Description
This idea will have plenty of skeptics, despite already being down 37% from its IPO price. There is mean reversion risk as Hayward was a clear Covid beneficiary and 3Q will be rough. New construction is slowing and guidance was cut as channel inventory is elevated. The company “proactively” reduced supply to prepare for 2023. Despite these near-term headwinds, the installed base of pools continues to grow. This will drive aftermarket revenues and should lead to healthy growth over time, even if the near term is bumpy. The industry is an oligopoly with good pricing power, high returns on capital and solid cash generation. If you own a pool, go take a look at your equipment – there’s a good chance it’s Hayward.
Besides potential macroeconomic concerns and pulled-forward demand, there is the overhang of potential sponsor (CCMP, MSD, Alberta Investment) share sales. Since this is a business I plan on owning long term, I’m less concerned with these technical pressures.
Ignoring those caveats, I think the Hayward shares are attractive at current levels. More on this later.
The business is straightforward. Hayward is a manufacturer of pool equipment for residential consumers (95% of sales) with 30%+ market share and >4,000 SKUs. Products include variable speed pumps (20%), filters (13%), cleaners (7%), gas heaters and heat pumps (20%), lighting (6%), salt chlorine generators, safety devices and sanitation and in-floor automated cleaning systems (13%). Replacement parts and other comprise the balance. A mobile app (OmniLogic) allows users to manage connected equipment and leads to SmartPad conversions. Approximately 60% of products sold today have an internet connection.
The geographic split is North America (83%), Europe (10%) and ROW (7% - mainly Australia). The majority of products are sold through specialty distributors (~76%), including Pool Corp which accounts for ~30% of sales. The remaining sales are to large retailers, major pool builders, buying groups, servicers (direct sales) and specialty online resellers. Relationships with its top 20 trade customers span 20+ years. Over 15% of products in the US are sold online. From the cost side, the manufacturing base is largely variable.
Growth is driven by several factors (management guides to HSD):
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Pricing (typically 2%-3% annually)
-More pricing took effect in June. 2H average pricing of 7%-8%.
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New products (6 new platform products) - upgrades/digital conversions.
-Benefits from these products include reduced energy and chlorine chemical usage.
-Nearly 25% of products were innovated over the past 3 years.
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Market share gains and content growth/positive mix (evidenced by higher permit values).
-Recently captured an estimated 250 bps of share.
-The average amount spent on pool equipment is up >2x over the past 10 years.
-The average variable speed pump is priced 2.4x vs the traditional single speed pump and a cartridge filter is 1.4x vs a sand filter.
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Dealer conversions. Totally Hayward Partners added >1,000 dealers ytd and 1,500 in 2021 for 10,000+ total members.
-Annual growth of 10% over the past decade.
-Sticky relationships as dealers need to buy at least 30 pieces of equipment in 3 different product categories.
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New housing.
-Migration to Sunbelt and de-urbanization.
-CFO commented that the US is underserved by 4 million single family homes. At 10 to 1 ratio, this implies 400,000 pools (3.5yrs of demand).
-New construction accounts for 80% of new pools. From 2012 to 2020, new pool construction has grown at a 7% CAGR.
-Pre war and inflation, the European pool market was projected to grow 9% annually from 2020-2026.
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Bolt-on M&A.
-Acquisition of Halco (lighting solutions) for $60 MM.
Some of these are repetitive but the total pie should grow as the installed base continues to increase (2%+ from 1990-2021 / 1.6% 2000-2021). The big risk is lower new pool construction after seeing how sales spiked during Covid. I believe some reversion to the mean is inevitable but this is tricky because pool installations are still far below prior peaks in 2005 (see graph). That was during a housing boom, I know.
*Note: 1 = 2000 and 22 = 2021 (I’m far removed from making graphs and formatting)
Regardless, the aftermarket represents 78%* of sales and this is effectively non-discretionary**. A broken pool heater or filter needs to be replaced. Theoretically, there should be pent-up replacement demand as the average pool age exceeds 23 years. This is a function of the strong industry growth from 1999-2005 (see chart above). The typical product replacement cycle is 9-12 years with major remodels/replacements at 15-20 years and significant repairs after 20 years. Furthermore, recent strength in new construction demand over the past few years delayed remodels as these customers were pushed to the back of the queue, another potential offset.
*Split between aftermarket – upgrades/repair (65%) and aftermarket – remodel (13%).
**OEM equipment as a percentage of total pool costs ranges from 10%-11%.
Determining run-rate earnings is the trick. I consider a few scenarios.
Let’s start with 2018 and 2019 performance. An inventory reduction largely due to the impact of tariffs in 2018 and cold, wet weather depressed 2019 results. For 2018-2019, Revenue and EBITDA averaged $756 MM and $183 MM, respectively. Since 2019, Hayward made $83 million of acquisitions. Let’s say that takes 2019 EBITDA to $195 MM. Add in normal market growth, some share gains and pricing and I think $250 MM+ of EBITDA is a reasonable 2023 estimate in a no-Covid parallel universe. This is well below consensus and annualized 2H 2022 guidance of ~$275 MM. Consensus EBITDA for 2023 is $350 MM.
At $250 MM EBITDA, the multiple is 13x EBITDA and 17x FCF. At $300 MM EBITDA, the multiple 11x and 13x. At $350 MM, the multiple is 9x and 11x. Even in my low case, I think you’re paying a reasonable multiple of a high quality business operating in an oligopoly with good long term growth prospects from a growing installed base, mix improvements and pricing power.
What causes this to go higher? It’s hard to say. I could see it get taken out (e.g. Berkshire-type business). If 2023 comes anywhere near consensus I think the shares will appreciate. FCF generation plowed into debt reduction, share repurchases and bolt-on M&A.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
-Takeout
-Hitting 2023 consensus
-Share buybacks
-FCF generation