Description

NCS has been written up by maggie1002 so I will keep my write up brief.

Thesis: NCS is a cyclical business that is currently trading at 14.5x FY’17 FCF and 8x management’s FY’17 EBITDA guidance at the midpoint.  The company is a dominant player with a strategic positioning and operating leverage that has started to capitalize on the cyclical recovery of the low-rise nonresidential construction market (i.e., Banks, Hotels, Farms, Hospitals, Schools, Religious, Manufacturing, Warehouses, Offices, etc.) While it has been ~7 years into this recovery, the low-rise nonresidential construction market is still ~30% below the historical 50-years cyclical average and slightly (~13%) below the average cyclical trough (excluding 2010). We think there is more cyclical tailwind until we get to the long-term average.

In addition to the cyclical recovery tailwind, NCS is positioned to benefit from its: (1) vertically integrated business model and high incremental margins, (2) leading market position across its three segments – including a #1 position in the high growth, high-margin IMP product line, and (3) execution of its cost saving programs (expects $30M - $40M of annual savings by 2018). This combination should result in profitable growth and value creation for shareholders.

What do they do? NCI is a leading designer, manufacturer, and marketer of nonresidential metal components, building systems and coil coating solutions. The company operates across three integrated business segments:

(1) Metal Coil Coating (6% of revenue, 28% EBITDA margin): Cleaning, treating and painting flat rolled metal coil substrates

• Market Share: #1 player with 40% market share in heavy gauge hot rolled steel coating (steel heated to 1,000 degrees and shaped into structural components) and 2nd largest player with 15% market share in light gauge coil coating (room temperature steel).

• Segment Overview: This segment cleans, treats and paints (for decorative and anti-corrosion protection) flat rolled metal coil substrates (aluminum/steel) and sells them to various manufacturers of other products (i.e., water heaters, lighting fixtures, ceiling grids, HVAC, appliances and building material manufacturers.) NCI consumes 50% of this production internally in their metal components and engineered building systems groups. This segment’s exposure to steel prices is about 5% of total firm wide steel purchases since so much of the business “tolling” where the customers supply their own metal. Sales cycle in this segment range from 1 to 14 days – allowing them to raise prices immediate if steel prices increase. They operate 6 metal coil plants - 2 of which are hot rolled.

• Competitive Landscape: Highly consolidated, high margin industry. Top 4 players controls ~85% of the market. Key competitor in the light gauge coil coating market is Precoat Metals with 40% market share vs NCS 15%. NCS has the competitive advantage of internally consuming ~50% of its productions.

(2) Metal Components (55% of revenue, 15% EBITDA margin): Manufactures and distributes pre-formed metal roof and wall systems, metal partitions and metal doors and insulated metal panels (IMP),

• Market Leader: #1 player with 12% market share in a highly fragmented metal components market and #1 with 49% market share in the fast growing, high-margin IMP market.

• Segment Overview: This segment manufactures: (1) pre-formed metal roof and wall systems – consisting of: metal partitions, metal trim and doors. These products are used in new, repair and retrofit applications for nonresidential construction uses. This segment has a sales cycle of 1-14 days and should be able to react if steel prices increase. (2) IMPs which are used for walls and ceilings for industrial / commercial buildings. IMP is the most material catalyst - IMP penetration in non-residential construction is 3% in N. America while in Europe the penetration is 15%.

More About IMP (24% of sales): IMP is a high growth high margin product. It offers contractors a much more efficient means to construct energy efficient walls in a much shorter period than traditional on-site wall construction. IMPs are two sheets of cold-rolled steel that sandwich a foam core (foam is the biggest COGS component for the IMP product). It resists air and moisture intrusion, offers superior R values (the higher the R value the higher the insulating quality) and higher strength. These walls provide contractors with the ability to earn LEED credits for their projects (and charge higher prices for the property).  There are three categories of IMP:  Cold Storage (~20% margin), Industrial/Commercial (~30% margin and the most opportunity for growth), and High-end Agriculture (+35% margin - more about aesthetics). In addition, NCS owns 28 manufacturing facilities in the US (7 are IMP focused) for this segment

• Competitive Landscape: Highly fragmented market with a wide breadth of end market application and customer.  IMP is a fast growing, high-margin product. The IMP market is highly consolidated. NCS is the market leader with 49% market share, followed by Kingspan (45%) and two other smaller players. NCS acquired CENTRIA and Metl-Span to become the market leader.

(3) Engineered Building Systems (38% of revenue, 10% EBITDA margin): Manufactures and distributes custom engineered building systems for the low-rise nonresidential market. Think of it as “Lego” pieces

• Market Share: #2 player with 22% market share. Top 3 players own ~70% of the market.

• Segment Overview: This segment utilizes its structural engineers to design a complete solution for contractors that is compliant with local building codes and ships parts to the job site ready for assembly. These “Lego” systems are made of:

• Primary structural framing – pre-fabricated heavy-gauge steel supports secondary structural framing, roof, walls and externally applied loads.

• Purlins (roof support) and Girts (wall support) strengthen the primary structural framing

• Metal roof & wall systems: light-gauge steel that support the walls and roof including IMP

Engineered Building Systems has the longest sales cycle (3-4 months) and accounts for ~50% NCS steel purchase. They operate 7 facilities is the US / Mexico.

• Competitive Landscape: Highly consolidated market with top 3 player controlling ~70% of the market. Nucore is the market leader with 26% market share.  NCS is #2 with 22% market share, followed by Bluescope (26%)

Vertically integrated business model:

Source: http://www.ncibuildingsystems.com/pdf/IP.pdf

Execution on its cost saving programs:

• Rationalization of Manufacturing Facilities: On track to generate $15-$20M cost savings from closing some facilities, streamlining others.  Has already realized ~$6M of savings in 2016 and ~$6.5M (including $4M from plant closure) this year. A bulk of the expected savings to come from automation and lean manufacturing process in 2018.

• ESG&A: On track to generate an additional $15-$20M cost savings by streamlining supply chain and back office functions and automation/outsourcing less complex engineering and drafting work to India

Cyclical tailwind from continued market recovery:

Source: http://www.ncibuildingsystems.com/pdf/IP.pdf

IMP Value proposition and growth:

• Q2 revenue of $109M (26% total revenue) and $17.7M (48% of total EBITDA)

• High growth, high incremental margin, fast growing product in the portfolio (double digit in 2017)

• Ample runway for growth. Market penetration in non-residential construction is only 3% in the US~A (vs 15% in Europe)

• #1 market leader in a duopoly market – top 2 controls 94% market share

• IMP offer contractors several advantages versus traditional building methods (build on site):

• Superior R2 qualities (insulate against heat and cold loss) vs. on-site insulation assembly

• Reduces construction time from 2 weeks to 1-2 days

• Offers a variety of colors, textures and shapes that match any traditional alternative

• High-end aesthetic appeal

• Market demand should increase:

• More states are expected to adopt more strict energy codes for new construction

• Metal building systems have taken 20% more market share from traditional materials (wood, concrete) in the low rise non-residential construction market

• NCS can cross sell IMP products through existing builder and component distribution network

• Provides existing sales force with a powerful tool to garner attention to their other products

Catalysts:

• Continued growth from its high growth, high margin IMP product (only 3% penetration in the US)

• Continued recovery of nonresidential market which is still 30% below historical cyclical averages

• Continued execution of cost saving program mostly completed and remains on track for 2017/18

• High incremental margin business benefiting from increased volume with cyclical recovery

• Increased demand for data centers, distribution centers, data-warehouse, and other end markets

• Possible (2018/19) tailwind from more manufacturing facilities and recovery in onshore Oil & Gas

Risks:

• Slowing of non-residential construction activities

• IMP product growth decelerates or margins contract. Currently a duopoly market with a larger, global operator (Kingspan).  Both should exhibit rational pricing discipline.

• NCS does not generate high ingremental margins or fails to generate the targeted cost savings

• End customers (contractors) take longer to work through their backlog due to lack of skilled labor

Catalyst

Catalysts:

1. Continued growth from its high growth, high margin IMP product (only 3% penetration in the US)

2. Continued recovery of nonresidential market which is still 30% below historical cyclical averages

3. Continued execution of cost saving program mostly completed and remains on track for 2017/18

4. High incremental margin business benefiting from increased volume with cyclical recovery

5. Increased demand for data centers, distribution centers, data-warehouse, and other end markets

6. Possible (2018/19) tailwind from more manufacturing facilities and recovery in onshore Oil & Gas