Description

As we know, Pool Corp. is the leading distributor of pool and outdoor living products. The company has disproportionately benefited from the surge in COVID-related demand. Historically, in ground pool installations grew 1-2% annually. In 2020, installations jumped by 23% and then another 25% in 2021.

On its last call, POOL estimated that new pool construction will be down by 10-15% compared to 2021. By the middle of 2023, new pool construction could begin to decline significantly. I read an interview with a former POOL manager who believes that activity could be cut in half to 65,000 pool installations. This is because the pandemic has pulled forward a lot of business due to the stay-at-home effect where families stayed in their backyards and did not travel. He views the recent drop off in demand for hot tubs as a warning sign to the industry. The manufacturing lead times for hot tubs blew up to nearly six months during 2021. Today, the lead times have already come back to the normal time of six weeks. During the summer, Jefferies recently conducted a survey with 39 pool builders and distributers across the country. 75% of the respondents expect business to be flat to down in 2023. 38% of respondents expect business to remain flat and 12% expect business to contract by more than 10%. This article is also particularly negative: https://www.poolspanews.com/business/pool-industry-monitors-effects-of-economy_o.

40% of the company’s revenue is tied to new pool installations, major repairs and remodeling. As illustrated above, the portion of the business tied to installation is at a cyclical high. With interest rates increasing, the capital available from refinancing and HELOCs will be limited compared to the past few years. As home prices decline and a recession looms, HELOC availability could completely dry up. Given that 50% of HELOC proceeds are put towards home improvement, pool installations could be hit rather hard.

When comparing new inground pool construction with home equity, an interesting correlation is evident.

The total value of owner-occupied real estate was $41.1 trillion according to the 2Q Federal Reserve Flow of Funds data compared to residential mortgages of $12.2 trillion, representing a 70.5% home equity rate. This is the 2^nd highest rate since 1Q 1983. According to recent surveys, homeowners are hesitant on using home equity lines of credit (HELOCs) due to rising rates. It is worth pointing out that HELOC activity was $131 billion during 1H22, which represented a 30% increase from 2021. This was the highest level since 2007.

The company has historically been awarded a high multiple due to its high concentration of “non-discretionary” maintenance revenues driven by the installed base of in ground pools, which grew by 2.8% from 2019 to 2021.

The company likes to highlight that 60% of its revenue is recurring. This portion of the revenue is related to maintenance and minor repair of existing swimming pools. Maintaining a proper sanitization balance and the related upkeep and repair of swimming pool equipment, such as pumps, heaters, filters and safety equipment, creates a non-discretionary demand for pool chemicals, equipment and other related parts and supplies.

It is surprising that management has not updated this revenue breakdown from 2019 to 2021. From 2019 to 2021, total revenue increased by 51%. It is hard to believe that the company grew its maintenance revenue by 51% when the installed base increased by less than 3% over the same time period. Chemical volumes also appear to have remained roughly flat from 2019 to 2021. The more likely explanation is that the company disproportionately benefited from the surge in new pool construction, which increased by 50% from 2019 to 2021. In addition, revenues likely benefited from price increases, major renovations and one-time catch-ups on deferred major maintenance. In other words, a material portion of the reported maintenance/minor repair-related revenue likely was discretionary.

The company has also benefited from inflation; it disclosed that inflationary pressures benefited revenue by 7-8% in 2021 and expects inflation to benefit revenues by another 10% in 2022. Approximately 25% of the 2021 inflation benefit and 40% of the 2022 expected benefit are the result of higher chemical prices, which is mainly due to the destruction of the largest trichlor (chlorine tablets) manufacturing plant in the US in August of 2020. This plant represented 40% of domestic capacity prior to its destruction. A replacement plant came online in November with 30% more capacity than before.

Chemical inflation has been as high as 40% and the company benefits because POOL takes a percentage mark-up.

The company also likely benefited significantly from the deep freeze in Texas during 1H22. The company claims that revenues increased by $15-20 million as a result of the replacement/refurbishment work from the impact of the storm; however, this estimate seems very low. In this article, https://poolpromag.com/deep-freeze/, Patriot Pool reports that over 90% of its customer base had pool equipment damage ranging from total equipment loss to small leaks, and everything in between. Fluidra, a Spanish-listed competitor noted on its May 5^th conference call:

Manuel Lorente
Analyst, Mirabaud Securities Ltd. (Spain)
Hi. Good morning. My first question is on the Texas freeze impact over the Q1 numbers. If I have understanding properly, I believe that you said that the impact of the overall Texas freeze should be roughly €30 million. I was wondering whether the vast majority of that has been already taking place in Q1 or we just have some comps on Q2 as well.

Bruce W. Brooks
Chief Executive Officer & Director, Fluidra SA
Okay. Manuel, good question, and I will remind everybody that this is not an exact science, but our belief is that the Texas freeze added about €40 million net sales to us last year. We think it is pretty equally split between Q1 and Q2. So, it started in kind of mid-February and we think by mid to late-May we'll start to see the wind-down of that impact.  

According to JP Morgan, Fluidra has a 10% market share in North America. Pool Corp has a 50% market share in the pool segment.

Another way to try to measure the impact to Pool is that according to Goldman Sachs, Texas has 8% of the 5.2 million inground pools in the US, or 413k pools. Assuming the cost to repair the damage per pool cost in between $500-$1,000, the total amount of additional revenue for the industry was $205-410 million. Assuming POOL’s market share of 50% is representative in TX, the potential benefit could be around $100 million.

One could argue that after functioning as a model “roll-up” company during its corporate life. It could be on the cusp of facing an increasingly competitive environment. In 2021, there were 3 private equity backed IPOs in the space last year: HAYW, SWIM and LESL. LESL is a retailer that has announced that they are moving into the pro area to expand their addressable market outside of the DIY customer. This could result in increased competition for POOL. In addition, Home Depot has discussed getting into the pool market more aggressively during a conference call last year:

- Scot Ciccarelli{BIO 1495823 <GO>}

And I guess a follow-up would just be my -- I guess my understanding at least historically has been the new HD Supply capability -- supply chain capabilities should enable you to penetrate markets where you really couldn't play before, you just didn't have that capability to be competitive. Are there any examples of where you're making progress on that front?

A - Craig Menear{BIO 15126612 <GO>}

Yes, I mean, the focus of the capabilities that we're building out is to be able to expand our reach into the pool customer. We've been very strong over the years with the smaller Pro and the unplanned purchase with a larger Pro. And what we're building is capabilities to actually extend into that planned purchase. And we're seeing that beginning to playout. So we're pleased what we're seeing in the early stages.

The company’s long-term growth algorithm is 1-2% installed base growth, 1-2% inflation, 2% new pool construction, and 2-3% market share gains for a total growth rate of 6-9%. Following growth of 100% during the last few years on 30% new pool growth and double-digit inflation creates a difficult base from which to grow.

During the 5 years prior to COVID, POOL grew EBITDA at a 12.5% CAGR. In 2020, 2021 and 2022 (expected), the company grew EBITDA by 34%, 71% and 23% (forecasted), respectively. Contributing to this strong growth has been inventory gains thanks to high inflation, where POOL can pre-buy inventory ahead of the season at low prices and then sell at higher gains. When inflation slows (or turns negative, which should occur with chemical sales), the pre-buy activity could have the opposite effect. Presumably, gross margins will contract from the 31% level to 29%, where they were from 2012-2019.

Over the next couple of years, as pool construction and remodeling decline and the inflationary tailwinds turn into headwinds, the revenue per location could decline by approximately 28%. This would bring the revenue per location in line with its pre-COVID trend. Gross margins should also revert to pre-COVID levels as demand comes under pressure and the inflationary benefit reverses. As a result, EPS should decline from $18.75 in 2022 to approximately $11.00 in 2024. It is surprising that estimates are still as high as $16.87 and $18.18 in 2023 and 2024, respectively.

Catalyst

- Earnings Miss

- Drought in Califronria and the Southewest