Description

Patrick Industries (PATK) is an Indiana-based manufacturer and distributor of components for the following five industries: recreational vehicles (RVs), marine, manufactured housing (MH), industrial and powersports. Despite its excellent and long track record of value creation since the GFC, PATK has only been covered once here in VIC, back in 2013, and as I will argue, that was a very different company. Furthermore, PATK’s main competitor, LCI Industries, has only been covered once (and as a short!), back in 2022. I would recommend reading those pitches as they provide some background. Finally, one of PATK’s largest customers, THOR Industries, has been pitched several times, most recently yesterday, and that report provides additional information on other parts of the value chain.

This lack of coverage is a little bit surprising as PATK is a perfect textbook case study of shareholder value creation, it is a boring business and, for the most part, has traded at reasonable valuations. I think today is one of those opportunities for long-term investors who are willing to trade some short-term uncertainty for potential future upside.

Historical background and M&A policy

PATK was founded in 1959 to manufacture components for the MH industry. Needless to say, the company found itself in a difficult position in the 2000s, as the declining volume of MHs over the decade eroded the profitability of the business. In this environment, the company decided to diversify its business in 2007 by acquiring Adorn Holdings, an Indiana-based manufacturer and supplier of interior components (primarily cabinet doors and wall panels) for RVs. The acquisition was a shrewd (and probably lucky!) move, as not only did they acquire a business that allowed to survive through the GFC, but the acquisition also brought with it Todd Cleveland, who was Adorn’s CEO and who would become PATK’s COO in 2007 and eventually CEO in 2009. Todd was also the driving force behind the subsequent expansion and diversification of the business in the 2010s. Todd passed the baton to Andy Nemeth (a long-standing PATK executive) in 2019, and has since served as Chairman of the Board until this year.

Over the past fifteen years, PATK has significantly expanded its RV business (now its main business segment), entered the marine business and, just a few months ago, the powersports business. As I will discuss below, one of the advantages of PATK’s participation in multiple end markets is that it can enjoy some economies of scope (and, to a lesser extent, economies of scale), as most of the products it manufactures are relatively similar across industries (think products such as fiberglass components, aluminium products, custom mouldings, laminated panels, bow trusses, specialty glass, bathroom and cabinetry products, flooring, lighting and air handling, to name a few), and it already has some experience and operations in place.

To give a sense of the relative importance of each business, in terms of revenues (the company does not break down gross margins or operating margins by business segment) the relative share using 2023 numbers is as follows: RV 43%, Marine 26%, MH 16% and Industrial 14%. Powersports was acquired in 2024 and will represent less than 10% of total revenues on a pro forma basis.

PATK acquisitions have been numerous, so it is impossible to describe them all in detail, but there are some common factors that are worth mentioning and that explain why PATK has been so successful in executing this playbook. First, they always leave the management team of the acquired company in place. Many of these companies are regional businesses with revenues of less than $100M, they are private and family-owned, and they see PATK as a natural exit to monetise their stake while retaining the ability to remain involved in the business. PATK, in turn, brings OEM relationships, distribution capabilities, new capital to the business for growth and, in general, a degree of professionalization to the activities.

Second, the transactions have been numerous and small (bolt-on), which reduces the integration risk. More recently, the size of the acquisitions has increased. PATK’s M&A targets have been twofold. On the one hand, it has targeted companies (Wet Sounds and Rockford Corporation) active in the marine space with a strong presence in the aftermarket business – a segment in which PATK has traditionally never been active due to the nature of its products. Both companies specialise in audio systems (i.e., amplifiers, tower speakers, soundbars, and subwoofers) and their combined revenues were $200M in 2021. PATK has guided that this segment has higher gross margins than PATK’s traditional products. Second, PATK recently acquired Sportech, a supplier to the powersports industry and a platform for future acquisitions in this space.

Finally, the profile of the acquisitions is not turnarounds, but businesses with a track record of profitability. PATK is obviously looking for some synergies using the levers discussed above, but the acquisitions are performing when purchased.

Some qualitative remarks about the quality of the business

As PATK is a small B2B company, it is difficult for an outside observer (rather than a consumer) to assess its manufacturing and distribution capabilities. Having said that, I think there are some things that we can glean about the attractiveness of the business. I would say that PATK two main sources of competitive advantage are switching costs and economies of scale (and scope), which make PATK a very good business overall.

With regard to the former, switching costs for customers are high for several reasons. First, most components are low-cost items, so there is usually little economic incentive for OEMs to switch. Second, OEMs operate with lean cost structures and just-in-time inventories (this is one of the reasons why returns on capital have been so good for THOR and the like), so the risk of supply chain disruption is critical for them. Thirdly, the large number of different products manufactured by PATK makes OEMs reluctant to switch suppliers; guys, this is no Texas Instruments, but the portfolio is still broad (see the appendix in PATK’s corporate presentations to get a sense of the different products). Finally, OEMs find it more convenient to deal with fewer suppliers (which goes back to the importance of the supply chain).

In terms of economies of scale, the issue is a bit more nuanced, as the manufacturing process is not highly automated, so economies of scale from higher production levels are modest at best – which explains why gross margins hold up relatively well during downturns. However, PATK does have some advantages over smaller competitors in terms of its logistics capabilities, and also when dealing with suppliers (mainly raw material suppliers). In addition, I would say that the business could exhibit Wright’s Law for several products, as they have been manufactured countless times.

Finally, a couple of final positive attributes that don’t fit neatly into the previous two factors. First, PATK is a regional manufacturing business with no foreign competition, which I think is an overlooked attribute (so no need to worry about things like Chinese overcapacity, trade wars and the like). And second, the RV industry (both OEMs and suppliers) benefits from being primarily based in Elkhart, which is one of the cheapest locations in the US in terms of labour, which is a large component of costs. The implications of being in Elkhart go beyond being the cheapest, but also relate to the importance of being close to your customers (and again goes back to the lack of foreign competition).  

On the downside, I would highlight the following two factors. First, PATK’s end markets (all of them) are cyclical, as they deal with discretionary products with high-price tags. These end markets have disproportionately benefitted from Covid and although there have been favourable long-term trends in demand the magnitude and the speed of adjustment is uncertain now.

Second, OEMs are highly concentrated in some of the PATK end markets. In the RV space, THOR, Forest River and Winnebago have almost 90% of the towable market. The same is true for powersports, where BRP and Polaris have dominant positions in several products. THOR has also recently acquired a number of component manufacturers in order to strengthen the reliability of its supply chain. Although the relationship between OEMs and suppliers has been good and close, it is obviously a factor that needs to be monitored.

Valuation

When looking at PATK’s financials, the first thing to note is that this boring business has delivered returns on capital well above its cost of capital over the past decade, despite the cyclicality of its end markets. Even in 2019, a very challenging year for the RV industry, PATK generated an unlevered return on capital (defined as EBIT after tax plus other operating comprehensive income items, divided by net debt plus shareholders’ equity) of 11%, which it leveraged to a ROE of 19%. The successful acquisition policy has resulted in a growing stream of profits (and economic profits) as more capital has been invested in the business.

In terms of KPIs, the most important one is the content per unit (the ratio of PATK’s revenues in that business segment divided by the industry’s wholesale shipments), as it is a good indicator of the company’s volumes and the evolution of its market share. In 2017, PATK’s content per unit was $2.2k in RV, $0.5k in marine and $2.2k in MH, while in 2023 these figures were $4.8k, $4.8k and $6.3k, respectively. Although there is some price inflation that distorts these figures, I would argue that most of the growth is due to volumes, as the company has been taking up more components.

Overall, this is the company’s track record in terms of profitability, which I think can be used as a nice “base rate” going forward:

Return on net operating assets (RNOA) is EBIT after tax plus other (and minor) operating comprehensive income items, divided by net debt (including accrued interest) plus equity. Return on equity (ROE) is comprehensive income divided by common shareholders’ equity. Both RNOA and ROE are calculated using two-year averages in the denominator.

At current prices of $105-110 per share, the company trades on a P/BV and EV/NOA of 2.2x and 1.6x, respectively, and a PE and EV/NOI (using 2023 results, which are depressed) of 16.2x and 16.9x, respectively. Assuming modest growth rates of 2% (as a benchmark, PATK has grown revenues at about 20%, net operating assets at about 30% and economic profits at about 10% over the past decade) and a conservative figure for future unlevered returns on capital in the range of 13-16% (the company has some goodwill on the balance sheet, so past accounting returns will be higher than future ones), we are looking here at IRRs in the range of 11-14% over the next few years. Higher growth rates would push IRRs into the 15-20% range.   

Downside risks

• Economic cycle.
• Consumers structurally lose interest in the products that represent PATK’s end markets (e.g., people become less interested in RVs).
• Leverage is somewhat high after the Sportech acquisition, but will be lower by the end of the year.
• Manufacturers in PATK’s main end markets have become increasingly consolidated over time, particularly in the RV industry (and also in the powersports industry). Although the relationship between OEMs and their suppliers is very close and has been good to date, further acquisitions of suppliers by THOR could erode PATK’s competitive position.
• PATK’s list of potential candidates is shorter in its core business (RV), which could lead to poor capital allocation decisions by the management team. Also, in the rest of the businesses, PATK will need to make larger acquisitions in order to move the needle, increasing integration risks.

Catalyst

None.