LATHAM GROUP INC SWIM S
December 04, 2021 - 4:02pm EST by
fulton4915
2021 2022
Price: 25.10 EPS 0.50 0.72
Shares Out. (in M): 120 P/E 50.2 34.9
Market Cap (in $M): 3,008 P/FCF 54.6 27.9
Net Debt (in $M): 143 EBIT 54 116
TEV (in $M): 3,152 TEV/EBIT 58.0 27.2
Borrow Cost: Available 0-15% cost

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Description

Latham (SWIM) is a manufacturer of fiberglass and vinyl pools, pool covers and vinyl pool liners which has benefitted from COVID-induced demand for its products. Latham was founded as a vinyl pool manufacturing company in the 1950s, transitioned to private equity ownership, and was acquired out of bankruptcy by Littlejohn & Co in 2010. Littlejohn sold the business to Wynnchurch Capital in 2015, and in late 2018 Latham was again acquired by Pamplona Capital Management for $375mm (Wynnchurch rolled a significant stake). The business went public in April 2021 and as of December 3, 2021, trades at an enterprise value of $3.0Bn. We believe that Latham is a classic over-earner story with a valuation that cannot support implied growth under any reasonable set of fundamental operating assumptions.

Our research into this name started with a broader study of the pool industry of the United States given the prevalence of pool IPOs over the past year (in addition to Latham, pool products retailer Leslie’s went public in October 2020 and pool equipment manufacturer Hayward Holdings went public in March 2021). We note that Leslie’s was written up by beep899 in September 2021 and would encourage readers to review that pitch for further context. Our view and a couple of simple conclusions on the pool industry are summarized below:

-The pool industry has an interesting history of growth in the United States, with roots which can be traced to the post-WWII “baby boom” and the start of a national migration to the sunbelt states (California, Arizona, Texas and Florida). These four states account for the majority of the installed base of pools in the U.S. today

-Beginning in the 1990s, pool construction ramped significantly with housing starts through the start of the housing crisis in the mid-2000s. Shortly before the crash, approximately 167k in-ground pools were being built each year in the United States. That number fell 70% to ~54k in-ground pools per year in 2009

-Although the economy, housing and adjacent discretionary industries have recovered from the mid-2000s, the base rate of installed base growth in the pool industry (as measured by new in-ground pool construction) has not returned to pre-GFC levels. Including a boost from COVID, 2020 growth in the installed base of pools was 100-110k or ~2/3 of pre-GFC levels. This same phenomenon is observable in other discretionary goods categories such as boats (see investor presentations of businesses such as Brunswick as an example)

-In order to explain the discrepancy between current and pre-GFC industry growth, we would highlight the increased share of recreational services spending as a percentage of total discretionary spending since the GFC. Recreational services accounted for ~60% of total discretionary spending in the 2010s (vs. ~40% in the 1970s). Of course, the share of spending between goods and services shifted drastically due to COVID. Today, recreational goods account for well over 50% of discretionary spending while spending on services has fallen closer to 40%. At a high level, we think these trends are well-reflected in the performance of businesses such as Latham both prior to and following the GFC (a period in which the spread between spending on services and spending on goods widened), and in the current COVID-driven environment (when spending has flipped in favor of goods vs. services)

-Perhaps needless to say, pools are incredibly expensive products with a long tail of aftermarket / maintenance expenses. There are three main types of in-ground pools with different costs / value propositions and considerations for the consumer:
• Concrete pools cost approximately ~$75k to build over a period of ~3 months. These pools also carry significant ongoing maintenance expenses for the pool owner
• Vinyl pools cost approximately ~$40k to build over a period of ~1 month. These pools are less durable and often require significant renovation over their lifecycle, but also carry lower ongoing maintenance expenses (about half of the expense relative to a concrete pool)
• Fiberglass pools are the “mid-price” option between vinyl and concrete (installation cost of ~$50k), but offer the durability of concrete without associated maintenance expenses, which are lower than those of both concrete and vinyl pools

As mentioned at the start of this write-up, Latham is a manufacturer of fiberglass pools (41% of 2020 sales), vinyl pools (18%), pool covers (21%) and vinyl pool liners (20%). It is important to note that each of these products, with the exception of pool covers, are big-ticket discretionary purchases which take place at the start of a consumer’s pool ownership journey or at the time of significant re-modeling work. Many readers are likely familiar with a business called Pool Corp (POOL), which has been an incredible compounding story supported by exposure to non-discretionary pool maintenance products (estimated by POOL to account for ~60% of total sales). Latham attempts to position itself in a similar light, with 95% of sales classified as “Repair & Remodel” and 5% of sales related to “New Construction”. This presentation is a fallacy if we look at Latham’s product mix referenced above. In contrast with Pool Corp. or recent IPO Leslie’s, 80% of Latham’s sales are discretionary in nature.

In addition to broader COVID-induced tailwinds which have supported the pool industry for the past ~18 months, Latham’s growth story is centered on increased penetration of fiberglass pools in the U.S. in-ground pool market. Fiberglass pools offer a tangible value proposition to the consumer (lower installation costs relative to concrete pools), and greater durability / lower maintenance costs relative to concrete or vinyl pools. Fiberglass pools can also be installed under a shorter timeframe (estimated by Latham to be 1 week vs. 1 month for vinyl and 3 months for concrete), which offers a reciprocal value proposition to pool contractors, who can install several fiberglass pools in the time it takes to install one vinyl or concrete pool. International markets such as Australia and Europe offer a clear template for fiberglass penetration in the U.S. over time. As of 2020, Latham estimates that fiberglass pools account for ~18% of the installed base of in-ground pools in the United States, while comparable fiberglass penetration is 70% in Australia, 40% in Spain and 35% in France.

Our short thesis on Latham takes no issue with increased fiberglass pool penetration in the United States, as we believe the value proposition of a fiberglass pool is obvious to both consumers and contractors. Our thesis is instead based on the following observations and assumptions:

-Sales of fiberglass pools are inherently cannibalistic to sales of vinyl and concrete pools, unlike a product such as an above-ground pool, which expands the opportunity set of potential customers (much lower cost and increased installation flexibility). Latham was founded as a vinyl pool business, and sales of vinyl pools / vinyl pool liners (sold for re-modeling purposes) were 40% of 2020 sales – about the same size as Latham’s current fiberglass pool business

-Prior to 2020, in-ground pool construction averaged ~64,000 pools / year between 2010 and 2019. Estimates suggest somewhere between 100-110k pools were installed in 2020, or 67% above the post-GFC base rate. The current pace of installation has continued through 2021, and many contractors are booked through 2022 or 2023. If the pre-COVID base rate holds any significance, several years worth of pool demand have been pulled forward

-Related to the points above, there is an incredible discrepancy between Latham’s current public valuation and its last private valuation of $375mm in December 2018. Latham’s current enterprise value of $3.0Bn is 8 times that amount over a <3 year period. COVID aside, there have been very few fundamental changes in Latham’s business over the past three years

We ran a couple of simple analyses using Latham’s growth objectives and guidance for the pool industry over the next several years. Latham suggests that they maintain a 55% share of the fiberglass pool market, and target 25% market penetration of fiberglass pools in 2023E (from 18% in 2020). Assuming that target is achieved, growth in the installed base of in-ground pools continues at ~100k pools per year, and Latham maintains its ~55% fiberglass share, we estimate that Latham sales will grow ~3% p.a. through 2023. This compares to consensus top-line growth estimates of a 13% CAGR over the next two years. Of course, there is meaningful downside to future growth if any of our highlighted assumptions prove to be overly optimistic.

Of note, our analysis assumes that increased fiberglass market penetration comes at the expense of concrete & vinyl market share. If fiberglass market penetration of 25% is achieved in 2023E, we would expect Latham’s vinyl pool and vinyl pool liner sales to decline at a ~6% CAGR from 2021 – 2023 (though we would note that implied vinyl sales in 2023 would still be above 2020 levels). We assume the remainder of Latham’s business grows mid-single-digits from 2021, in-line with historical pool industry growth.

We highlight the above as a bull case and forecast a -10% consolidated sales CAGR through 2023 in the event that in-ground pool installations revert to the historical base rate.

In summary, we believe that Latham presents an asymmetric short opportunity with a limited upside branch and an embedded put option given underlying industry cyclicality (while not at all core to our fundamental thesis). Latham currently trades at ~4x forward sales and ~19x forward EBITDA, which strike us as high on an absolute basis. We are not interested in valuation shorts, but feel that these multiples are likely to decline in the event our base case proves to be correct.

From a technical perspective, Latham trades approximately ~$7.5mm per day (L3M ADTV) with easy borrow. While we understand liquidity may be on the lighter side for some investors, we would expect this dynamic to improve as sponsors sell down their stake over time.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

We do not typically invest behind catalysts, but believe the following would help to reconcile expectations with reality:

-Gradual resolution of supply chain issues. We believe the current environment tends to exaggerate demand among contractors. Since many contractors are currently operating at capacity and not able to take on new jobs, the incremental pool buyer will call several contractors to get their pool installed (thus if five calls are made, then demand is overstated by 5x, as only one pool will ultimately be installed)

-Inflection in consumer demand which will highlight the fragile nature of contractor bookings. Bulls frequently point to the fact that contractors in the industry are booked through 2022 / 2023. We have not found any evidence to indicate that contractors have effectively locked consumers into their purchase decisions. Said differently, consumers can simply back out of their decision to purchase a pool, and any weakness in demand (potentially in the coming winter months) will highlight this dynamic

-Public company seasoning. Latham went public in April 2021, and we believe the story is not yet well understood by the market
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