Description

Executive Summary:  SiteOne (SITE) is the largest national wholesale distributor of landscape supplies in the US & Canada, with 12% share of the $20bn+ sized industry. At >4x the size of the #2 distributor, the company enjoys a scale advantage where it can trade better customer access for better pricing from its vendors and can offer its own customers a breadth of products available coupled with value-added services and capabilities that its competitors cannot match.

Rather than employ a low-price strategy, the company has reinvested to improve capabilities that make their customers more profitable and more efficient, resulting a differentiated offering that should support steady market share gains in an industry growing 3-5%. Notably, SITE’s investments in e-commerce, logistics, and product availability have paid dividends during the pandemic and our field work suggests the company may have accelerated its penetration of more profitable smaller customers during this period.

SITE has complemented its organic growth opportunity with an aggressive M&A strategy to roll-up leading local distributors and build out product capabilities in ~200 MSAs. Since 2014, SITE has completed 49 acquisitions, adding an incremental $920mn in sales to its core base. The company continues to think it has significant opportunity to scale in its existing markets, noting that it has a full product line in just 25% of its core markets. And with just 12% of the market, the company thinks it could easily triple market share over time. We’d note its CEO has experience rolling up industries and his ownership of ~2.9% of outstanding shares suggests his incentives are well aligned with shareholders.

At ~$130, SITE shares look expensive, but it is important to note that (1) consensus estimates look too low because they likely fail to embed prospective M&A, and (2) consensus earnings per share include non-cash amortization charges that we think should be excluded. On our estimates, cash EPS should almost double from FY19 to FY22 to >$5, equating to a reasonable 25x multiple for a business we think can grow sales and profits at an attractive rate for a long period of time.

Company overview:  SiteOne is the only national wholesale distributor of landscape supplies in the US and has a growing presence in Canada. Through its network of over 550 branch locations in 45 US states and 6 Canadian provinces, SITE serves its 230,000 customers – primarily residential and commercial landscapers – with a selection of over 120,000 SKUs including irrigation supplies, fertilizer and control products, landscape accessories, nursery goods, hardscapes, outdoor lighting, and ice melt products. In 2019, the company generated $2.4bn in revenue and sales have increased at a 14% CAGR since 2013.

The company has a balanced mix of sales across product categories, construction sectors, and end markets:

Its product offerings are classified into 5 verticals: Irrigation & Outdoor (33% of sales); Agronomics (28%); Nursery (12%); Hardscapes (13%); and Landscape Accessories (14%). SITE is the only distributor with products offerings in all these verticals.

The company has over 230,000 customers, with minimal concentration. Its largest customer (Brightview) accounts for 2% of consolidated revenue and its top 10 customers account for just 4% of revenue. Small customers (annual purchases up to $25K) account for ~28% of revenues, Medium customers ($25-$150K in purchases) account for 34% of revenues, and Large customers ($150K+) account for 38% of sales. In general, small and mid-sized customers are more profitable while larger customers provide SITE with the purchase volume necessary to drive more favorable vendor procurement prices. Since 2017, SITE’s small and mid-sized customers have increased from 58% of total sales to 62% (sales CAGR +16% vs. +7% for larger customers).

Industry Overview: Wholesale distribution of landscape supplies in North America, estimated to be a $20bn addressable market, is a highly fragmented industry served by ~1,000 distributors. Most of these are local ‘mom and pop’ operators and regional private businesses that typically have a small geographic footprint, a limited product offering, and limited supplier relationships.

While there are some larger companies in the industry, with ~$2.4bn in sales (~12% market share), SiteOne stands head and shoulders above the rest. It is ~4x the size of the #2 player in the industry and is larger than the rest of the top 10 combined. Moreover, the company has a much broader product offering compared to larger peers.

Within the industry, product sold for residential applications represent the largest segment, followed by commercial and recreational/other (in line with SITE’s mix). Management believes nursery products represent the largest category in the industry accounting for ~1/3 of sales, followed by landscape accessories (~20%), and the remaining categories (control products, hardscapes, irrigation products and outdoor lighting, and fertilizer each account for ~10% of industry sales. 

In general, growth in the industry is correlated to a broad array of factors, including consumer spending, housing starts, existing home sales, home prices, commercial construction, repair and remodeling, and demographic trends. Approximately 40% of sales are related to maintenance, primarily fertilizer and control products, and this demand helps provide stability in their financial performance across cycles. Another 40% of sales are related to new construction of homes, commercial buildings, and recreational spaces and these products include irrigation, nursery, hardscapes, outdoor lighting, and landscape accessories. The final ~20% of sales are related to the repair and upgrade of existing landscapes and these sales benefit from existing home sales, increasing home prices, and rising consumer spending.

Company history: SiteOne was established in 2001 as a subsidiary of Deere & Company when the parent company entered wholesale landscape distribution (via M&A) with the idea that it could build relationships with landscape contractors by selling consumables and ultimately use the relationship to sell lawnmowers. Its original name was John Deere Landscapes and the business grew rapidly via M&A during the housing boom, culminating in its ill-timed 2007 acquisition of LESCO, a leading supplier of lawn care, landscape, golf course, and pest control products with 345 stores. LESCO’s store base, which was losing money even before the recession, suffered poor operating results during the Great Recession and John Deere Landscapes was forced to close a lot of stores and consolidate.

Coming out of the recession, Deere had a CEO change and a change of focus to growing internationally, which left John Deere Landscapes as an orphaned asset that was managed for cash flow until 60% of the business was ultimately sold to Clayton, Dubilier, & Rice (CDR) in December 2013 and renamed SiteOne.

Once in charge, CDR installed a new leadership team, including its current CEO Doug Black, with experience growing distribution businesses, then spent the next few years integrating its disparate businesses, paying down debt, and improving the organization. In 2014/2015, the company began pivoting towards M&A-driven location growth that has continued today. In May 2016, SiteOne completed its IPO, and Deere and CDR fully exited their investments in SITE in 2018.

Investment Highlights:

SiteOne has scale in a fragmented industry: The company is an outlier in an industry that remains highly fragmented. The landscape supply industry consists primarily of local ‘mom and pop’ operators and regional private businesses that typically have small geographic footprints, a limited product offering, and limited supplier relationships. 

In contrast, SITE is the only nationwide distributor of residential landscaping related supplies with over 550 branches in 45 US states and 6 Canadian provinces, and the company is 4x larger than the #2 player in the industry with a 12% share of the $20bn+ industry.

Serving over 230,000 landscaping customers (vs. ~600,000 landscaping companies in the US) and offering 120,000+ SKUs from 4,000 different suppliers, SITE enjoys an enviable position serving as the middleman in an industry that is shaped like an hourglass. Its scale enables it to provide better customer access for its suppliers and more product selection/availability for its customers, and in return the company is able to generate significant economies of scale in purchasing.

Scale benefits reinvested to help customers grow revenues, not save on costs: Rather than employing a broad-based price leadership strategy, SITE aims to be price competitive and instead opts to reinvest procurement cost savings into initiatives that make it easier for customers to do business with SITE / help their customers make more money. Examples of this strategy include:

(a) Investing in an online capabilities and transportation management to streamline the customer experience.

(b) Offering a loyalty program(Partners’ Program) that allows larger volume customers to enjoy special pricing to reward increased purchasing activity (our conversation with regional management noted that discounts off list for larger customers could equal as much as 30-40%. With materials equaling ~10-25% (maintenance ~10% vs. projects up to 25%) of a landscapers’ COGs, this could equal 3-10% savings on the cost of a job). The Partner’s Program also provides business and personal rewards for loyal customers.

(c)  Providing bidding and estimation consulting services at no charge for SITE customers. This saves landscapers time/reduces hassles. The company also offers to white label bid sheets for smaller customers (to look more professional on larger bids) and proactively scours public sites for new projects to alert its best customers (while also providing them with material cost estimates to help with estimating / try to win more business).

(d) Offering technical training, licensing, and certifications, and business management seminars to help its customers develop their employees and business acumen.  

We think this strategy makes intuitive sense because B2B distributors that can make their customers more profitable and efficient engender a loyalty that a low-cost strategy could never match. Moreover, it is a business model that is not replicable by any of its local market competitors and helps insulate the company from irrational competition at the local market level.

Local market outgrowth story just getting started and pandemic may have accelerated this shift. With unmatched scale, a full product portfolio to cater to landscape professionals increasingly offering additional services to meet their customers ever evolving needs, and the financial wherewithal to invest in the capabilities that help save their customers time and make them money, SITE has a differentiated offering that should support share gains over the long-term. However, it takes time for SITE to build its reputation in a given market, because (1) SiteOne is a newer a brand and (2) its smaller (and more profitable) customer often doesn’t know they exist or what value they bring to the table. 

Beginning ~4 years ago, the company revamped its sales force to help drive penetration into small- and mid-sized customers where they have historically punched below their weight. It added an inside sales time to help with servicing larger customers and altered outside sales compensation practices (slowly) to focus their reps on business development (vs. their historical role as more of a servicer). The company also aggressively invested in digital marketing and boots on the ground marketing efforts to try to raise awareness and educate these customers on the benefits of SITE. On public calls, management has noted that it believes these initiatives would comfortably support 100-200bps of market outgrowth annually building over time, but our fieldwork suggests COVID may have accelerated penetration with smaller and mid-sized customers as its e-commerce capabilities, logistics advantages, and product availability have proven critical to customers during this year.

SITE is levered to construction activity, but business is more recurring than you’d expect. While SITE has meaningful exposure to construction activity (~41% of sales), recurring maintenance work that is not discretionary for commercial customers and only slightly discretionary for residential also accounts for a large chunk of their business (~42% of sales in 2019). Importantly, the installed base of maintenance properties consistently grows over time and the landscaping industry benefits from some the same trends that are driving home maintenance work from DIY to DIFM (i.e. aging population, increase in 2 paycheck households, 2nd home ownership, and less free time in general).

Management has historically viewed its markets as growing volumes 1-2% with pricing/inflation driving another 2-3%, suggesting all-in industry should grow sales in the 3-5% range annually. Based on our bottoms up thinking, management’s view on industry growth seems reasonable, though near-term residential growth is likely to be elevated as long as COVID fears keep people in their homes while commercial construction is likely to become a headwind in late 2021 / into 2022 as the existing backlog of projects in progress are completed. We would also expect inflation to be slightly elevated given product shortages and higher logistics costs as a result of the pandemic, which should drive pricing towards the higher end of its range.

Net-net, we expect industry sales growth to remain elevated in 2021 before slowing to a below average rate in 2022 and then ultimately settling into a more normal pace.

Thinking through downside, demand for repair and upgrade will always be supported by a baseline level of existing home sales activity, while the country has structurally underbuilt housing since 2006 based on household formation trends and that should buoy new home construction activity, particularly if rates remain low. Commercial construction is probably the most cyclical business, but it tends to lag residential into recessions and SITE’s position as being the last piece of the project suggests its other businesses would be in the early stages of recovery right as commercial would bottom out.

• GFC was a perfect storm for John Deere Landscapes. The global financial crisis was a particularly bad recession for the company, mainly because both construction sectors were so overbuilt heading into it, but also because the company was poorly run with most stores losing money before the recession began. As a result, John Deere Landscapes saw its store base erode almost 40% from its peak in 2007 to its sale to CDR in late 2013 (657 stores to 400 stores).
• Shutdown this Spring was short but probably a better indicator of current worst-case scenario. The most recent recession this Spring could also be illustrative, even if it was short-lived. Management noted that in the worst of the shutdown (April), sales declined 11% Y/Y.

Several levers to continue to drive margins higher. Despite steady improvement since 2015, we think the company continues to have several avenues to increase margins and ultimately reach its target of >10% adjusted EBITDA margins (vs. 8.5% in FY2019).

• Gross margins: SITE has been able to drive over 300bps of gross margin improvement (to 32.6%) over the past four years, but management thinks gross margins can ultimate reach the mid-30s. Most of the improvement thus far has come from, (1) a centralized pricing and discounting system supported by data and analytics, (2) category management (i.e. consolidating SKUs with preferred vendors and growing private label business), and (3) supply chain initiatives (building centralized DCs / better fleet utilization). According to management, pricing should be less of a tailwind going forward, while category management and supply chain initiatives should continue to drive improvement as the business scales. Two other drivers of margins are customer mix (smaller = more profitable) and product mix (nursery & hardscapes higher gross margins).
• Operating expenses: SG&A has not been a driver of operating leverage thus far, because the business needed investment to support its organic growth initiatives after years of under-investment within Deere and SITE’s M&A activity has muddied organic results. With organic growth initiatives in place and the low hanging fruit on gross margins captured, management has pivoted to initiatives designed to generate operating leverage on SG&A. Initiatives include barcoding and e-commerce efforts (designed to improve store productivity/throughput), operational excellence (best practices implemented at branch levels), and salesforce performance initiatives. Over the next few years, we expect operating leverage to be a continued source of margin improvement, even with elevated M&A. long-term, the company thinks SG&A expenses should migrate down the low 20s % of sales range (slightly elevated vs. POOL), representing 400bps+ of opportunity.  

SITE remains very well positioned to execute on continued roll-up of industry. From 2014 – 3Q2020, SITE has completed 53 acquisitions, adding 248 branches and an incremental $1.03bn in sales to its core base, and the company continues to believe it can add 7-13% growth via M&A annually. The company believes it is the consolidator of choice for small landscape distributors, providing a strong platform of inventory management, supplier relationships, and technology, and its scale allows the company to generate cost/revenue synergies that its competitors would have difficulty matching.

The company is interested in ~230 major markets across the US and Canada, and the company believes it has a full product line in only ~50 of these markets. In most markets, the company is missing a presence in nursery and hardscapes so the company is expecting a lot of deals in those categories though it will look at all targets. Longer-term, the company believes it can increase market share from 12% today to 35-40%

Historically, the company has been able to acquire landscape distributors 6x to 8x EBITDA and the vast majority of deals have been negotiated sales. It acquisitions typically have profit margins close to the corporate average, and management aims achieve an incremental 100bps of margin improvements from the realization of synergies (purchasing primary source initially but operational and cross-selling benefits realized a few years post-close). Pro forma for synergies (but no growth subsequent from deal closure), we estimate SITE realizes unlevered pre-tax returns on investment of ~16%

On our estimates, SITE can acquire ~$200mn in revenue annually funded entirely from its own cash generation, though we would note that it has an under-levered balance sheet currently (with net leverage at 0.8x vs. a target of 1-2x) and could support meaningfully higher levels of acquisition activity.

Strong management team with aligned incentives. SITE’s leadership team includes 2 veterans of Oldcastle, an integrated building materials manufacturer and distributor that executed a successful roll-up strategy that serves as the blueprint for SITE today, suggesting the team is well-suited to execute its strategy today. Its CEO Doug Black was formerly Oldcastle’s President and COO, and their head of M&A Mr. Scott Salmon also had leadership roles with Oldcastle.

In addition to having the right capabilities, we think the company’s incentives are aligned with shareholders. Doug Black owns 2.9% of outstanding shares, Adjusted EBITDA targets drive ~70% of cash bonus compensation (and these are challenging targets with a success rate of just 25%), and long-term equity growth is tied to revenue growth, pre-tax earnings growth, and ROIC.

Operating model: We agree with management’s views on industry growth in the 3-5% range over time, though stay at home dynamics should drive elevated residential spending in 2020 and 2021 before normalizing in 2022. On our estimates, we think industry volumes can increase above normal in 2020 (~6%) and at the high-end of its normal range in 2021 (~5%) before the normalization of residential spending and commercial construction weakness drives below average growth (~2%) in 2022. We expect market share capture to drive ~2% outgrowth annually. We also expect SITE to add $200+mn in sales annually through M&A, which translates to ~6-7% growth annually (below management guidance for 7-13%), equating to all in revenue growth of 12%/15%/11% in FY20-22 (vs. consensus of +11%/+8%/+8% which likely embeds no M&A).

We expect adjusted EBITDA margins to increase to ~9% in 2020 on strong gross margin improvements and pandemic constrained operating expense growth, and continue to climb in FY21 and F22 from both gross profit margin increases and operating leverage to reach ~10.5%, which would drive adjusted EBITDA growth of 19%/24%/20% in FY20/21/22 .  Longer-term, we expect the company to continue to make progress on margins though the timing of M&A could optically depress improvements in heavy deal years.

Our cash EPS estimate for FY22 is $5.08, almost double what the company reported in FY19.

Valuation: At 47x forward earnings and 24x forward EBITDA, SITE looks expensive on an absolute basis and relative to history (avg. PE and EV/EBITDA of 40x and 18x, respectively) but we would caveat that these are consensus estimates which we think are too low. Moreover, SITE’s EPS does not back out non-cash amortization which is a >$1 impact to earnings per share by 2022. On our estimates, SITE is trading at a much more reasonable ~24x cash earnings.

On a price-to-sales basis, SITE is also trading at historical highs, though its discount relative to POOL (the company it is most often compared to) has remained relatively consistent.

Risk Factors:

• SITE is levered to economic activity, with ~40% of revenues tied to new residential and commercial construction and 20% tied to repair and upgrade.
• SITE is competing for deals with several private companies, a subsidiary of POOL, and one-PE backed firm that has acquired ~90 branches since its founding in the beginning of 2019. To the extent the company cannot source enough deals or is forced to pay higher multiples, its roll-up strategy may not be attractive.
• SITE faces execution risk on both its organic and inorganic strategies.

Catalyst

-Continued market growth and share gains

-M&A announcements