Description

I am recommending Howden Joinery (HWDN LN), the UKs number one supplier of kitchen to tradesman (“builders”) with an estimated share of over 60% of the market in the trade only market (>30% overall). The stock is currently trading at 440p which gives it a market cap of GBP 2.6bn (all numbers are in GBP). The company has 267m of cash and no debt. In the current calendar year ending 2019 Howden earned 265m of EBIT for an EV/EBIT of ~9.5x. Returns on capital employed are >20% and the company has been able to grow organically ~5% per year over the last 4 years.  I highly recommend the previous writeups by rab and skca74 for background information.

Like all companies the shares have been hit hard in the recent sell off declining from a peak of ~740p. In my view I think this gives the long term investor an opportunity to buy a terrific business at a great price with secular tailwinds. It is a great business because it has dominant market share due to local scale efficiencies which in turn provides always available inventory to their customer  the builder. In addition, the scale and vertical manufacturing allow the company to offer great prices to the buyer (an average kitchen costs ~<3,000 GBP). Their culture is second to none as I have experienced first hand and their employees are incented through annual bonuses and P&L responsibility to be entrepreneurial.

 Given how quickly markets are moving I will be brief in what I believe are the key points and happy to respond to any questions in the Q&A. 

• What’s changed since the previous write up?

• A new CEO took over in 2019 – Andrew Livingston.

• Andrew had a great track record at Screwfix where under his leadership revenues doubled in 4 years and margins improved significantly as well. I think it’s an understatement to say he has invigorated the company by focusing on adding digital capabilities (this year builders will be able to order supplies and kitchens online), rethinking the depot layout (simply rethinking the way they stack shelves has increased capacity by 20%), reducing excess SKUs/kitchen ranges, exiting non-core countries and focusing on the UK and developing France. The early results look promising with 2019 UK sales growing 5%, gross margins improving 50bps to 62.3% and adjusted operating margins improving 60bps to 16.7%.

• They have been remodeling older stores to the new depot format called Howden 2.0. The change in the front of store layout allows to open office space, customer design centers, more kitchen displays and change in racking has shown to provide a meaningful uptick in same store sales. The new racking allows for more inventory as mentioned above and the cost of the new format is lower at 300k per depot than traditional stores. Furthermore, from speaking with management it seems as though the new depots actually have a higher annual sales base resulting in returns that exceed the depot-wide average today.  

• The company has invested in a new distribution center and warehouse. They will run 2 warehouses simultaneously in 2020 and then go to one which will save 7mm in ’21.   

• The competitive environment has become more benign for the trade only kitchen industry.

• Homebase was acquired by Hilco and while they previously had a trade business they now only have a flat pack and pre assembled offering.

• B&Q laid off their in house kitchen installers and went to an outsource model which has had extremely poor results.

• Benchmarx, which is owned by Travis Perkins has struggled to compete with Howdens and while they have tried to replicate the Howden model they are a small part of a large building materials business.

• The two remaining large players – Nobia and Wren are retail focused and so tradesman (“the builder” as Howden calls them) do not like to bring their customers there.

Secular Tailwinds:

The current Corona-virus will clearly have a near term impact on all discretionary spending. However, I believe that given the low interest rate environment and significant stimulus that will be provided in the UK there will be significant pent up demand for housing and RMI. Combined with the dampened consumer environment during the BREXIT roller coaster between 2016 and 2020 a lot of consumers were unsettled and in January of this year we started to see some positive data points begin to emerge.  Finally, the secular trend to DFM continues which will benefit Howden’s trade only business model.

 Financials:

The numbers are as follows. Note that while it is extremely difficult to forecast the impact of the coronavirus their most significant sales month is October as customers like to have a new kitchen in place for the holidays. My assumptions are based on current weakness being offset later in the year from deferred demand.

I assume the business can grow conservatively 5% per year (I think given the secular tailwinds it will likey be high single digit) and expand operating margins 20-30bps/yr given the investments they are making in new capacity and digital capacities. In this scenario EBIT will be 285m this year and 315m next. There is no interest expense and taxes are 20% for EPS of 40p in ’20 and 44p in ’21. The company is buying in shares (have bought back ~1mm shares the past 5 days) yet will still have excess cash of ~100m, or 45p per share at the end of ’21 (they use 150m as minimum cash required on the balance sheet). 

I think that given the businesses dominant position, great returns on capital and strong balance sheet it should trade at 16x-18x normalized earnings or 700-750p. This represents upside of 50%+ from current levels.

Catalyst

Great business at a cheap price