Description

Select Interior Concepts, Inc. has been written up on VIC twice before. The write-ups and comments do a good job of highlighting the business attributes, investment potential and shareholder frustrations incurred over the prior years. This write-up will instead focus on recent events and highlight how recent developments currently suggest this investment presents a compelling risk / reward dynamic.

Shares have languished pretty much ever since the company made its debut into the public markets in late 2017. Today at $5.66 and trading at ~5x normalized EBITDA (2019’s $50M of EBITDA plus the ~$15M of costs the company is taking out this year) versus peers that cluster around 8-10x or higher, the company has either been incredibly snake-bit or mismanaged, but most likely, a good bit of both.  

The valuation gap to peers exists for a number of reasons. The company is small. Float is limited. And while their remaining original PE investors appear committed to seeing this through to a good outcome, there has been meaningful and deleterious turnover of large shareholders over the years (which is probably an understatement). Whereas building product peers like IBP and BLD have been widely praised for sound execution, SIC has been another story. Some elements seem to be due to bad luck. They came public just as housing was entering a mini-downturn as the Fed began hiking rates in 2018. The company, and particularly their RDS segment, was heavily over-indexed to high end housing in southern parts of California that were more negatively impacted than other areas of housing on the back of SALT tax implementation. On the execution side of things, costs have remained elevated and have in fact increased at a somewhat concerning pace. And then the company was the target of an activist campaign, leading to distractions, a seemingly never-ending strategic review process and a basic lack of progress in terms of executing on the company’s goals of playing the role of lead consolidator in both the RDS and ASG segments.

Recent developments have mostly been favorable for the company and prospective shareholders. They include:

• -        Changes at the board level driven by shareholders committed to achieving this company’s potential and the likely culmination of a rotation in the existing large shareholder base

• -          The completion of the strategic review process which has resulted in a commitment to more closely integrate the two businesses and pursue the big white space growth opportunities in both the ASG and RDS segments

• -          The identification of $14-16M in costs that the board / management believes they can eliminate this fiscal year

o   Recent comments suggest this figure may be closer to $20M on a run rate basis and may have further upside as the two businesses eliminate duplicative functions like insurance, office leasing, healthcare and other miscellaneous expense items

• -          In June the company was kicked out of the Russell given its low market cap

• -          Also in June, Bill Varner joined the company as the new CEO. His background suggests an ability to deliver results which includes:

o   A number of roles as President/CEO rightsizing, fixing and growing industrial and building product companies  

o   And notably a ~6 year tenure at United Subcontractors Inc. beginning in 2012 where he oversaw the company’s results improve from ~-$20M of EBITDA on a base of $180M of sales to ~$50M of EBITDA on $1.5B of sales resulting in a sale to TopBuild for ~$480M

• -          Varner looks to be building an impressive team. Recent hires include:

o   Patrick Dussenger to lead the ASG business who has followed him from USI (which is typically a good sign)

o   Deme Christian to lead HR who was previously Director of Global HR Services at UPS

• -          2Q Results can generally be described as unspectacular but very likely mark a bottom in fundamentals as the housing market continues to improve exiting the March lows

After these developments, we feel shares present an attractive risk reward here. Primary considerations include:

• -          Expectations the company will be cash flow positive this year

• -          A cheap valuation on likely trough EBITDA

• -          A strong housing market exhibiting improving fundamentals

• -          Cost out opportunities that appear meaningful and achievable (i.e. $20M is ~40% of 2019’s EBITDA)

• -          A recently installed new management team with a demonstrated history of success

• -          Leadership status in attractive business segments with ample white space

• -          The potential return of accretive and potentially sizeable acquisitions (although not necessarily imminently but likely on the medium-term horizon after the company demonstrates success in day to day operations and cost take-outs)

Risks

-          Macro – a risk for all pro-cyclical housing businesses

-          Leverage – though this appears manageable at likely 3.4x trough LTM EBITDA with no meaningful payments due until 2023

-          Tariffs – though this appears somewhat mitigated as ASG sourcing has been further diversified in recent years

Catalyst

  Improving execution and earnings growth trajectory

-          Greater investor awareness as IR activity increases as demonstrated by the company’s presence at the upcoming DA Davidson virtual conference in September

-          Accretive acquisitions