Description

Bluelinx is an overlooked and unloved distributor of lumber and building materials to customers serving the US homebuilding and repair and remodel industries. Potential investors see thin margins, a heavy debt load and a high mix of products susceptible to volatile commodity price swings and move on to their next investment candidate. They should take a closer look.

A more thorough examination reveals a market leading company well-versed in managing lumber price volatility and low margins with quick turns and an efficient logistics network. An old mark on the company's real estate portfolio obfuscates a company that is trading at a fraction of its liquidation value. Over the years, its debt structure and associated real estate holdings have been both a blessing and a curse. Its distribution center ("DC") network has been a valued source of collateral and in some cases a source of funds to lean against during the depression-like conditions in the housing market over much of the last decade; at the same time, this network and the 10 year CMBS umbrella mortgage loan that binds it has served as a deterrent to migrating operations to a more cost-effective and higher margin business mix. The December 2015 expiration of the $1M / month prepayment penalty on the CMBS mortgage due June 2016 changes all this. Investors should look past the ugly surface level financials and dig in.

Company History

BXC corporate history presents a fascinating case study and is critical to understanding the company's current situation and future prospects. Bluelinx operations began as the captive distribution arm for Georgia Pacific (“GP”). Its network of 48 DCs was built to suit the needs of the parent company lumber manufacturing operations where many DCs were oversized and attached to vast lumber yards so that GP could run their lumber mills flat out and stow excess lumber at the adjacent yards. In 2004, a struggling GP began a massive restructuring effort which led to the sale of its distribution assets to Cerberus in a tax-free transaction that preserved the old real estate valuation on the company's books. BXC then went public with Cerberus offering up just under half of the company in an IPO in December 2004. The company had a mortgage on its DCs and an asset backed revolver in place for its working capital needs. In 2006, Cerberus increased and refinanced the mortgage to the 10 year CMBS umbrella mortgage that is still in place today. The company trudged forward into a wobbling housing market. And then the bottom fell out of it.

Since then the company has been eeking its way through a tough market in hopes to survive long enough to see a brighter day. It's certainly been bumpy. There's been a revolving door in the C-suite, a Cerberus freeze-out attempt in 2010 (at levels well in excess of today's market cap) that was subsequently negated by existing shareholders, two PIPEs that have diluted shareholders, an ill-fated and poorly timed speculative inventory position in 2013 and a few DCs sold off along the way for cash to keep the company afloat. But survive it has, and the company now looks poised to once again go on the offensive into a housing market that has recovered and begun marching slowly but steadily upward. The company’s survival can be seen as a validation of a few important factors: its durable distribution business model, its valued real estate, a PE oriented owner that wants to see its investment succeed and a counter cyclical working capital cycle which allowed the company to delay any value destructive measures until the company was a full six years into the worst housing downturn since the Great Depression.

With the important high level history mostly out of the way, we'll skip the rest of the company and industry struggles over the last decade and move on for a quick discussion of the business model and further assessment of current operations and strategy. However, prior to our projections, we will offer a timeline of key events as an efficient way to highlight a few elements of the story important to the investment thesis. Generally these comments will focus on key events, people changes and noteworthy shareholder actions.

2 Step Distribution and Bluelinx

Pro-dealer Builders Firstsource recently defined the pro-dealer, lumber and building materials product distribution market as approximately $100B in size. Precise and timely data for the market for two step distribution is more difficult to locate, but prior estimates and market share claims from Bluelinx put the current figure likely at or above the $20B level. Bluelinx, the largest independent two step distributor, competes with the captive distribution arms of Boise Cascade, Weyerhouser, Universal Forest Products,  independent publicly traded peer Huttig Building Products and hundreds of small mom and pop distributors, most of whom do less than $200-300M in sales and make up the remaining 60-70% of the industry.

The building materials products supply chain remains a highly fragmented space, with two steppers similarly serving a still heavily fragmented base of lumberyard and pro-dealer customers. Accordingly, Bluelinx distributes over 10,000 SKUs from 750 suppliers to approximately 11,500 customers with minimal customer and supplier concentration. Bluelinx wins by providing a reliable, efficient and cost effective delivery platform to fulfill its customers’ order requests consistently, on time and in full. Its efficient, IT enabled logistics platform allows the company to order large, break bulk and deliver smaller quantities to customers who cannot source products effectively direct from their larger manufacturing supplier partners. Its cost plus pricing model makes it less susceptible to commodities than manufacturers while its industry leading scale creates buying power it can leverage by passing better pricing along to its customers.

Success in this business comes from a dependable delivery offering, scale, quick turns and efficient working capital management. According to conversations with industry participants, well run two steppers are capable of sustainable mid-cycle ebitda margins in the 3-6% range, depending on product mix. Right-sized inventories and fast turns (8x or more on the whole but faster for the commodity oriented Structural category) mitigate lumber price volatility. Minimal capex needs allow the business model to generate a return sufficient to cover the cost of capital and generate excess free cash flow. While it’s just a glimpse, before the housing market rolled over, we can see BXC paid out more in dividends than it required for capex. Competitor HBP has been discussed here a couple of times (once in 2000 and more recently in 2014), and prior posts are a good place to look for further insight into the business and the business model’s cash generation potential in a more normal housing environment.

Bluelinx Pre-housing Downturn and Now

As of 10/3/15 for the last twelve months, BXC did $1.9B in sales and $31M in ebitda, for a 1.6% ebitda margin. This is down from the $4B - $5B top line figures and 2%+ ebitda margins the company did in the years prior to the housing bust. Then, as now, these sales are highly correlated with the growth in new residential construction for single-family homes. Repair and remodel, multi-family and some industrial (which includes things like manufactured housing and furniture manufacturing) comprise the rest. Before the housing downturn, the company’s product mix was skewed heavily to Structural products, at greater than 60% of sales. Structural products include things like lumber, OSB and plywood. The higher margin Specialty products bucket includes things like molding, engineered wood products and insulation. The warehouse delivery channel was generally responsible for a little more than half its mix, with approximately a third of sales going through the lower margin direct channel. This is generally not the preferred mix split given the greater weight of lower margin products that are more susceptible to commodity price swings. But, it’s not altogether very surprising, given the configuration of the company’s operating platform and the tendency for captive distributors to place more focus on volume at the expense of profitability. Even so, with an efficient back end and quick turns the company became adept at navigating an operating environment that is very different from the one we know today as evidenced by their solid free cash flow generation.

Mitch Blake joined the company as CEO in 2/2014. Since then the company has been pursuing a more decentralized and cost efficient operating structure. Previously, the company had held a top-down centralized structure where sales calls were made by inside sales reps in either of the Atlanta or Dallas offices. Over the last year, the company removed a reporting layer and pushed VPs into the region where they could be more in touch with the day to day needs of the local markets. Additionally, the company has implemented a contribution margin based selling tool that gives sales reps the ability to factor in both gross margin and cost to serve into their profit equation which enables them to focus their efforts on sales that are better for the company bottom line. This is a better approach towards targeting the many different localized markets the company is serving, as it empowers employees to make the right decision for that market in a timelier manner. It is a more cost-effective way to run the business, and the greater accountability and responsibility over time is also likely to attract a higher quality sales rep. Technology allows the company to marry a market facing customer approach with company-wide coordinated scale in procuring materials. LEAN initiatives have also been implemented as the company pursues a culture of iterative cost-outs. Despite this cost focus, with minimal capex needs, the company has also managed to invest in itself during these difficult years, by enhancing its IT offering and adding more fuel efficient trucks to its fleet of 800 tractors.

This is absolutely the right way to run a distribution business. Distribution businesses should be run with a focus on costs, efficiency, local market relationships and iterative rather than step-change oriented improvement in company operations. Progress is being made, though you have to look closely at the financials to see it this year, given the negative impact a large decline in lumber prices has had on this year’s results.

The recently reported Q3 offers a good look at the company’s performance in a tough lumber price environment. The company reported topline down -6% in total with commodity deflation contributing to three-fourths of the decline. According to the Random Length’s Composite Index, lumber price deflation for the quarter averaged about -15%. The company managed to offset this decline in part by turning inventories around 8x with ebitda coming in -6% versus 3Q14. That’s certainly not ideal, but given the lumber deflation for the quarter looks to be the worst year over year quarterly comparison since the ‘06 - ‘08 period, it should be a positive indicator that the company was still able to put up $11M of ebitda at a 2.1% ebitda margin. The timeline further below highlights some recent developments in more depth, but lower costs and better margins are beginning to show up in the company’s income statement, despite the still low industry volumes.

Taking a bigger picture view of the company in its current form, we see it has made good progress on the long held company goal of flipping their mix to a greater weight of Specialty products, which is now running near 60% of the mix. The company has also moved the warehouse channel, where they earn the highest margin and have the stickiest customer relationships, to an all-time high level of 73% of sales. This improved mix and lower cost structure look to be significant contributors to the respectable margin levels the company has achieved at these lower volumes. It stands to reason further progress can be made on a real estate footprint that is likely oversized and inefficient from a cost perspective relative to their preferred business mix. As the company moves forward into a housing market operating at higher volume levels, it should benefit from improved mix, lower costs and a real estate footprint that is more congruent with a SKU mix comprised of higher value-added products. Given the dramatic difference in mix from peer Huttig, these factors provide a path to considerable upside for the company.

Capital Structure

Bluelinx has two pieces of debt. It has an ABL for working capital which borrows against its inventory and accounts receivable and the aforementioned 10 year CMBS umbrella mortgage. The ABL is a $468M facility due 4/17. It calls for a $35M payment by 5/16 which is not to come from operations, which means it’s most likely slated to come from its mortgage refinancing. This $468M figure also includes a $20M Tranche A loan due 6/16.  There is a small loan around $10M to a Canadian subsidiary on similar terms, due 8/18. The company pays near a 4% rate on both. There is a fixed charge coverage ratio covenant on the ABL, but it is superseded by a stipulation that requires the company to have excess liquidity of greater than $33M. At October 3^rd, BXC had total borrowings of $284M and excess liquidity of $64M.

The mortgage, secured by the owned DCs, is due 6/16, carries a rate of 6.35% and contains a $1M / month prepayment penalty. Additionally, it has a cash sweep feature so any property sales bypass the company and go immediately to service the principal, an event that happened on prior sales. Per management, the company has never missed or been late on a payment; some eyebrows were raised when the company appeared in the special servicing category of the CMBS mortgage pool, but it was strictly as a result of the property sales. The recent Eastdil analysis shows the properties are valued somewhere in the neighborhood of the $332 – 352M range. At October 3^rd, the balance due was $169M. Over the life of the loan the company has now accrued around $173M of equity which provides it some flexibility.

Given the terms of the mortgage, the company hasn’t had much incentive to move forward on any asset sales. But that should change as the calendar flips to 2016. As discussed previously, BXC has a volume-oriented DC network. There are many oversized warehouses on large property sites at railheads in big metropolitan areas in what has become valuable industrial property. You can see this on Google Maps (or building square footage stats in the S1) where for example the Lawrenceville, GA site looks quite a bit larger than many of its other DCs (as well as its peers which also tend to have smaller DCs). Also in the S1 is an interesting comment where the company states it could increase capacity by 50% with minimal investment. This implies an oversized footprint, particularly if the company is targeting a higher mix of Specialty products. So it seems the door is now opening for the company to pursue a product mix and footprint that are more in tune with another.

Timeline

-          5/2004: Cerberus buys distribution assets from GP in management-led buyout valued at $824M.

-          12/2004: Just under half of BXC shares come public under an IPO.

-          6/2006: Current 10 year CMBS put in place.

-          3/2008: Stephen Macadam resigns as CEO.

-          3/2008 to 10/2008: Howard Cohen serves as interim CEO.

-          10/2008: George Judd, former BXC COO and GP vet, hired as CEO.

-          8/2010: Cerberus freeze out attempt initiated at $3.40, subsequently upped to $4.00. On the then 44M fully diluted share count, the $4 offer implied a market cap of $176M. Adding the 6/30 net debt figure of $429M, we get a TEV offer of $605M. This for a company with $4.3M of LTM ebitda in a housing market that would do 586k single family (“SF”) starts. The offer was subsequently blocked by remaining shareholders as 90% of shares were required to be tendered. There are some very interesting filings from this period including the Cerberus offering document filed August 2nd and a 13D filed on August 18th stating the case to block the merger. In a letter to the Board, the shareholder states net asset value (after accounting for the appraised value of the real estate) is more than 2.6x the original $3.40/share offer (or >$389M). It also refers to February 2010 management projections for $4.4B of sales and $170M ebitda in 2014 when the housing market returns to 1.3M starts. Obviously, we’re yet to see these numbers. But it’s also quite easy to see that the chief culprit is the housing starts assumptions, which proved overly optimistic, as many others of that time did. We also don’t know exactly what assumptions underlie those projections. It’s reasonable to assume it did not include the current low proportion of SF starts to total starts or a lumber price at the $300 level. Specialty / Structural product mix and warehouse / direct delivery mix are also unknown inputs. Even so, these projections and sales and ebitda levels in the 04/05 time period make for useful data points as we try to forecast what this company can do when housing starts do indeed return to more normal levels.

-          7/2011: Cerberus leads PIPE for 18M shares at $2.10 for $37M of capital raised.

-          3/2013: Cerberus leads PIPE for 23M shares at $1.75 for $40M of capital raised.

-          4/2013: CEO George Judd resigns. Howard Cohen serves as interim Executive Chairman during CEO search.

-          2Q 2013: Ill-fated and poorly timed oversized inventory position contributes to disastrous 2Q results. This quarter highlights the sometimes ugly performance that results from speculative inventory positions or the pursuit of an improper operating strategy.

-          5/2013: BXC strengthens board presence with two well-regarded additions. Roy Haley, former Chairman and CEO of Wesco International becomes Chairmen and Kim Fennebresque, former CEO of investment bank Dahlman & Rose, join the board. Both deepen the independent side of the bench with Haley bringing considerable distribution operations experience and Fennebresque bringing sound strategic and financial counsel to the company.

-          1/2014: Mitch Lewis joins as CEO. His prior role was as CEO with Euramax, another building materials products turnaround effort. Early BXC initiatives include a focus on streamlining its inventory position and pushing a more decentralized and cost-efficient operational model.

-          5/2014: Susan O’Ferrell appointed CFO. She joins after a 15 year career with Home Depot and leaves as former VP of Finance with particular focus on At Home Services group.

-          1Q 2015: BXC reports second ebitda positive first quarter in seasonally difficult Q1 (after 2014 Q1) in the last eight years. This report points to good success on cost cutting initiatives and their ability to be profitable at a low volume levels.

-          6/2015: SVP Sales position eliminated. This move further enables the path forward to a more decentralized operating structure.

-          2Q/2015:  BXC reports ebitda of $10M. The company reports topline sales down -3%, hurt by a   -7% decline in commodity pricing and a -3% hit from a lost contract to a big box retailer. Notably the contract loss in the direct shipment category was from the lowest margin business segment and least sticky delivery channel. Structural volumes were +1% and specialty volumes were -1%. BXC reports further progress on decentralization initiative with its VPs now reporting directly to the CEO. Positively, the warehousing segment, the highest margin and stickiest business is now 73% of sales, the highest in company history.

-          7/2015: NYSE standards listing notice issued on July 31st after shares fall under $1. The company states listing criteria will be met either through improving financial results or if necessary, by a reverse stock split. Note standard protocol would indicate the reverse split would come after approval from shareholders at the company’s shareholder meeting, expected to be held in May. 

-          8/2015: Board member Ron Kolka leaves. The move appears to be related to recent Cerberus / Remington related actions.

-          10/15: BXC issues 8-K on October 2nd to respond to unusual trading activity. Bluelinx states it’s unaware of a fundamental reason for sell-off and states it hired Eastdil Secured to assist with its mortgage and associated real estate portfolio actions.

-          3Q/2015: The updated appraisal per Eastdil indicates property valuations in the $332 – 352M range, in line with the 6/06 appraisal which the company had previously relied upon.

Scenario Analysis and Return Outcomes

Handicapping potential outcomes here isn't a terribly precise exercise. We simply don't know just yet what actions the company will take when 2016 rolls around and the company has the operational flexibility it has lacked for the last ten years. Given the company has hired Eastdil Securities to assist it with its RE portfolio and has also commissioned an updated appraisal for the property valuations, it's reasonable to believe some level of asset repositioning is likely. And with the market cap of $60M and asset values of $600M (or ~$851 after adjusting for the value of the DCs) resting at such a wide disparity, it seems sales here should be value creating. Given the complexity in estimating the impact to the company's financials stemming from the unknown level of asset sales and pursued path forward, let's triangulate around a couple of possible paths forward. For the downside case, we’ll assume housing starts don’t roll over and use NAV and a theoretical liquidation value as a starting point. For the base case, we’ll assume no property sales and the company pursues the path forward that looks most like the company’s historical operations. And for the upside case, we’ll assume the company has some success in evolving their operations to a higher margin mix.

Downside case: The real estate adjusted book value calculation yields a value of $2.44. Depending on the haircuts put on the inventories (85%), receivables (90%) and machinery (75%), a liquidation analysis cuts that figure in half, to $1.24. The traditional liquidation haircuts are probably a little penal in this case given the PE ownership would likely imply stability through a sale. Even so, we’ll use the liquidation analysis as our downside case. This of course is absent a macro shock or housing downturn. But even in the event housing starts did roll over, it seems the company’s real estate and working capital would again provide a cushion to enable the company to survive through another down cycle, provided of course it doesn’t last another six years as the last one did. Downside case = $1.24.

Base case: With most of 2015 in the books, we’ll use it as a jumping off point for future projections. We will use 10% growth as a SF starts forecast and we’ll basically hold the mix and cost structure relatively constant with what we’ve seen so far in 2015. We’ll assume no asset sales, minimal improvement in working capital and a steady product mix across the Structural and Specialty categories. We’ll then compare this to some of the ebitda margins proffered in the old management team’s projections. While we don’t know what mix or real estate assumptions the old projections incorporated, they should prove a useful point of comparison. For our TEV calculation, we’ll assume some minimal debt paydown from these levels as without a change in mix, the company’s improvements in the working capital position are unlikely to be very dramatic. With 10% SF starts growth to 2019, we arrive at a market building 950k+ SF houses a year and a company doing a 3.0% ebitda margin on $2.6B. Our buildup doesn’t land too far afield from the prior projections, where we believe the major reason for the shortcoming is the lack of housing starts and the skew towards multi-family. For the sake of comparisons, the prior projections called for a 3.4% ebitda margin in FY13, when they expected to be running at a clip of 1.2M total starts, a number that likely implies a similar level of SF starts given that many expected SF to continue to contribute the ~85% of starts to total starts it historically had. At 7x FY18’s $78M ebitda, we have a TEV of $550M. Assuming the company ends FY18 with net debt of $355M versus the $429M at FYE 14, we arrive at a valuation in the low $2s. Not bad for a three year return on assumptions that feel conservative.

Upside case: We’ll use the same macro assumptions we’ve used in the base case, with SF starts growth at 10%. Given we don’t know what level of asset sales the company is likely to pursue, we’ll assume none for simplicity. This will omit the improvement to the company’s balance sheet through its real estate sales and associated inventory run off. This will also not capture the impact of any potentially reduced sales as a result of a smaller footprint, which is a possibility. However, in attempt to highlight some of the benefit achievable from a better mix, we will give the company credit for these moves by growing their Specialty mix to 75% of GP from 70% and give them a lower working capital requirement. We’ll assume the company can move from its 15%’ish level as a percent of sales to 10%, still a far cry from HBP’s consistent 8%’ish levels. Commensurate with the working capital improvement, we’ll accelerate the debt paydown given the minimal capex needs and the $2B of NOLs that will minimize the tax bill going forward. In the upside case on the same macro assumptions, we’ve now got a company doing $100M of ebitda on $2.5B in sales. Aside from the obvious benefit the higher margin product lines carry for the company’s profitability levels, the lower working capital requirement can facilitate a faster paydown in debt, creating an impact on the equity valuation that could be quite dramatic. Should the company be able to move towards a working capital level near 10% of sales, it could pay down $200M of debt by FYE18. Putting a 7x multiple on FY18 ebitda and a net debt position of around $225M would yield a share price in the low $5s. And that’s a return that would be quite exciting.

Questions remain in determining the most likely outcome. Even so, with valuation at such a seeming disconnect from company asset values and company end markets moving in the right direction, it seems well worth the risk to buy now and stick around to find out how this plays out.

Risks

-          Housing starts: The company needs a growing market to generate the returns discussed in the base or upside case. The pace of starts growth and the composition, single family versus multi-family, are a consideration as well given the company has relatively little exposure to the multi-family market.

-          Management execution: The company isn’t quite out of the turnaround stage yet and there’s a lot of heavy lifting to do to right-size the footprint and more profitably grow sales. Still, early signs of progress, obscured by intense lumber price deflation this year, point to competent management pursuing the right strategy.

-          Lumber prices: Per the 10K, a 10% down move typically costs BXC in ~$6M of GP in the Structural business. Commodity prices are of course very hard to predict, so we’ll spare everyone the in-depth analysis. But generally the idea is to buy low and sell high. With lumber prices recently rebounding from under $300 earlier this year, a level that over the last 20 years has generally proved to be an excellent entry point, there looks to be more upside than downside here.

-          Industry consolidation: There has been some recent high profile consolidation amongst the company’s pro-dealer customer base. At some level of scale, they may look to take these operations in house. But even after two recent deals, the end market is quite fragmented.

-          Controlled company: BXC’s PE owner doesn’t look to have always made the right moves, highlighted by the 2013 inventory position. But since then they have made good strides in the operations starting by placing solid distribution experience at the board level. They have also supported the company with capital infusions when necessary. At some point down the line, possible secondaries will present an overhang on the stock. But at these levels and given the overall position as a positive caretaker Cerberus has assumed, it seems very unlikely.

Model Excerpts

Downside case

      Base case

Upside case

Catalyst

-          Reverse stock split: In response to the NYSE listing notice, the company has stated in the absence of improved results leading to compliance with a share price over $1, it is likely to do a reverse stock split to come into compliance. Protocol suggests this would be approved at the annual shareholder meeting, expected to be held this coming May. Either action would dramatically improve the marketability of the stock as many shy away from stocks at these levels. Greater marketability would also improve liquidity, attracting further investors.

-          DC sales: Sales of certain DCs would give the company a nice cash infusion, both from the asset but the working capital as well. This would lead to immediate improvement in the company’s balance sheet and likely attract further investor interest.

-          Debt paydown: Whether through DC sales or organic cash from operations accelerated by the $2B NOL position, a balance sheet that looks more “normal” to most investors will attract much more interest while also accruing value to the equity holders.

-          Lumber prices: These are clearly cited as a risk factor as they should be. However, even a return to last year’s average price could add $10-15M to the company’s GP line.

-          M&A: The company is obviously out of the game as an acquirer at the moment, but its $2B NOL position presents a strategic asset that can be used effectively in the M&A game. The NOLs make BXC more attractive as a takeout or merger candidate. 

Disclaimers: The views expressed herein are for informational purposes only, and are not intended to be, and should not be, relied upon as an investment recommendation in connection with any investment decision for any purpose. The author makes no representation as to the accuracy or correctness of the information contained herein. The information and the views contained herein are provided as of the date this summary was posted and present the views of an investment firm that currently holds a long position in the company’s securities. The author has no obligation to update any of the information provided herein. The author reserves the right to decide to purchase, sell, or engage in any other transactions involving the company’s securities as it deems appropriate based on a number of factors. These factors may include its ongoing evaluation of the company’s financial condition, business prospects, conditions of the stock market, general economic and industry conditions and other relevant factors. Past performance is neither indicative nor a guarantee of future results.