Description

Currently the market is pricing in close to no chance of a recession with SITE being valued at 37X TEV/EBIT and 48x tangible book value with uninspiring 5% organic growth w 5% free cash flow margins, especially while taking on a boat load of macroeconomic risks. Site’s business is driven off 41% new construction of residential and commercial. In March the construction industry reported: 27% layoffs or furloughs and 59% said seeing delays from materials and permitting. I am not sure what makes SITE richly valued? Very thin balance sheet, poor economics, hugely sensitive to construction, with a very rich valuation. My guess is that SITE gets credit as a roll up strategy to buy smaller competitors are lower multiples than the whopping public market valuation of SITE. On the bear case,  SITE looks somewhat similar to PRTY low gross margins 25-32%, low inventory turns, a lot of working capital, and heavily seasonal..In the best of times 5% free cash flow margins and organic revenue growth and worst of times -20% to -40% and last cycle they saw commerical -60% decline over several years. A -15% decline would be a problem.  As of 12-31-19 Current assets (3% cash and mainly inventory and AR) equal net debt. On bull case, SITE wants to be the POOL of landscape supplies....there are a number of material differences. POOL has 23% ROIC vs. SITE 7%. POOL has a large maintenance supply business far above average household net worth with 60% recurring revenue. 

Here is how SITE describes their business from the annual report: 

"Our typical customer is a private landscape contractor that operates in a single market. We interact regularly with our customers because of the recurring nature of landscape services and because most contractors buy products on an as-needed basis." 

"We derived approximately 56% of our 2019 Fiscal Year Net sales from the residential construction sector, 31% from the commercial (including institutional) construction sector, and 13% from the recreational and other construction sector. By end market, we derived approximately 42% of our 2019 Fiscal Year Net sales from maintenance of residential, commercial, and recreational properties.The sale of products relating to new construction of homes, commercial buildings, and recreational spaces accounted for approximately 41% of our 2019 Fiscal Year Net sales. These products primarily include irrigation, nursery, hardscapes, outdoor lighting, and landscape accessories. Approximately 17% of our 2019 Fiscal Year Net sales were derived from sales of products for the repair and upgrade of existing landscapes. These sales benefit from increasing existing home sales, increasing home prices, and rising consumer spending."

I think few would dispute that we are in some kind of recession: https://www.bloomberg.com/graphics/us-economic-recession-tracker/

Balance Sheet: $284 million in A/R, $427 in inventory or $710 million vs. $835 million in debt and CL (just for a sec get rid of leases right of use asset vs. liability). 

I have rarely encountered nearly 14 pages of risk factors that many apply right now, I would suggest reading pages 11-25: https://www.sec.gov/ix?doc=/Archives/edgar/data/1650729/000165072920000004/site1229201910kdocument.htm

Big risk #1: 

 “Our Net sales also depend, in significant part, on commercial construction, which is cyclical in nature and subject to downturns, which can be severe. Previously, downturns in the commercial construction market have typically lasted about two to three years, resulting in market declines of approximately 20% to 40%, while the most recent downturn in the commercial construction market lasted over four years, resulting in a market decline of approximately 60%. We cannot predict the duration of the current market conditions or the timing or strength of any future recovery of commercial construction activity in our markets.”

Just out of the gate from March: https://www.forconstructionpros.com/equipment/press-release/21127040/associated-general-contractors-of-america-agc-reports-rising-construction-layoffs-potential-cares-act-loan-exclusions-for-smaller-firms

"The share of firms responding to the AGC survey that said they had been directed to halt or cancel projects by their clients had jumped to 55% from 39% the week prior. Over one-quarter of respondents reported they had been directed to stop construction activities by government officials.The share of firms responding to the AGC survey that said they had been directed to halt or cancel projects by their clients had jumped to 55% from 39% the week prior. Over one-quarter of respondents reported they had been directed to stop construction activities by government officials."

Depending on your belief of what happens in this economic cycle....If you are bearish on new construction...the tide may go out rapidly for SITE and there could be real trouble IF that happens. I think the fixed costs are close to $700 million (which I believe are hard to cut), and IF revenue fell to $2bn with 32% gross margin the business would be in trouble with around $700 million in gross margin and $700 in OPEX. 

A breakeven business would be trouble:

A.      $700 million operating expenses 

B.      $57 million in tangible equity

C.      $283 million in A/R w 44 DSO's as they provide financing to landscaping crews (best of times default rate 3%)

D.      $450 million in inventory (turns every 100 days)

E.       $300 million in goodwill and intangible assets (likely written off on a goodwill impairment test if the stock tanks)

F.       48 acquisitions since 2014 on over 200 locations spending $900+ million (what could go wrong?) 

G.      $500 million in net debt w/ total obligations $1.1 billion.

CEO of SITE in Feb 2020 “Right now, builders are very bullish about 2020, and we have seen a tick up in new residential backlogs with our customers. Overall, we expect this market to be solid with mid-single-digit growth in 2020.”

SITE customers consist of “Hundreds of thousands of landscapers” 1) 26% make annual purchases less than $25K 2) 33% buy between $25-150K and 3) 41% buy over $150K a year.

Risks include:

• The landscaping industry is considered an essential service and still allowed to operate in the current market. The store I went to was totally empty both times over the last week. My second visit, the store went from 3 employees to 1 and they are cutting back hours of operation as well. 
• So far, it seems consumers are willing to spend on furniture. Are consumers will to extend this to spend heavily on outdoor landscaping? Artifical turf, or hardscape, or irrigation. I doubt that the business will be stronger this Spring/Summer than last year. Then again, direct consumer to SITE is only 13% of revenue. 
• SITE issues stock given the company's enormous valuation. 
• Construction does not slow and there is no recession. 

SITE is largely a specialty retailer/wholesale landscape supply company. In a bull market it is probably on a 1-10 a 4 or 5 and in a recession a 2-3 and depression a 0 given business model and sensitivity to new construction. To make this a high qaulity business, SITE would need to buy up a large % of the rest of Landscape Supply market which is $20 bn. There would need to be some scale break points where they can meaningfully increase free cash flow margins and organic revenue growth up a lot to continue the roll up strategy. The market has priced this in as all but certain at 37x TEV/EBIT. 

As a retailer I think fixed costs are pretty fixed: leases, employees, debt, interest and it is very hard to drive incremental traffic to a wholesale landscape supply company if landscapers do not have the work. It seems to me that if site offered 20% off sale, that Landscapers are not going to take on inventory pvc pipling or buy extra rakes, weedwhackers, etc unless they have the business. As they say in their 10K, purchases are made on an as needed basis (no work/no business)... It seems like a tough business to drive foot traffic or responds well to discounting. 

Its seems like a complicated business with many moving parts: 120,000 SKU’s, it requires $500 million in working capital of which $430 million is inventory

Site has $283 million in accounts receivable w/ days sales outstanding of 44 days. Some are credit card sales that are typically paid in 2-3 days…SITE with 44 days sales outstanding shows they are extending credit to largely small landscaping crews. In the best of times Site reserves 3% bad debt write off.

Home Depot has 17% EBITDA margins and sells A-Z home essentials vs. 7% for SITE. I visited a Siteone yesterday, and the discounts arent better than HomeDepot on items i checked on and HD sold nearly everything SITE did. I just can't put my finger on what makes SITE so special. 

HD earns +32% returns on capital

POOl: +23% returns on capital 

Site: +7-8% returns on capital 

Simple look DCF

Assume a best case scenario:

·         Assume 5% revenue growth (business has no impact to market conditions),

·         instead of 5.5% free cash flow margins assume they nearly double it to 10%

·         Discount at 7% (probably way too low given risks)

·         Value come out around $68 a share…

The days to cover are about 13 days on the short side. 

As I mentioned earlier .....I am not saying SITE is the next Party City.....but these businesses that look to dominate low margin heavy working capital roll up strategies...sometimes run into severe problems when the tide goes out: PRTY is now .40 cents a share

Party City Holdco Inc. is the leading party goods company by revenue in North America and, we believe, the largest vertically integrated supplier of decorated party goods globally by revenue. The Company is a popular one-stop shopping destination for party supplies, balloons, and costumes. In addition to being a great retail brand, the Company is a global, world-class organization that combines state-of-the-art manufacturing and sourcing operations, and sophisticated wholesale operations complemented by a multi-channel retailing strategy and e-commerce retail operations. The Company is the leading player in its category, vertically integrated and unique in its breadth and depth. Party City Holdco designs, manufactures, sources and distributes party goods, including paper and plastic tableware, metallic and latex balloons, Halloween and other costumes, accessories, novelties, gifts and stationery throughout the world. The Company’s retail operations include approximately 875 specialty retail party supply stores (including franchise stores) throughout North America operating under the names Party City and Halloween City, and e-commerce websites, principally through the domain name PartyCity.com.

SiteOne Landscape Supply, Inc. is the largest and only national wholesale distributor of landscape supplies in the United States and has a growing presence in Canada. Its customers are primarily residential and commercial landscape professionals who specialize in the design, installation and maintenance of lawns, gardens, golf courses and other outdoor spaces.

 Disclosure: This does not constitute a recommendation to buy or sell shares of SITE. We are short SITE shares and we may buy or sell shares without updating this board. 

Catalyst

41% of business driven by new construction

New construction slows, the last economic cycle was terrible for company (read risk factors) 

SITE has what we believe to be far above average risks and an far above average valuation for a business in a bull market to be considererd just an okay business.