Description

Leslie’s is a pool retailer that sells chemicals and pool equipment. The company grew revenue +60% and EBITDA +80% since 2019, after chlorine shortages drove Trichlor chlorine tablet prices up +2.5x. Total Leslie’s pricing is up +20%, with temporary market share gains driving volumes up another +30%. Chlorine has recently come back into balance, with prices starting to fall and Leslie’s losing market share again. We expect revenues and earnings will decline in 2023, and are -30% below consensus EPS estimates. At 17x $0.55/share EPS in 2025, discounted back to 2022 is a $8/share price target (-50% downside from $16/share today).

Thesis

(1) Chlorine prices are declining

• Chemicals are 45% of Leslie’s sales, of which 15% are Trichlor chlorine tablets. Trichlor prices are up +2.5x due to a supplier fire in 2020, driving the entire pool chemicals value chain. Leslie’s chemical prices up +50% since 2019, so total Leslie’s prices are up +20%.
• Chlorine prices have recently started declining with prices down -15%, and are expected to decline further in 2023. The supplier factory was rebuilt, pool demand has slowed, imports have increased and inventories have been rebuilt.

(2) Leslie’s organic volumes have been declining for 20 years

• While Leslie’s promotes its growth algorithm as +M-HSD revenue growth, we calculate Leslie’s same store volumes have been declining -1.5% per year for 20 years, as they’ve lost share to Walmart, Home Depot and Costco.
• Leslie’s volumes grew +30% since 2019, as they temporarily gained market share during the chlorine shortage when their retail competitors were out of stock. There are three chlorine suppliers in the US, and Leslie’s fortunately sourced their chlorine from the two that did not have a fire.
• With chlorine supply normalizing, Leslie’s volumes have recently started declining. Customer file declined in the June quarter, and data shows transactions down -10% Y/Y in the September quarter.

Leslie’s overview

Leslie’s is a pool retail chain with 15% market share for DIY pool products.

• Chemicals (45% of sales): chlorine tablets, chlorine shock, liquid chlorine, specialty chemicals
• Equipment (30% of sales): pool pumps, filters, heaters, robotic cleaners
• Other (25% of sales): pool covers, pool toys, lounge chairs, rakes, nets, hot tubs, above ground pools

Source: Leslie’s presentation, ICR conference, January 2022

Leslie’s was founded in 1963. It has been owned by 4 different private equity firms.

• The company was founded by Phil Leslie with a single store in Los Angeles, CA.
• Hancock Associates acquired the company in 1987, when it had 66 stores, for $23mm.
• Leslie’s went public in 1991 with 80 stores at a $60mm valuation.
• Leonard Green and Hancock Associates acquired the company in 1997, with 280 stores, at a $140mm valuation.
• CVC and GSO acquired the company in 2010, with 645 stores. The price was not disclosed.
• L Catterton and GIC acquired the company in 2017, with 890 stores. The price was disclosed.
• Leslie’s became public, for the second time, in October 2020, with 936 stores, at a $4bn market cap.
• LESL currently has a $3bn market cap, $40mm ADV, $0.5bn short interest (22% of float).

Chlorine prices are declining

Leslie’s has tried to understate the importance of chlorine to their business.

• With their S-1 filing in October 2020, Leslie’s disclosed that chemicals are 45% of sales. They have not updated this number since then. During their IPO roadshow in October 2020, they disclosed that their chemicals business was 10% Trichlor tabs, 15% shock and other sanitizers, and 20% specialty chemicals. 
• On their Q2 2021 earnings call, they disclosed that “chlorine” prices were up +40% Y/Y, and contributed +300bps to comparable sales. We can back into chlorine being ~10% of sales.
• On their Q4 2021 earnings call, they disclosed that “Trichlor” added +600bps to comparable sales in FY 2021, with +$40mm from price and +$30mm from volume. Sales growth was +21%, so the implication was that growth excluding Trichlor was +15%.
• The company has not disclosed the impact of Trichlor or chlorine to total sales since Q4 2021, even though chlorine price inflation accelerated in FY 2022.

Source: Leslie’s FQ4 2021 presentation

We believe chlorine drove most of Leslie’s price inflation.

• Leslie’s disclosures around chemical inflation has been very specific: Trichlor tabs. But the Trichlor tab shortage has driven strength in the entire chemicals value chain. First customers went into other forms of chlorine tabs (Dichlor), then other forms of solid chlorine (granulated chlorine), then liquid chlorine. After that, they went into salt systems, borates, enzymes and ultra-violet light. The prices of all of these products have risen sharply.
• PoolCorp chemicals prices are up +50% vs. 2019. (They disclosed chemical prices were up +19% Y/Y in Q2 2021 and +40% Y/Y in Q1 2022). Chemicals are 10-15% of PoolCorp sales, with Trichlor 20-25% of the chemicals business.
• Leslie’s disclosed company-wide prices were +8% in 2021, +10% in 2022, for +20% price increases vs. 2019. They don’t report price every quarter, making them one of the few retailers we track that don’t disclose traffic vs. ticket. We estimate chemicals pricing has driven most of their company-wide price growth, with the 45% of their business that are chemicals up +50%, which includes the 15% of their business that is Trichlor up +100%.

Chlorine prices increased +2.5x from 2020 to 2022.

1. Factory fire. BioLab’s factory burned down in September 2020, after it was hit by Hurricane Laura in Westlake, Louisiana. There are only three suppliers in the ~300mm lb chlorine tab industry: BioLab (120mm lbs), Occidental Petroleum (120mm lbs), Clearon (40mm lbs) and imports (20mm lbs). BioLab’s fire took 40% of the US capacity off the market for 3 years.
2. Increased demand. Chlorine demand is a function of pool usage. Leslie’s estimates pool owners have used their pools +6% more since covid, increasing from 16 to 17 days per month.
3. Increased commodity input costs. The most common form of pool chlorine is Trichlor, which combines chlorine, caustic soda and urea. Over the last three years, caustic soda prices are up 2x, urea up 5x.
4. Increased transportation costs. Chlorine is a low price-to-weight product (a 50lb tub used to cost $100), so increased trucking costs impacted the retail price of the product. Also, the marginal source of chlorine tabs is imported from Japan, with higher ocean freight costs adding to US costs. After the BioLab fire, the US market started sourcing from China as well, paying the 78% anti-dumping tariff just to get product.

Leslie’s argues that chlorine prices will not go down. This is parroted by the sell-side analysts covering the company.

• FQ2 2022 earnings call: “We get a lot of questions about what happens to chlorine tabs pricing reverses and we have price deflation. We do not believe that is likely in the near or medium-term… Any absolute increase in Trichlor supply will need to come from high-cost imports, where new domestic capacity utilizing high cost imported chlorine and all Trichlor manufacturing will be analyzing high-cost urea. Given these challenging supply dynamics and continued robust demand, we believe it is highly unlikely to cost of Trichlor and the retail price of chlorine tabs will go down in 2023.”
• FQ3 2022 earnings call: “We still think there's a lot of cost pressure on the Trichlor across the manufacturing base, particularly in North America. So we don't see what has been established as the new retail prices coming down, but we would expect a more normalized promotional rate, which is what we believe we saw in Q3… I don't think we're going to see any significant decrease in Trichlor costing. And based on that, I think the industry pricing will hold.”

Source: Leslie’s FQ2 2022 presentation

We believe chlorine prices have already rolled over.

• Chlorine availability has improved. BioLab has rebuilt the Westlake factory: they broke ground on a 30% larger plant in July 2021 which opened in August 2022. The factory is currently ramping production.
• Industry inventories have been rebuilt. In FQ3 2022, Leslie’s inventory dollars were up +61% Y/Y against sales up only +13% Y/Y, so inventory days were up +40% Y/Y. From their FQ3 earnings call: “Most of the inventory growth is in Trichlor”. Counter-seasonally, inventories increased from FQ2 (March) to FQ3 (June).
• In the last month, Leslie’s has started promoting Trichlor products. Their 50lb tub sold through Amazon (their benchmark product through their main online channel) is now -15% off, see chart below.

Source: camelcamelcamel.com

Leslie’s inventories ($mm)

Leslie’s organic volumes have been declining for 20 years

Leslie’s highlights its business grew +7% per year from 2000 to 2021.

• The company promotes its “growth algorithm” as +M-HSD revenue growth per year, which consensus models going forward (+6% in 2023, +6% in 2024).

Source: Leslie’s FQ2 2022 presentation

We calculate that organic volumes have been declining -1.5% per year over the last 20 years.

1. From 2000-2019, revenue grew +6.5% per year. This excludes +50% revenue growth from 2019-2021.
2. From 2000-2019, branches grew +5.2% per year. Revenue per branch has grown +1.2% per year. Branches are now mature and expected to grow only +1% per year going forward.
3. During 2012-2016, the company made 3 eCommerce acquisitions that added +$200mm to revenue (+25% impact). Excluding acquisitions, branch revenue grew +4.9% per year. Revenue per branch has declined -0.3% per year. This business has been comping negative for decades!
4. We estimate pool inflation has averaged +1-2% per year over this period. That means organic volume per branch has been declining -1.5% per year. Compounded over 20 years, branches in 2019 had -25-30% less volume than they did in 2000. We believe Leslie’s has been losing market share to Walmart, Home Depot and Costco, all of whom are lower price competitors.

Leslie’s AUV (revenue per store, $mm)

Source: see Appendix B. Leslie’s disclosures from prior public ownership (1991-1997), public bond filings (1998-2009), S-1 disclosure (2017-2019), current public ownership (2020-2022) and private equity press releases (2010, 2016).

Leslie’s discloses that eCommerce is 25-30% of sales.

• This is misleading, as lesliespool.com is only 2% of sales, with limited integration with the brick & mortar business. “Buy online, pickup in store” only started last year!
• The majority of their eCommerce business are three acquisitions made in 2012-2016, which are not integrated with lesliespool.com. Leslie’s brick & mortar is high price, high service, which doesn’t work with eCommerce. Leslie’s eCommerce sales come from different brands (Pool Supply World, In-the-Swim) using lower prices.
• Leslie’s eCommerce business is only 25% pure eCommerce (= a website). The rest is 25% catalogue (chlorine sold through a catalogue to Midwesterners, which is a declining business) and 50% Amazon / eBay / Walmart storefronts (which are low value, low margin, competitive businesses).

The chlorine shortage drove temporary market share gains, which are now unwinding.

• When the BioLab Westlake plant burned down, Leslie’s was very lucky: they bought their chlorine from Oxy and Clearon, not BioLab. They were able to have access to chlorine when the market went into shortage.
• Leslie’s volumes are up +30% vs. 2019. We estimate the majority of their volume growth came from market share gains from the chlorine shortage. In FQ2 2021 they started disclosing their “customer file” (unique customers in their database) grew +15% Y/Y in 2021.
• The customer file has already started declining in FQ3 2022 (June), which the company attributed to chlorine comps: “Total target file growth was minus 1.7% a quarter. The comparison to last year is distorted by outsized file growth in Q3 2021, driven by the pervasive media coverage of the chlorine shortage. Adjusted for that event, file growth was 5.5%”. This suggests the company calculated +7pts of their +15% customer growth were temporary chlorine customers.
• Credit card data shows that transaction volumes are down -10% Y/Y in FQ4 2022 (September), with unique customers down -9% Y/Y. The volume declines are accelerating, with September volumes down -14% Y/Y.

Customer file growth (% Y/Y)

Credit card data

Growth (% Y/Y)

Source: Earnest Research

Valuation

At 30x 2025 earnings on our estimates, Leslie’s is not discounting chlorine price declines.

• On consensus 2023 estimates, Leslie’s trades 16x P/E, 15x FCF, 11x EBITDA and 2x sales. On our estimates, which are -30% below consensus, Leslie’s trades 24x P/E, 24x FCF and 14x EBITDA.
• Leslie’s bulls point to PoolCorp as the aspirational comparable. POOL currently trades at 20x NTM P/E and 15x NTM EBITDA. Historically POOL has traded 27x P/E and 19x EBITDA, the LESL bull case is that it should trade at a small discount to POOL.

Leslie’s has -50% downside to our target price.

• Base case target price of $8/share in YE 2022 (-50% downside from $16/share today), based on $0.55/share EPS x 17x earnings multiple (9.5x EBITDA multiple), discounted back two years at 10%.
• Bear case target price of $5/share in YE 2022 (-66% downside), applying 12x earnings (7.5x EBITDA multiple), which is a more appropriate multiple for structural volume declines and market share losses.  
• Bull case target price of $23/share in YE 2022 (+55% upside). Earnings grow to $1.10 in 2025 based on algorithm from FY 2022 (adjusting for higher interest expense). PoolCorp historical P/E multiple of 25x applied (15x EBITDA multiple). The stock IPO’d at $22/share in 2020 and peaked at $29/share in 2021.

Risk factors

• Unit growth. Leslie’s has 1,000 locations, but management believes they have white space for 700 more locations. There are 8,000 mom & pop pool retailers in the country, Leslie’s can either acquire them or take their share.
  • Mitigant: Leslie’s is mature, unit growth has slowed. In the last 5 years, they have averaged 15 greenfields and 10 acquisitions per year. If they really had a 700 location opportunity, this cadence would take them 50 years to reach it!
• Pro initiative. Leslie’s is gaining share within Pro by competing with PoolCorp directly. Pro is 15% of Leslie’s sales, and growing quickly (+86% vs 2020). Leslie’s has 79 Pro store locations, and has identified white space for 200 more locations.
  • Mitigant: Leslie’s Pro growth was aided by their access to chlorine. The Pro business will unwind with the chlorine cycle.
  • Mitigant: Leslie’s Pro growth has not been substantially faster than PoolCorp (+47% vs 2020) or PoolCorp’s chemical business (+60% vs 2020).

Appendix A: Pool industry overview

The pool industry is a $23bn revenue industry at retail prices.

• $7bn new pool market. Split between pool construction (concrete, fiberglass, vinyl) and pool equipment (pumps, heaters, filters, lighting, automation).
• $8bn aftermarket. $3bn pool equipment, $3bn chemical sales (chlorine), $1bn service.
• $8bn remodel. Discretionary spending on pool equipment.

The industry builds 120k new pools per year.

• 120k new pools at $56k per pool. New builds peaked at 180k in 2005, troughed at 50 in 2012. Grew from 78k in 2019 to 117k in 2021. Expected to grow to ~120k in 2022.
• 5.4mm install base at $1,500 per pool per year. $600 equipment, $600 chemicals, $300 service. The install base grows 1% per year (= 120k new pools – 50k attrition = 70k net pools on 5.4mm install base).
• 500k remodels at $15k per remodel. 10 year useful life (= 5.4mm install base / 500k remodels). Grew from 475k in 2019 to 543k in 2021.

Revenue drivers depend on where companies sit in the value chain.

• Pool equipment manufacturers (PNR, FDR SM, HAYW) are 25% new, 75% aftermarket, driven by remodeling.
• Pool construction manufacturers (SWIM) are 70% new, 30% aftermarket.
• Pool retail (LESL) is 5% new, 95% aftermarket. Focused on chemicals (45% of sales).
• Pool builders are private companies, mostly new pool driven.

Source: PK Data

Industry revenues grew +60% from 2019 to 2021.

• We estimate new pools up +100% (+50% units, +30% price/mix), aftermarket up +45% (+2% units, +40% price/mix, partially driven by chlorine prices up +50%), and remodel up +60% (+15% units, +40% price/mix).
• The industry benefited from covid “work from home”, with people spending more time in their houses. This was compounded by sold-out recreational goods (boats, RVs) and limited vacation travel, activities that traditionally compete with pools.
• There were also one-time benefits from the Texas freeze in February 2021 (~100k pools needed their equipment replaced) and a regulatory requirement to change from single speed to variable speed pool pumps in July 2021.

Appendix B: Revenue per store

Appendix C: SG&A

Leslie’s SG&A has grown out of control.

• SG&A dollars are up +66% from 2019 to 2022, compared to revenue up +67%. Despite a tailwind from chlorine prices, Leslie’s has not been able to lever SG&A margins.
• With branches up only +4%, and we estimate organic volumes up only +30%, we believe the majority of the +66% SG&A inflation has been wage inflation. In their 10-K, the company used to break out SG&A between “sales volumes” (= more employees) and “compensation expense” (= higher wages), but in the last two years has started bundling this disclosure together.
• In our research, we’ve found that Leslie’s has struggled to attract and retain knowledgeable branch managers. This cost inflation may be structural.

Source: Leslie’s 10-K and 10-Q

Disclaimer: The author of this memorandum presently has a position in securities of this issuer and may trade in and out of these positions without notice.  This memorandum is for discussion purposes only and is not intended to be, nor should it be construed or used as, financial, legal, tax or investment advice or a general solicitation.  This memorandum is as of the date posted, is not complete and is subject to change. The data contained herein are prepared by the author from publicly available sources and the author's independent research and estimates. Certain information has been provided by sources believed to be reliable, but has not been independently verified and its accuracy or completeness cannot be guaranteed and should not be relied upon as such.

Catalyst

Earnings on November 30