TopBuild Corp. (BLD) Earnings Call Transcript & Summary

Good afternoon. Welcome to the continuation of our afternoon session of day 2 of our 15th Annual Homebuilding -- JPMorgan Homebuilding & Building Products Conference. My name is Mike Rehaut. I'm the senior analyst covering the homebuilders and products names for JPMorgan's Equity Research Group. And with us, we're excited to have TopBuild. We have CFO, Rob Kuhns, and Vice President of Investor Relations, Tabitha, off to the side. This will be a 35-minute session. It is a fireside chat. And it's Tabitha Zane, for those that don't know her last name. I'll be moderating it with a bunch of questions, but we also have time and ability to take questions from the audience. And if you'd like to submit a question, you can do so through the button -- Submit Question button on your digital conference book, and I'd be happy to relay that to the management team. So Rob and Tabitha, thanks again for the time and for joining us today.

I'm going to kick it off with just a question about the broader positioning of the company. The insulation installation market and your position there and the opportunity, what's your approximate share of the insulation installation market? Why did you create such a tongue twister in that market? And how should we think about the remaining market opportunity in terms of potential for further M&A and consolidation?

Yes, Michael. So when you think about insulation, installation, that is a bit of a tongue twister. There's really 2 markets, right, there's residential and commercial. On the residential side of things, the thing is on both of them, they're about $5.5 billion in terms of total addressable market. And on the residential side, between our installation business, we had about -- with our installation business, we've got about 30% market share. And on the distribution side, probably another 10%. So we're picking up about 40% of the share on that piece. And then on the commercial side, we've got about 11% share between installation and distribution.

Okay. And obviously, you have a very large -- another publicly traded competitor. Outside of that competitor, is it fair to just think of the rest of the market being open potentially for consolidation over time? Or are there other nuances we should consider?

Yes. I think it's definitely open for consolidation. There's a couple of other, call it, $50 million to $100 million size players out there, and then after that, it's very highly fragmented.

Okay. So still a couple into more medium size, but certainly, it appears not as much as in prior years.

Correct. It's highly fragmented. On the commercial side, it's even more fragmented.

Right. Okay. Second, obviously, TopBuild and the rest of the entire sector has been -- the stocks have been impacted by significant concerns around potential downturn in housing. In the event of a more significant housing downturn in the next couple of years, how should we think about TopBuild from a -- in terms of any potential reactions, business strategies, cost cutting, what have you? How should we think about -- and maybe even price cost, to the extent that there's cost inflation, what's kind of the playbook for TopBuild in reacting to a much significantly softer backdrop?

Yes, yes. And that's -- I mean, we really feel like at TopBuild, we've got a model that's going to outperform in any market. One thing that's very different about us today than just a few years ago is our revenue base, right? It's much more diversified after the acquisition of DI last year. So we've gone from over 80% of our revenue being tied to resi to now around 63% of our revenue being tied to the residential house market. So a little less tied to residential, a little more on the commercial industrial side of things. And then another great thing about TopBuild is our flexible cost structure, right? So we've got 70% of our costs are variable costs, which are made up of material costs and direct labor costs. And so in the event of a downturn, we can quickly reduce those costs. And then the other chunk of costs, the 30% that's left, the biggest chunk of that is also payroll costs. So we went through this exercise and put together this playbook back when COVID first hit in 2020. So in the month of March, our sales declined 20%. And as we were putting together our forecast for the rest of the year, we were thinking that's what we were looking at for the rest of the year. So we laid out the playbook to cut those costs and to try to get our decremental to be in line with what we talk about from an incremental standpoint, which is be in that 22% to 27% range, and we had the playbook to do it. Now luckily, that downturn was short-lived and we didn't have to implement that full playbook. But we certainly have the playbook to do it, and that's why we think we'll outperform regardless of the market conditions.

Great. I also wanted to hit a little bit on product mix. Your mix certainly remains a little more concentrated than your other public peer on insulation and accessories. And I guess this is really -- correct me if I'm wrong, but I have here on a consolidated basis. I believe this includes DI and industrial, but 81% of your trailing 12 months on insulation and accessories, what's the chance that this could change over time and particularly, and potentially just BLD, TopBuild going after potentially perhaps a broader array of products to expand your total addressable market.

Yes. We say, never say never, right? We're always looking at opportunities when they come to us. So we're -- we'll look at adjacent products, but we love the advantage we have with the core of insulation. So that's one thing. When I talked about how our revenue base has changed over the last 5 years from 80% residential to 60%, when you look at the core of what we do product-wise, it's been 80% insulation, it's still 80% insulation. And we feel like there's a lot of white space left in those markets we serve, right? We talked about the $5.5 billion residential insulation installation market. We talked about the $5.5 billion on the commercial side. And now with DI, we also have a $5 billion market of mechanical insulation, right? And so we've got 40% share of the residential, 11% on commercial and about 10% on the mechanical, and so we see a lot of white space in there. We're the #1 player in all 3 markets, but they're all highly fragmented after us. So still a lot of room for roll-up. And the synergies we're going to get on those deals, we just feel like are much greater than what we're going to see as we go outside of our core. Also, if you go back in time, Masco had that strategy years ago when they owned TopBuild Home Services. You would have seen at certain points in time, we had over 40 different products, right, that we were doing across the country. And when housing starts were over $2 million a year, we can make money doing that, but they quickly found as things slowed down, that was harder and harder to do. It's different skill sets with the labor. So that's why as we've come back out of the housing crisis, we've stuck to our core. Like I said, we still feel like there's just a lot of room to grow in that core.

Right? I certainly remember some of those years with Masco, and those were lean years, I guess, you could say, from a profit side at least. Maybe just hitting on the mechanical insulation market a little bit. With first quarter results featuring solid progress integrating DI, how do you see further M&A progressing in this space over the next couple of years? And you kind of mentioned that in residential and commercial outside of maybe a couple of opportunities in residential, it's much more highly fragmented. If you could comment any in terms of the range of sizes of targets in mechanical, I think that would also be helpful. And if you've developed and started to go after maybe some of those targets in terms of a pipeline.

Yes, yes. No, that was one of the great things about DIs, they had rolled up a number of companies. So they came to us with a pipeline of deals. And inside of that pipeline, so I talked about that market, it's about a $5 billion market, they've got about 10% share. They're the largest player, but the next 4 or 5 players in that market are all $200 million of revenue or higher, I'd say, all private right now. So those are all potential future opportunities for us out there. It's pretty fragmented after that, similar to our other core markets, but there are a few chunkier deals out there, which is part of what we liked about the DI acquisition.

You said the next 4 or 5 players after that was $200 million.

Yes. It's roughly the next 5 players after that are over $200 million.

Right. Okay. Perfect. And so just more broadly then on M&A, how do you rate the current M&A pipeline relative to 12 or 24 months ago? And if the housing market softens, do you think your pace of activity could -- would decelerate or perhaps even accelerate if certain targets move closer to selling?

Yes. I mean our pipeline right now is really good. We've got a lot -- we've got a dedicated team that's out there focused on talking to potential sellers. So the pipeline is good. In a downturn, I think, we're going to be just as active. Of course, it depends on how bad the downturn is. But the good thing about our model, as I talked about, with our flexible cost structure. We're also very capital efficient. We don't have a lot of money tied up in CapEx or working capital. So we're going to continue to generate cash in a downturn. So I think what you'll see us continue to be acquisitive throughout a downturn. From a multiples perspective, we haven't seen any major changes there as of yet. Typically, on most of the deals we do, the small to midsized deals, we're paying 5 to 6x EBITDA. And we haven't seen any major shifts on that so far.

Okay. Maybe shifting to margins for a moment. Your incremental organic EBITDA margins, you have the long-term goal of 22% to 27%. Incremental organic margins in 2022 are expected to be at the high end of that range, and it follows '21 at 34% and several other years above that as well. So how do you think about the range relative to some of those numbers that I just threw out? Do you feel like is it too conservative potentially? And in a similar vein, how do you view the long-term EBIT or EBITDA margin itself in terms of potential for the company? Right now, in '21, your EBITDA margin was 17.4%, how do you see runway for that over the next few years?

Yes. No. I mean we're always looking to do better than that 22% to 27% that we put out there for guidance. And we've done a great job in the past basically since spin of overachieving that mark, right? And that's through leveraging our fixed costs, managing our fixed costs every day, the productivity initiatives we have in place to make our installers and our salespeople more productive. Those are the things that have pushed us above that mark, but we're not ever going to apologize if we land with a 27% EBITDA flow through either, right? So we feel good about that as well. So we feel that, that's a good target moving forward. We're going to try to over -- we're going to try to do better than that for sure. As far as the overall EBITDA, as you mentioned, I mean, that range does imply that we do see room for growth from our existing EBITDA, right, going from a 17% if we keep layering on 22% to 27%, it's going to go up. But what you're not going to see is the incrementals year-over-year being as good as they've been in the last couple of years, right? So if we land -- and that's just the math of it, right? The 30% flow-throughs we were getting when our EBITDA was 15% is getting us 100 to 200 basis points. It's not going to be the same when we're at 17%, 18% EBITDA.

Right. Right. No, that -- understood. Maybe also on the margin front, and before I ask because I'm kind of actually -- you're coming close to the end of my group of questions, and I appreciate all the answers and the succinctness of them, which is always helpful, to be honest. A direct answer to a direct question is sometimes rare. But just want to remind people in the audience again, if they'd like to ask a question, please submit it through the Submit Question button, and I'd be happy to pass along. I see one in the queue, and if there are any others, happy to pass those along as well. So the last question I just have here really for you guys is also on the margin side, on the specialty distribution business, when you think about building products distributors or at least I've covered this space for a long time. And an operating margin of 5% to 10% was more typical, and obviously, you guys have blown past that over the years and low to mid-teens is kind of the track record more recently. So what are the differentiated attributes of this distribution business that allows for those now mid-teens operating margins versus historically being something more in the high single-digit range at best? And how sustainable are the drivers of that business in terms of initiatives that have been implemented and to potentially even drive further improvement?

Yes. So I mean, our distribution business, we put in a new management team at the end of 2019 that have really come in with a focus on making sure we have good strong customer service metrics, and that we're getting paid for the service we provide, right? So the backdrop of the last year with high price inflation has certainly helped, right? This pricing environment has been a good time to be a distributor. But the changes we've made in the business in terms of productivity, fixed cost management, those are sustainable drivers to our margin. So getting to your question about long-term sustainability, the question becomes when and if material becomes more abundant and prices drop, will we be able to sustain those margins. For sure, the things we've done from a productivity and fixed cost perspective, that's going to stick, right? We're going to keep that. And we're going to work our hardest, right, on the material supply side with our supplier partners. As material becomes more abundant, we're going to get price reductions from them as well to look to maintain our margins on that side of the business.

And do you have any sense of the productivity and fixed cost benefits, what those represent from a margin standpoint over the last 3 years?

Yes. We haven't broken out the components of that margin improvement, but that's been a big piece of the story, for sure.

Okay. All right. Well, I have one question from the audience. It's a little bit similar to, I think, some of your last statements that you just made around price and normalization, but I'll throw it out there anyway in case, perhaps there's an element that are missing. What is your view -- and I have another one coming in as well. But what is your view on whether price increases will stick once the market normalizes and cost decline? Are some products more likely to maintain price than others? If so, why?

Yes. I mean it's really 2 different conversations, too, right? It's the installed side of the business and the distribution side of the business, right? So on the install side of the business, we're not just selling materials, right, we're selling material and labor to the builders or to the commercial contractors. And so there's been times in the past where material prices drop, but we've been able to hold price or even increase price because labor has been tight, right? So there's 2 pieces to that equation. And the answer is going to depend on what labor looks like at that given time. On the distribution side, when there's more material, certainly competition is going to start dropping prices. We know with our systems, we've got good pricing discipline. So we're not going to be the ones driving down the market. But for sure, we're going to stay disciplined. And as prices drop, like I said, we'll be working back with our manufacturing partners to make sure on the material side, we're getting our costs reduced as well.

Great. I have another question here, which is around the end markets that you serve, MRO versus new construction. And I feel like I'm not -- you'll tell me how on the mark this is. But the question is as follows: seeming that 50% of the business is MRO versus new construction, can you go into detail into what that MRO business is and what the drivers are? I mean that's basically the full effect of the question.

Yes. I think it's probably helpful that I clarify there what those numbers are. So if you look at our legacy TopBuild business before DI, I I'd say, roughly 7% of our revenue was tied to R&R-type work. And then the 50% MRO we're talking about, that's related to the DI business alone, right? So when we acquired DI, one of the things we liked about it was the strong recurring revenue from MRO, and that's roughly half of their revenue. So with mechanical insulation, you're insulating pipes in plants that are exposed to high temperatures or cold temperatures, and so that installation has a lot more wear and tear, and there's requirements around replacing that, right? And so it's that replacement cycle that drives that MRO. Now that cycle is -- it's not exact that we can say, hey, we're going to get it on this date, right? But we know over time, those parts are going to have to be replaced, and that's a nice recurring stream of revenue that I mentioned.

Right. Okay. That makes a lot more sense. And sorry, I didn't feel that one out myself a little bit, knowing that the core business is -- the residential and commercial is much more new construction-driven. So I appreciate that. All right. Well, that actually does it for the session. There's no more questions in queue, and I've exhausted all of mine. So we'll end this one a little early. And so I just want to thank your participation, and always great to have you. And we'll be resuming the conference going forward. And we actually have a little bit of a break, but past that in the latter part of the afternoon, we have Century Communities at 3:00 p.m. and 4-star Group at 3:45. Again, Rob and Tabitha, thanks so much for your time and participation. It's great to see you, and hopefully, next year in person.

All right. Thank you. Thank you, Michael.

Thank you. Bye.

Thanks so much. Bye-bye.