from 11.4% to 12.6%. Therefore, it more than offset the expansion in gross profit margin. As a result, the operating income margin contracted modestly, from 4.10% to 3.80%.

For the quarter, interest expense as a percentage of consolidated net sales fell by 0.4% to 0.6%. As a result, it bolstered its net income margin as it expanded from 2.20% to 2.40%. The decrease in interest expense was attributed to the generation of higher interest income from its cash and cash equivalents. On the other hand, I do notice that its adjusted EBITDA margin contracted, but the contraction was modest. Adjusted EBITDA margin contracted from 5.90% to 5.30% year-over-year. For context on BXC’s seasonal patterns, it usually has higher adjusted EBITDA margins in the second and third quarters.

Decelerating New Home Starts

According to the new residential construction statistics for March 2024 released on April 16, 2024, by the US Census Bureau and the US Department of Housing and Urban Development, March's single-family housing starts were 1,022,000. For February, the reported figure was 1,167,000. This implies a decrease of 12.4% from February’s figures. According to the National Association of Home Builders, the decrease in housing starts was mainly due to a higher than expected interest rate. The higher-than-expected interest rate was due to persistent inflation.

For May 2024, single-family housing starts reported were 982,000, which represents a 5.2% decline from April’s reported figure of 1,036,000. The reason for the decline in May was due to high mortgage rates. Looking at the following US single-family housing starts chart, housing start numbers started to fall after February 2024, and May’s figure is already back to last year's October level.

As mentioned in BXC’s 10K, its business also relies on the new residential construction market, particularly single-family home construction. Furthermore, its products are used more commonly in single-family than in multi-family. For context, new home construction accounts for 40% of BXC’s total sales. Therefore, the health, performance, and outlook of the single-family market play a crucial and important role in BXC’s financial performance and results.

Mortgage Rate

Looking at the 30-year mortgage rate chart, June 2024’s mortgage rate is sitting at 6.87%. Although rates have come down slightly from its peak of approximately 7.79%, mortgage rates are still considered high when compared to historical levels. Before the COVID-19 pandemic, rates were averaging approximately 4%. Ever since 2022, mortgage rates have increased significantly, and it is currently averaging about 7%. As a result of the higher mortgage rate, it is taking a toll on the overall US housing market.

The increase in interest rate, which affected the mortgage rate, was due to the rising inflation rate that began in 2021. Although inflation has come down significantly from its peak of approximately 9% that happened in 2022 to the current 3.4%, it is still well above the Fed’s target inflation rate of 2%. In fact, looking at the chart, inflation has remained persistent in the range of 3%–3.5% since June 2023. It is almost a year and inflation are still moving side way. As a result, the Fed held on to the interest rate in order to bring inflation back under control.

Leading Indicator of Remodelling Activity [LIRA]

According to the Joint Center for Housing Studies’ leading indicator of remodelling activity [LIRA], it is forecast that the annual spending for repairs and improvements to homes will decrease in the third quarter of 2024 and will flow into the first quarter of 2025. LIRA estimates that the annual expenditure for renovations and maintenance will drop by more than 7% in the third quarter of 2024. For the first quarter of 2025, it is forecast to decrease by 2.6%.

This decreasing projection indicates that the repair and remodelling market is still expected to face headwinds until the first quarter of 2025. Due to the forecast provided, the LIRA is considered a forward-looking metric. Repair and remodel activities are important to BXC because, according to its sales by end market, repair and remodel activities account for 45% of its sales. Therefore, the outlook and performance of the remodelling market will have an impact on BXC’s outlook as well.

Relative Valuation Model

In my relative valuation model, I will be comparing BCX against its peers in terms of growth outlook and profitability margins. For growth outlook, I will be comparing on forward revenue growth rate, as it is a forward-looking metric. In addition, it gives us a good gauge of BXC’s growth potential compared to its peers. For profitability margins, I will be comparing EBITDA margin TTM and net income margin TTM. These metric comparisons give us a gauge of their operating performance and how they stack against each other.

Firstly, for growth outlook, BXC underperformed its peers. BXC has a forward revenue growth rate of -9.95%, which is lower than peers’ median of -5.32%. The negative forward revenue growth rate implies that BXC’s next two fiscal years’ revenue estimate will be lower than FY2022 revenue. Although BXC has a negative forward revenue growth rate, its peers’ median does not fare well either, as it also reported a negative forward revenue growth rate.

Moving onto profitability margins, BXC also underperformed in both EBITDA margin TTM and net income margin TTM. Firstly, BXC’s reported EBITDA margin TTM of 5.27% is lower than peers’ median of 10.93%. Secondly, BXC’s reported net income margin TTM of 1.57% is also lower than peers’ median of 7.16%.

Currently, BXC’s forward non-GAAP P/E ratio is 12.20x, which is higher than peers’ median of 11.47x. Given BXC’s underperformance in both growth outlook and profitability margins, I argue that its forward non-GAAP P/E ratio should be below peers’ median. Therefore, I will be adjusting my target 2025 forward non-GAAP P/E ratio for BXC downward. In doing so, it also better and more accurately reflects BXC’s underperformance. My target 2025 forward non-GAAP P/E ratio for BXC is set at approximately 10.32x, which represents a 10% discount to peers’ median.

For FY2023, BXC reported net revenue of approximately $3.14 billion and EPS of $5.39. For FY2024, the market revenue estimate for BXC is approximately $3.06 billion, while EPS is approximately $6.91. For FY2025, the market revenue estimate is approximately $3.25 billion, and EPS is approximately $8.93.

When I analysed its earnings call transcript, management did provide outlook and guidance with regard to the overall market conditions and BXC’s margins expectations. For the housing and building products market, although the market is optimistic about it, the building product market is still being affected by headwinds due to the Fed's rate decision.

On the other hand, the housing market continues to be volatile, as both housing starts and permits declined in March 2024. The short-term outlook for the industry BXC operates in is still uncertain and muted. Based on management’s outlook and my forward-looking analysis as discussed, these pointers support the general market’s estimates. Therefore, by applying my 2025 target P/E to BCX’s 2025 EPS estimate, my 2025 target share price is $92.14.

Risk and Conclusion

The risk associated with BXC is its dependency on housing market conditions. Firstly, BXC’s business depends on residential repair and remodelling activity levels. Such activities have correlations with economic strength, which is dependent on factors such as inflation and employment levels, to name a few. If economic conditions were to improve, it would encourage consumers’ spending, particularly on discretionary items, which would lead to increased spending on home improvement projects.

In addition, BXC’s business also depends on the new residential construction market and single-family home construction in particular. Although inflation is still above the Fed's target rate, it has come down significantly from its peaks. If inflation were to start cooling or cool further, it might prompt the Feds to begin their rate-cut measures. Such actions will have an impact on the housing market in general as they reduce the mortgage rate. In this scenario, it will create tailwinds for BXC, leading to share price appreciation.

After a strong FY2022, FY2023’s net sales decreased due to price deflation and lower sales volumes as a result of market conditions normalising. For its 1Q24 results, net sales fell, but profitability margins remained robust year-over-year. Currently, the housing market is facing headwinds from the higher-than-expected interest rate. Additionally, the Fed kept rates unchanged due to persistent inflation. According to LIRA, it is forecast that the annual expenditure for renovations and maintenance will drop by more than 7% in the third quarter of 2024, and it is expected to flow into the first quarter of 2025. Given the mixed outlook and a lack of margin of safety in its share price, I am recommending a hold rating.