Simpson Manufacturing is the leading structural connector manufacturer in the United States and Europe. Its products, known as joist hangers, connectors, and anchors by the trade, are steel devices that are used to strengthen, support and connect joints in wood-to-wood, wood-to-concrete and wood-to-masonry construction. The products enhance the safety and durability of the structures in which they are installed and can save time and labor costs for the contractor.  They also improve structural integrity and improve structural resistance to seismic, wind and other forces.  In effect, SSD buys steel coils (a commodity) and runs it through galvanizing processes and stamping machines to produce joist hangers. 

 

The company claims they are 5x largest their nearest competitor, which I believe is USP (http://www.uspconnectors.com), owned by Gibraltar Industries.  Other than that, there are no meaningful competitors in the structural connector business. A contact at USP believes Simpson has a 70% market share for the US connector business.

 

Part of Simpson’s industry dominance is due to their tremendous job convincing building inspectors, city planners and engineers to specify the Simpson products in building codes.  Simpson is listed in almost every building code I’ve read, so if anything is built that requires a permit, a “Simpson product or approved equal” is used.  In essence, they are required in almost any wood construction…so when a building inspector looks at a building, it has to be Simpson or approved equal.  If not, the building will not be allowed to be occupied.  In addition to code, the company has over sixty patents preventing product duplication.   

 

The reliance of the building industry on their products creates a wide moat.  It is this moat that has allowed Simpson to increase prices and pass along raw material increases with ease.  As an example, Home Depot, Simpson’s largest customer accounting for 15% of sales, attempted to force a price decrease onto Simpson sometime in the first quarter of 2006.  Simpson responded with a price increase to cover rising steel costs, and a semi-public feud erupted in the ensuing SSD conference calls.  HD attempted to restock its shelves w/ a competitor product, but in the end customer demand prompted HD to reverse course.  Additionally, Simpson was able to successfully put through a price increase.  I believe this speaks to the loyal following Simpson’s products have among contractors, many of whom shop in fear of not passing inspection.  To them the peace of mind is a fraction of the overall cost of the project.  In fact, my conversations with contractors and architects indicate Simpson typically charges 30% more than the nearest competitor USP.  Engineers, whose reputations depend on infallible structures, are not willing to ‘chance it’ with competitor products when those products are not listed in code.

 

The company’s moat has allowed them to earn consistent profits and a nice return on invested capital year-in and year-end.  The following is the company’s ROIC since going public:

 

1992 = 18%

1993 = 18%

1994 = 13%

1995 = 20%

1996 = 25%

1997 = 24%

1998 = 24%

1999 = 24%

2000 = 21%

2001 = 22%

2002 = 22%

2003 = 22%

2004 = 22%

2005 = 21%

2006 = 20%

2007 (Q3 TTM) = 16%

16 year Average = 21%

 

 

The company has undercapitalized with no debt and $3.20/share in cash.  Subtracting the cash from the current share price, you are paying 13.6x P/E for a core business that generates a consistent 20% ROIC:

 

Share Price: $26.50 (as of 12/28/07)

Less: Cash/Share: ($3.20)

Adjusted Share Price: $23.30

 

’08 Consensus Earnings Estimate: $1.82

Less: Interest Income after Taxes: $.07

Adjusted Earnings Estimate: $1.75

 

P/E = 13x

 

I believe good businesses like SSD should trade at a premium to the S&P, which is currently valued at 18x earnings.  Applying a 20x p/e to Simpson’s core earnings, which I think is reasonable, and adding back excess cash gets you to a $38/share price target, or 35% upside to current prices.

 

This idea falls in the camp of great business currently out of favor and being offered at a fair price.  It is not a near-term earnings miss/beat thesis, and as such investors must be patient as the housing downturn finds a trough.  With that said, Simpson has weathered the housing decline quite successfully.  What follows are the y/y US new home starts % change and SSD revs % change for reference:

 

	US Starts (y/y % Chg)	SSD Revs (y/y % Chg)
2005 Q1	6%	15%
2005 Q2	5%	23%
2005 Q3	5%	24%
2005 Q4	(1%)	22%
2006 Q1	5%	17%
2006 Q2	(10%)	8%
2006 Q3	(23%)	(3%)
2005 Q4	(25%)	(12%)
2007 Q1	(27%)	(10%)
2007 Q2	(24%)	(4%)
2007 Q3	(25%)	(4%)

 

Simpson’s revenue outperformance compared to new home starts can be attributed to: 1) new geographic markets outside of the US and growth of existing foreign markets; and 2) more Simpson products in each new build via new products and stricter building codes.  We are almost two years in the worst housing downturn since the ’70s and SSDs revenues are tracking down 6% for the year.