Description

Description

Cornerstone Building Brands (CNR) is the largest manufacturer of exterior buildings products in North America.  CNR primarily produces windows and siding for homes, with approximately two-thirds of sales related to residential new construction or repair and remodel.  The remaining one-third of sales are primarily metal roofing, components, and panels for low-rise (buildings under 5 stories, such as offices and warehouses) commercial construction.  

CNR was created in 2018 after private equity firm Clayton, Dubilier, & Rice (CD&R) took Ply Gem private and later merged it with NCI Building Systems in the public market.  The resulting business was a market leading, highly levered, cyclical corporation, with significant exposure to the US economy.  

For more background, please see Motherlode’s pitch from last year.  Not only has the idea worked well since he pitched it – despite the pandemic - I believe the setup is significantly better now, and the name has passed what should be the biggest test it will encounter. 

2020

CNR entered 2020 with a 5.3x debt/EBITDA ratio, and ~40% of the business was exposed to commercial construction as an end market… if the company was going to go bankrupt, it was last year.  CNR was almost fully shut down for half of Q2, had to draw on its credit lines for a few months, and still has not seen a recovery in the commercial business.  Yet it is going to exit 2020 having done ~$240-260mm in FCF and net leverage is going to drop half a turn to 4.8x.  Now, as we enter 2021, the macro is reversing, results are going to reflect that, and I believe the stock will move much higher in the future.  

2021  

On the residential side – which has ballooned to nearly 2/3 of the business – new single-family permits and starts are hitting levels we haven’t seen since before the 2008 housing crisis.  

Multiple housing CEOs have talked about the rapidly improving outlook of the new housing market, and a few have compared conditions today to conditions during the last housing boom (read the KBH Q4 earnings transcript, for an example).  Months supply of existing housing is at all-time lows, home prices are rising at high-rates, and the Biden administration has stated that housing is a priority – the only release valve available is new housing.  

As this relates to CNR, ~1/3 of their business is exposed to residential new construction, and this shows up in the numbers >90 days after housing starts begin – windows, doors, and siding come later in the home construction process, well after framing begins.  

The window and siding industries are relatively stagnant, without massive changes in market share, and CNR has the highest market share in both vinyl windows and siding – nothing in our research suggests that this will change.  Thus, in the near future – specifically around end of Q1/start of Q2 - we expect to see the abnormally high single-family start stats flow through into sustained organic growth in the residential side of CNR’s business.  And on the 2020 Q3 call, management mentioned that the windows business would already be up 6% YoY, absent a ransomware attack that stopped supply for a few days. 

CNR also has ~1/3 exposure to residential repair and remodel.  This is a much more consistent business than home construction, as home repairs are continual and never declined more than low double digits (on a YoY TTM basis) even during the housing crisis.   R&R is more dependent on the age of housing stock and the consumer’s willingness to spend.  

However, due to the pandemic of 2020, there is a new wrinkle.  Last year, many people began working from home, and this is a trend that seems to have legs well beyond 2020.  For many, the house has now become a home/office hybrid, and at the minimum the value the average person places on their home has increased significantly, due to work, entertainment, and living in general.  Couple that newfound sense of importance with a rapidly recovering economy and likely high disposable income due to increasing gov’t stimulus, and the conditions are ripe for home R&R to sustain its upward trend for many years.  

Anecdotally, R&R backlogs and lead times for contractors/handymen in many regions of the country are still unusually high, lending credence to the belief that residential R&R should be a big tailwind for CNR. This part of the business will likely grow low to mid- single digits organically next year.  

The commercial side – now around 1/3 of the business – is the great unknown but results were so skewed due to the Q2 shutdown that it will be difficult for the numbers to be down materially in 2021 unless the economy falls off a cliff.  In Q2 of last year, both sales and EBITDA fell around 23%, and both metrics are likely going to be down around 10%+ in Q4.  

The company has stated that the commercial business has “stabilized” over the past 2 quarters, so if we apply that to next year’s numbers and drop Q1 sales and EBITDA 13%, and drop Q2 sales and EBITDA 13% versus a baseline (ie. assuming no shutdown), it results in 2021 sales and EBITDA flat for the full year (assuming constant margins).  Thus it’s entirely possible that even if commercial construction spending declines 4-5% next year, CNR commercial business will outperform, if not grow.  

There are also a couple of other reasons to be less negative on the commercial business than the market suggests.  First, 25% of the commercial business pertains to warehouses heavily exposed to cold storage and data centers, two areas that have done quite well and should continue to perform better than the broader market as trends persist in their direction.  

Second, on the whole, the commercial division is very macro-sensitive, as we saw last year.  But given consensus calls for 4%+ real rebounds in GDP, and outliers like Goldman calling for 6%+ real growth in GDP, the risk on commercial seems to be to the upside – especially when one factors in an increasing pace of vaccinations and what should be the gradual fade of COVID as 2021 progresses.  Areas such as offices could begin to bounce back later this year as vaccination efforts ramp. 

Lastly, the commercial biz typically lags the housing upturn by 1.5-2.5 years, so it’s entirely possible that by the end of the year the sentiment on commercial will flip as revenue changes direction and indicators start pointing up.  A big Biden infrastructure bill would likely go a long way towards turning the tide on the commercial business, although it’s unclear if it’s even needed for the commercial segment to begin working again. 

Mgmt/cost cuts

Beyond the macro, management and CD&R’s involvement should supercharge EBITDA growth.  Nate Sleeper – CD&R’s CEO – is on the board and has a tremendous track record investing in industrials and is one of the more creative dealmakers around, and between him and Jonathan Zrebiec the CD&R team is going to relentlessly push for cost cuts.  It is absolutely not a coincidence that Jeff Lee – the CNR CFO – was brought in from another CD&R investment to clean up the cost structure - costs are going down.  We expect around $40-60mm in cost cuts in 2021 vs 2020, resulting in margin expansion as the compounding 2020 cost cuts flow through into the 2021 numbers and the company cuts costs further this year.  

Interest expenses are going to decline as well – in the second quarter the company will likely redeem their 2026 8% bonds at a premium to par.  The 2029 6.25% bonds now trade at a YTW of 5.0%, so assuming they could issue bonds at this rate, the company will cut ~$20mm in yearly interest expenses on this debt swap alone.  In addition to this, ~40% of the term loan facility is (effectively) floating.  Thus the company will likely see a benefit from a LIBOR rate that averages below 2020’s level.  

Value/Torque

Putting this all together, the stock is absurdly cheap.  Net debt likely falls to ~$2.9b by year end and with a current market cap of $1.5b, the EV is $4.4b versus 2020E EBITDA of ~$600mm, or 7.3x.  

• Mid to high single digit sales growth for the entire company (flattish commercial biz and resi biz +HSD to +low DD) pushes EBITDA from $600mm to $640-650mm.  

• Cost cuts will bump EBITDA to $680-700mm.  

• FCF will come out somewhere between $250-300mm as interest expenses fall and working cap continues to contribute to the FCF build – working capital contribution to FCF could potentially double in 2021.  

So by the end of 2021 debt falls to $2.6-2.7b, dropping net leverage from 4.8x at the close of 2020 to ~3.8x by the close of 2021.  This causes EV/EBITDA to drop from 7.3x at the close of 2020 to 6.0x.  Meanwhile, the FCF yield will remain unusually high around 16-20%.  

Looking forward, if the EV/EBITDA level moves just slightly to 7.5x trailing, then the stock prices moves from $11.85 to $20 by year end.  

But there is reason to believe that 7.5x is the wrong multiple – that level is relatively low versus peers such as BECN (>10x trailing), DOOR/JELD (>8.5x trailing), FBM (bought out ~8.5x), and others, and it suggests that the FCF yield should stay elevated perpetually.  

As the commercial business starts to see daylight near the end of 2021, as the macro environment becomes much more favorable to a cyclical business, and as cash continues to pile up and the leverage ratio declines, I think it will be much more likely that CNR sees the EV/EBITDA ratio rise.  And due to the torque owing to a large debt balance, this results in a huge price increase from current levels, with the stock trading up to $22.60 @ 8x, and $28.10 @ 9x.  

I think a realistic price target for CNR, by year end 2021, is $20-25, equating to 7.5-8.5x EBITDA.  

Disclaimer: The information contained herein reflects the views of the author as of the date of publication. These views are subject to change without notice at any time subsequent to the date of issue. The author has an economic interest in the price movement of the securities discussed in this presentation, but the author’s economic interest is subject to change without notice. All information provided in this presentation is for informational purposes only and should not be deemed as investment advice or a recommendation to purchase or sell any specific security. While the information presented herein is believed to be reliable, no representation or warranty is made concerning the accuracy of any data presented. In addition, there can be no guarantee that any projection, forecast or opinion in this presentation will be realized. All trade names, trademarks, service marks, and logos herein are the property of their respective owners who retain all proprietary rights over their use. This presentation is confidential and may not be reproduced without prior written permission from the author.

Catalyst

- Covid Easing

- Stimulus

- New Housing