Description

Overview:

Select Interior Concepts is a homebuilder services contractor that designs and builds high value/margin kitchens and baths for leading US homebuilders.  Their clients, in order of size, include most of the top 10 homebuilders in the US… TOL, DRH, TPH, LEN/Cal Atlantic, TMHC, and others. SIC is also making inroads into multi-family builders and AvalonBay is now a top 10 customer.  In 2017, SIC’s core Residential Design Services (RDS) business, was merged with a company called Architectural Services Group (ASG). The combined entity now offers design/installation services and also imports and distributes natural and engineered stone from 44 locations in 15 states.  While levered to the west coast and homebuilders, the platform is rapidly growing towards the east coast and is also scaling up a significant amount of renovation and remodeling business (30% or revs right now). This is becoming more meaningful to SIC in terms of smoothing out inevitable cyclicality with homebuilder customers.

Ultimately, the company’s value add to homebuilders is their logistics process and technology. They complete 100’s of installs a week…on time and with little error.  Because of this, they have never missed a closing date and 90%+ of their business is repeat. Their offering is so integral to their clients that they are begging them to open up in other markets.  This is a key growth driver and allows them to enter a new market with customers in place…also a significant driver of business and acquisition upside.

The balance sheet is clean with $40 mln of liquidity and only $127 mln of debt (refinancing this to lower rate).  Net debt/EBITDA is very reasonable at 2.3x.

OPPORTUNITY:

After the merger of RDS and ASG, SIC did a private placement in November of 2017.  On August 16, 2018, they listed their shares publicly without an IPO. Because of the low-key listing and only one firm covering the name, shares have not closed any part of what I consider to be a 4-5x valuation multiple arb to its closest peer.  Despite having the highest margins (14%) and growth rates (12% organic and 30%+ with acquisitions) in the industry, shares only trade at 5.6x 2019 EBITDA due to a lack of coverage and awareness of the story. Shares actually trade below the peer group range of 6-12x 2019 EBITDA.

The closest comps to SIC are TopBuild (BLD) and Installed Building Products (IBP) which install insulation for the top US homebuilders.  When you compare the business models they are almost identical in terms of customers, margins, and growth metrics, yet SIC trades at a 3-4x discount to these names on 2018 EBITDA.  Just a bottom range peer multiple of 8x would yield $19 (50%+ upside) and you can argue there are a lot more advantages to SIC’s product market, business model, and value-added relationship they have with the homebuilders.

Through accretive acquisitions and 12%ish organic growth, SIC has grown to a critical mass and scale ($472 mln in revs and $63 mln in EBITDA) where they are now the main consolidator in a highly fragmented and profitable segment of the homebuilder services space.  They have done 5 accretive acquisitions since 2017, just announced another recently, and their current pipeline is larger than it has ever been. This, along with organic growth can drive expansion eastward and continue 25-50% revenue growth they have been able to show since 2015.  They have a very simple business model…. target markets where their existing clients operate, acquire a private co for 3-4x EBITDA, and ramp up the business with TOL, DRH, TPH, etc then repeat.

UPSIDE AND POTENTIAL CATALYSTS:

Volume has been extremely light since listing and that creates an opportunity.  Any block trades providing liquidity and taking out sellers can send shares significantly higher and draw attention to the name and valuation discrepancy.

SIC is reporting their 2Q18 on Sept 6 before market open.  Taking cues from TOL and other large customers that crushed their 2Q reports, SIC’s should show continued strength and growth when they report.

New CFO from Superior Industries (SUP) brings public company experience and his first job is to refinance the $127 mln of debt lower than current 7.25% cost.  Incremental EPS impact will be beneficial.

At a $314 mln market cap, this will get added to the Russell 2000 soon - should be 4Q or 1Q 2019 at the latest.  Russell math and analysis of similar market caps from recent rebalances point to demand of roughly 500k shares of SIC to be bought.  That would be significant here given current volumes and float.

Additional coverage should be on the horizon.  While SIC does not need to raise more capital and can completely self-fund, they do have several larger potential acquisitions that could happen.  To fund one or more of these, they would do a secondary and more robust introduction of the name to investors. This could result in 1-2 more analysts picking up coverage of the name.

Once geographies are covered, or even sooner, there is a significant opportunity to move into lateral markets like cabinets (already happening), hardware, carpets, and appliances.

SECTOR AND DOWNSIDE PROTECTION:

While homebuilding fundamentals have remained strong, shares have acted like crap recently.  This is most likely due to interest rate and affordability fears masking significant demographic demand.  An almost identical setup occurred heading into 2016 as the group significantly lagged the broader recovery.  But then you can see the moves the group had through 2016 and 2017. We think this pullback is a similar misperception and the setup is strong into 2019.

As an asset light business model, the company is extremely immune from downturns.  Almost all costs are variable (hourly emps, commissions, WIP) and 85% of inventory is receivables. Because of this, neither RDS or ASG have ever had a negative EBITDA quarter. Even through the downturn…while volumes clearly declined at 85% for the industry, they went down 70% at SIC and GM stayed steady at 30%.  The worst EBITDA quarter during the crisis was about +$500k.

SIC’s offering accounts for only 3-4% of a home’s total cost.  This gives them pricing power on their services…at TOL, they charge a 20% premium to what it would cost TOL to do it themselves. This is only a 0.6% increase in the total cost of the home but nothing for TOL which actually makes a better margin and have never had a closing missed by SIC.

Catalyst

See above