Description

The views expressed are those of the author and do not necessarily represent the views of any other person.  The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

St. Gobain is a global leader in building products trading at an undemanding valuation for normalized margins today.  We see a major sustainability catalyst and a successful management transformation that may not be finished.

Key product categories include building glass, ceilings, thermal and acoustic insulation, piping systems, roofing, flooring, etc.

They will generate about 43 billion euro of sales this year. 43% of sales and 22% of EBIT comes from distribution with the remainder from manufacturing.

Below you can see the end market and geographic breakdown.

They have leadership positions in many product categories:

• #1 flat glass maker in Europe and #2 worldwide

• #2 worldwide in plaster & plasterboard (ex-China)

• #2 worldwide in insulation

• #1 worldwide in mineral wool

• European leader in building materials distribution

• #4 worldwide in U.S. in exterior products

• #3 in U.S. for roofing

• #2 in U.S. for Vinyl siding

• #3 worldwide in suspended ceilings

• World leader in ductile cast iron pipe systems

We believe they are on the precipice of a structural change in growth driven by sustainable construction spurred by the European Green Deal.  70% of Saint Gobain’s products are “sustainable” and since the announcement of the Green Deal, they have noted revenue growth acceleration and market share gains across various geographies and product categories.  This is in the very early stages.

What is the European Green Deal?

Launched in 2020, the European Green Deal is a plan put forth by the European Commission to transform the EU into a resource efficient economy and be the world’s first climate neutral bloc by 2050. The large goals are 55% emissions reduction by 2030 (compared to 1990 levels) and no net emissions of greenhouse gases by 2050. EU emissions have already dropped by 25% from 1990 to 2019, so the plan requires an additional drop of 40% to achieve the 55% target.

They are planning to spend 1/3 of the 1.8 trillion euro investments from the NextGeneration EU Recovery Plan towards the Green Deal.

Building renovation is “meant to be one of the flagship programs of the Green Deal. The buildings sector accounts for 40% of energy consumption in the EU (80% of which is heating and cooling) and 36% of energy related emissions. The key objective there is to “at least double or even triple” the renovation rate of buildings, which currently stands at around 1%.”

As it relates to building renovations, the Social Climate Fund will provide EUR 72.2 billion over 7 years in funding for renovation of buildings, access to zero and low interest financing, or even income support. “In addition to homes, public buildings must also be renovated to use more renewable energy, and to be more energy efficient.”

The Commission proposes to:

• require Member States to renovate at least 3% of the total floor area of all public buildings annually

• set a benchmark of 49% of renewables in buildings by 2030

• require Member States to increase the use of renewable energy in heating and cooling each year, until 2030

  According to JPM, the 55% reduction will require EUR 275 bn of investments per year, representing 32% upside to the Euroconstruct’s renovation spend estimate.  (Nothing precise about this, just trying to get the right order of magnitude.)

  

  What does this mean for Saint Gobain? Some back of the envelope math argues that this could be a significant revenue driver and lead to ~$1.00+ of incremental EPS.

   

  What are their sustainable products?

  The Group offers solutions for sustainable construction through a variety of products including insulation and glazing solutions.  These include building glass products which help provide thermal insulation, their Gyproc Ergolite plasterboard with a 25% weight reduction for a reduced carbon content, ultra-lightweight glazing developed for automobiles by Sekurit, reducing the weight of a car by up to 6 kg. Their double glazed windows have the ability to reduce yearly energy expenses. A study by the French Environment and Energy Management Agency found that 30% of the heat escaped through a non-insulated house in winter or entering in your home through summer goes through the roof. Thus, their ISOVER solution can help consumers save on their annual heating/cooling bill.

   

  New Management

  CFO Sreedhar N. has been with the company since 1994, starting as a low-level accountant at one of the company’s Indian factories.  He became CFO in January 2019, the first non-Frenchman in that role. He is hyper focused on working capital management, FCF generation and thoughtful capital allocation. He was in charge during the execution of their Transformation and Growth plan which resulted in significant margin expansion.

  New CEO Benoit Bazin replaced Pierre-Andre de Chalendar effective July 1st, 2021. Bazin had been with the company since 1999 – first in France and starting in 2002, in the United States. During 2017, he was President and CEO of CertainTeed Corporation in the United States. He was appointed Chief Operating Officer of Compagnie de Saint-Gobain on January 1, 2019 and elected to the Board on June 3, 2021. He was appointed Chief Executive Officer as from July 1, 2021.

  We would encourage you to listen to their presentations at the company’s October investor day.  We find them honest, conservative and focused on the right things.  Where they could have hyped cyclically high margins they have consistently talked down to a normalized number.  Where they could have hyped a reduction of working capital, they conservatively guide to a portion of that coming back as supply chains normalize.  They are frank about how poorly the company was managed in the past and we believe they have addressed the right things. 

  You have probably found too that when the right management comes to a poorly managed company they tend not to be “done” after two or three years.  There may be a whole new level possible here that we can’t see yet as they take it a step at a time.  The CFO does not sound like the type who is ever satisfied.

   

   

  Margin Transformation – In Nov 2018, the company launched a 2-year transformation & growth plan. As part of this, they restructured the business to increase local team accountability, simplified the decision making process by removing layers, aligned incentives, significantly pruned the portfolio by divesting underperforming businesses, and generated significant cost savings (EUR 250 mm). Fifty-five percent of these cost reductions came from simplification of the internal structure, 20% from more streamlined support functions and central functions, and 20% from synergies and optimizations obtained at country level. These initiatives are reflected in a significant step up in margins. They had EBIT margins of 7.7% in 2018 and had LTM margins of 10.4%. The company believes 180 bps of the step-up from 2018 is structural and here to stay, implying a new normalized margin baseline of 9.5%.

• Of the 180 bps of structural improvement, 120bps are driven from their transformation plan, and 60 bps from structurally higher volumes in Europe. They are benefiting from 90 bps of “non-recurring” margin benefit from price-cost spread and pent up demand from COVID.

• Part of the margin benefit from their transformation plan came from EUR 5.3bn worth of sales divested since end of 2018 (with 2% EBITDA margins) and the acquisition of E1.5bn in sales (with 20% EBITDA margins).  Get out of bad businesses and invest in good businesses.

Financials

Sales have been flat over time due to a slow growing renovation market and divestitures. Margins have expanded significantly over the past few years (as noted above) with a large part of this driven by their Transformation & Growth Plan initiated in 2019. GAAP to non-GAAP adjustments appear recurring but cash flow nicely matches non-GAAP earnings. Largest addbacks include capital gains and losses on disposals, asset write-downs and material non-recurring provisions – nothing looks particularly concerning but I would hope to see these abate as the cost savings initiatives and large divestments are behind them. They are expected to generate EPS of about 5 euro this year.

Strong balance sheet with 1.2x net leverage. They ended 2Q21 with cash of $6.6 bn, debt of $7.58 bn implying net debt of $7.58 bn which is a 1.2x leverage ratio on 2021E EBITDA.

FCF conversion has improved and has actually been ahead of earnings the past couple years due to working capital. Capex has historically approximated D&A, which makes sense as they haven’t been growing.

Over the past 5 years, they have been somewhat acquisitive while also divesting less profitable businesses. 2020 aside, they have paid a dividend of ~700 mm/year (2% yield) and done some share repurchases. Looking forward, they are interested in investing in growth both organically and through M&A.

Valuation

We underwrite earnings to a 9% normalized EBIT margin.  That is a bit less than some are thinking but is about where management is comfortable guiding.  This could rise over time but we are not assuming that.  The stock is currently trading at an undemanding valuation of 13x EPS, a 7% FCF yield and 7x EV/EBITDA.

That is about 10% below fair value in our view if there were no future growth.  But clearly we believe there will be.

We quantify the growth part thinking about reinvesting 1/3 of the earnings at a 25% return on incremental capital.  For a five year runway that comes out to about 20 euro per share incremental intrinsic value.  But the runway could be a lot longer than that in European renovation.

To simplify, to buy St. Gobain you need to believe two things:

1. the margin transformation sticks

2. they are a beneficiary of the European New Deal and see strong revenue growth in their core business and can execute on that opportunity at a high return on incremental capital

Catalyst

Sustainability spending in Europe