Description

This write-up summarizes our Hillman Solutions (HILMN) thesis, which can be summarized as follows:

• Little growth and low ROIIC despite huge tailwinds pre-COVID
• Benefited from unsustainable factors post-COVID
• Tailwinds reversing to headwinds
• History of missing aggressive guidance
• An overvalued bad business

Business Description

HLMN sources (mostly from Asia) and sells hardware/fasteners (68% LTM Sales), protective equipment/gloves (15% Sales), keys/accessories (13% Sales), and engraving /resharp equipment (4% Sales) to Home Depot (24% 2022 Sales), Lowe’s (22% Sales), Ace Hardware (12% Sales), Wal-Mart (7% Sales), Tractor Supply (3% Sales), and other home improvement stores/retailers (32% Sales).

Little Growth and Low ROIIC Despite Huge Tailwinds Pre-COVID

HLMN began selling construction fasteners to Lowe’s in 2015 and Home Depot in 2016.  Said differently, HLMN began selling its largest product (~25% of 2022 Sales) to the largest customers in the industry.  This should’ve been a massive tailwind to HLMN.  Yet from 2014-2019, HLMN’s organic growth was only 3% and EBITDA margin fell 320bps.  Further, HLMN deployed $764mm of capital (including $549mm on M&A) from 2014-2019 yet EBITDA grew only $47mm.  This equates to a ROIIC of only ~6% or ~4.5% after taxes, so far below HLMN’s cost of capital.

Benefited from Unsustainable Factors Post-COVID

From 2019-2022, HLMN deployed $200mm of capital (including $48mm on M&A) and EBITDA grew $30mm.  This equates to an ROIIC of 16% or > 2.5x HLMN’s 2014-2019 average.  Why?  Excessive consumer stimulus and WFH led to more repair & replacement (R&R), which accelerated from 2014-2019 CAGR of 5% to 2019-2022 CAGR of 12% (SOURCE). 

In addition, HLMN benefited from significant price hikes.  Since 1Q21, HLMN raised prices by 15% or $225mm due to $120/80/25mm of higher shipping/commodities/labor costs. 

Tailwinds Reversing to Headwinds

The last time (and only other time since 1996) that R&R accelerated to a 3-year CAGR of 12% was in 2006.  After 2006, R&R spend fell the next two years and didn’t reach its new peak until eight years later.  We expect R&R to continue falling back towards trendline and act as a major headwind.  Per the graph below, we are already starting to see this.  Hence, HLMN guided to 2023 Sales falling despite huge price hikes.  As further evidence, Home Depot and Lowe’s traffic has been falling at least 7% for six straight months (Source: Placer.ai/KeyBanc).

Also, most of HLMNs costs have fallen and are much lower today, so management admits their large customers will force them to cut price.  On the 3Q23 earnings call, HLMN CEO said: “I think we would be naive to think we're not going to give some price back to some retailers next year”.  This is not surprising given HLMN’s substantial customer concentration with large retailers that have far more leverage.

On top of COVID tailwinds reversing, HLMN faces several other headwinds.  HLMN already sells construction fasteners in ~50% of Lowe’s stores and Lowe’s wants to retain multiple suppliers, so HLMN management admits it’s unlikely to gain more share.  HLMN has also been selling construction fasteners to more Home Depot stores each year since 2016, so that growth is likely to slow.  Relatedly, HLMN largest product category to Home Depot is gloves (Firm Grip brand).  But recently, Home Depot also started selling a competitor’s gloves (Milwaukee brand).

Lastly, HLMN sources most of its product from Asia.  Due to the Red Sea Crisis, ocean freight rates are spiking again and could increase a major cost for HLMN just as its customers are asking for price cuts.

History of Missing Aggressive Guidance

Unsurprisingly, HLMN came public through a SPAC in March 2021.  At that time, the company guided to 2021 EBITDA of $240mm and 2022 EBITDA of $260mm.  A few months later in July 2021, HLMN cut its 2021 EBITDA to $220-230mm and 2022 EBITDA to $245-255mm.  In March 2022, the company reported 2021 EBITDA of $207mm with $79mm of “non-recurring” items and cut 2022 EBITDA again to $207-227mm.  In February 2023, HLMN reported 2022 EBITDA of $210mm with $51mm of “non-recurring” items.  Also, HLMN initially guided to $125mm+ of FCF in July 2021, cut to $75-85mm in August 2022, and then reported only $49mm of FCF.  For 2023, management initially guided to $215-235mm EBITDA but then cut to $215-220mm in 3Q23.  We think they could miss this 2023 guidance when they report on 2/22.

On the 3Q23 earnings call, HLMN “informally” guided to 2024 Revenue being flat to slightly down but EBITDA rising.  Given the tailwinds reversing to headwinds described above, we think management could be forced to “formally” guide 2024 lower on the 4Q23 earnings call and will ultimately cut/miss its 2024 guidance.

An Overvalued Bad Business

HLMN is effectively a middle man squeezed between Asian manufacturers and behemoth US home improvement retailers.  We expect profits to continue falling and management to attempt to offset this by continuing to waste capital on bad acquisitions that destroys shareholder value.  This strategy becomes riskier when considering HLMN already has nearly 4x of net leverage.

Despite HLMN being a bad business, it currently trades for > 12x LTM EBITDA.  In May 2014, CCMP paid ~11.5x for HLMN but that was with the upcoming tailwinds of selling construction fasteners to Home Depot and Lowe’s.  Even the SPAC paid < 12x during the SPAC bubble.  We would argue that Spectrum Brands (SPB) is HLMN’s closest comp b/c SPB sources from Asia, sells to large US retailers, and has struggled to grow organically for years.  SPB trades for ~7.5x LTM EBITDA and would imply HLMN is only worth $4 per share (equating to a ~55% return on the Short).

Catalyst

Missing 2023 guidance

Formally guiding to weaker a 2024

Cutting/missing 2024 guidance throughout the year