TopBuild Corp. (BLD) Earnings Call Transcript & Summary

Thank you, everyone. We'll go ahead and get started. Good afternoon, and thank you for joining us for our next meeting of the day. My name is Trey Grooms, building materials analyst for Stephens. And joining me this afternoon is TopBuild's CFO, Rob Kuhns and Vice President of Investor Relations, Tabitha Zane, there. First off, I want to say thank you to the TopBuild team for joining us. Always a pleasure to have you here in Nashville with us. TopBuild is the largest residential insulation installer and distributor in the U.S. with a strong presence in industrial and commercial end markets as well. I think Rob is going to start with a few comments. I will kick off Q&A and then open it up to the rest of the floor. So with that, I'll turn it over to Rob.

Sure. Thanks, Trey. Thanks for having us here. We're coming off a great third quarter at TopBuild. We just had sales of $1.3 billion for the quarter with sales growth on the same-branch basis of 23% and volume growth of 9%. Our EBITDA for the quarter was 19.9%, a record for the company, up 120 basis points from prior year. It's definitely an interesting time in our industry right now as we're very busy, as busier as we've ever been. But obviously, we see the potential slowdown coming here on the residential side, for sure. Roughly 65% of our revenue is derived from the residential side of things. We had a good quarter on the residential side of things. And we think we've got a good enough backlog right now to get us through the first quarter of next year. And then after that, it's going to depend on where interest rates fall, how starts look here over the fourth quarter and the first quarter. And then what's really different about TopBuild today versus TopBuild a few years ago is the nonresidential side of our business, which is now 35% of our sales. Even a year ago, that was closer to 20%. And we've grown that through the acquisition of DI, which is going very well right now, and you can see that in our results. So we're cautiously optimistic on that side of the business moving forward. We're seeing good order volumes, good backlog. Until this morning, all the forward-looking data was looking good, but the ABI this morning did shift negative. So we're obviously monitoring all those forward-looking metrics. But our backlogs are good, and we're hopeful that we could see growth in that side of things for next year. So with that, let's start the Q&A.

Sure. Sure. Thank you for that introduction there on that. And I wanted to ask quickly on kind of the nonres, which you just touched on, 35% of your business. Can you talk about how the product set compares to your residential offerings? And then how that side of your business, which I know you didn't own all of it in the last prior downturns, but how that side of your business has generally performed in recessions, not looking to the financial crisis, but in something more mild?

Right. Yes. So if you look at that 35%, that basically breaks down, about 15% of that is our legacy commercial business. So that's on our legacy building insulation, primarily on the installation side of things, but also a little bit of distribution there as well. And then the other 20% is the acquisition of DI, which I'll talk a little bit about. As far as going back to the legacy piece as far as the products, as far as your question, Trey, on products, the product mix is similar. It's probably a little less heavy on the fiberglass side than on the residential side of things, a little heavier on spray foam, a little more fireproofing, fire-stopping, that side of things. That side of the business has certainly been slower to recover since COVID. A lot of those projects have been slowed down and delayed. We did see a good quarter this past quarter of same-branch sales growth, which is good to see. And like I said, our backlogs there are strong, and we feel good looking forward. As far as how that's going to trend in a recession, they're not immune to interest rates, right? So we're eyes wide open there in terms of whether projects are going to get slowed down or canceled. I think typically, the commercial construction cycle lags the residential one. So we're certainly monitoring that. But it gives us some positive outlook for 2023. And then as you shift over to Distribution International, their mix of business is commercial as well as industrial, and that's now 20% of our 35% that I'm talking about. And like I said earlier, that piece of the business is doing very well. Backlog is strong. Synergies are ahead of what we expected at this point. So we signed up for $35 million to $40 million of synergies, and those are rolling in. The product mix there is different. We're purely a distributor on that side of things. And what they're doing is mechanical insulation, right? So if you think about our legacy business, what we're doing is the insulation that goes in the walls of a building like this, the attic of your house. That's the type of insulation we're dealing with. With mechanical insulation, they're handling the guts of a building, right? And they're insulating pipes. And so in the commercial and industrial side, you're dealing with chemical plants and liquid natural gas facilities and manufacturing facilities, and you're insulating the pipes that go into those facilities. So there are -- fiberglass is one of their primary products, but there's a lot of other products, aerogel, foam glass. There's a lot of different products that go -- there's metal wraps that go. So there's a lot of different products on that side of things. And from how that's going to react in a downturn, we think it's going to be less cyclical than even the regular commercial cycle because 50% of their revenue is MRO. So it's repair/replacement. So when you think about insulating the pipes at an ExxonMobil or a chemical plant or something like that, there's a repair/replacement cycle that has to happen because those pipes are often exposed to high temperatures or the elements outside. So that should give us a steady revenue flow. Now I do talk -- I have talked on the last couple of calls about how their revenue can be lumpy. So over the long term, that gives us a smooth revenue cycle, but even those MRO projects can be large, and from quarter-to-quarter, we can have large project shipments that can make revenue fluctuate a little bit more.

And what kind of visibility do you have into that side of the business?

Yes. I mean the long-term forecasting on commercial and industrial is definitely more challenging than on the residential side. There's -- we look at the Dodge data that's out there, and we're trying to get comfortable with that. We have -- we're bidding activity late into '23, even into '24 now on some large projects. So we have some visibility there. But these are large projects that can get slowed down and delayed. So it does make the revenue forecasting side of it a bit challenging.

Have you seen anything -- on the commercial side, have you seen any cancellations or pause or push to the right or anything as far as your contracts, your backlog, those types of things at this point?

Yes, definitely on our legacy business with the installation side, we've definitely seen projects delayed. And I think that's more to do with all the constraints that the industry is dealing with, both material and labor. So projects that they're working on are just taking longer, and it's taking them longer to get to the next project. On the DI side, not as much. We haven't seen that as much. Not a lot of cancellations, which is good at this point. But again, like I said, they're not immune to higher interest rates. So that's potentially a risk as we move forward.

Got it. Switching gears a little bit here to the residential side. You mentioned you're very busy now, should see continued activity here through 1Q just from the backlog you have. But can you talk about the -- when we do start to see a bit of a slowing, your expectations for, number one, pricing in the industry, which I know there's been a lot of inflation on fiberglass especially. There's another increase announced, I think, for January, I believe it is, from the manufacturers. Can you talk about your expectation for the pricing side of things in -- as we kind of get into the slower times here, which are -- which seem to be looming. That number one. And number two, what dials you can turn in a more challenging kind of operating environment?

Yes. As we think about pricing moving forward, I mean, we're definitely coming off a historic level of inflation in the last couple of years. And we've performed well in that environment. We've done a good job of passing those cost increases along. As we move forward and we think about pricing, as you mentioned, there is an announced price increase here in December and January. It differs by manufacturer, but here late Q4, early Q1, there's an announced price increase. We'll see how sticky that remains. I mean, what's unique about the time we're in right now is that the builders are certainly seeing the slowdown, but the manufacturers and ourselves right now, we're still basically at capacity. We're still working on allocation from the manufacturer. So I think they're still dealing with inflationary pressures on their side, and that's why you're seeing these announced price increases. So as we go into next year and think about how pricing is going to look next year, I think it comes back to volume for me and where you think -- where interest rate is going to settle at, where will starts come out, because ultimately -- I think the fiberglass manufacturing capacity is probably somewhere around 1.5 million starts and completions, and it's always going to be a little lower than that due to maintenance. And so if you think completions are going to be significantly below that going forward, I think that will make a pricing environment more difficult because I think there'll be more material available. If you see that staying tight, if you see completions staying tight with that capacity, I think it could remain with some price pressure. And then as far as -- I think your second part of the question was around levers we can pull in a downturn. One of the great things about our model is that it's high variable cost. So we -- 70% of our total cost structure is variable cost. And so in a downturn, we're targeting decrementals to be in the same range that we have on the incremental side of things, which is around -- EBITDA around 22% to 27%. And so if you think about that cost structure and how we get there, if you make up a scenario and say, hey, sales are going to be down 20% next year, with that -- if that 70% cost bucket, which the biggest piece of that is our material cost, we can obviously variabilize that very quickly. The second biggest piece is our direct labor. So that's our installers. So we would need to let them go as the work goes away. And the majority of them are paid on a piece rate. So if they're not working, they're not getting paid. So that bucket is easy to variabilize. And when you get into our semi-variable/fixed cost, the other 30%, by far the largest chunk of that is our back-office, people support, sales people, things like that. And in order to -- if sales are down 20%, we've got to take out 20% of the variable cost, and we've got to take out about 10% of the semi-variable/fixed cost in order to get to that 27% decremental. The caveat we've put on that, right, where we may come in worse than that from a decremental perspective is, one, if we decide to hold on to labor longer, right? So if we expect this downturn to be short-lived, we're not going to quickly let go the labor. We're going to hold on to it a little bit longer because labor has been tight, and it will be more difficult to add back in the future. And then the second is if we did get into a deflationary price scenario, again, to do that same work, you've got to hold on to the labor. So your decremental in a negative price scenario is going to be a little bit higher as well.

Okay. That's super helpful. I'll pause and see if there's any questions from the audience. No questions, okay. I'll keep going with my list here. I've got a few more. So as you think about the labor side of things, it's been a fairly tight labor market. Is there -- as you start to see things kind of easing, as we were talking about, do you see the ability to maybe see less inflation on the labor side coming up maybe next year or 2 than what we've been seeing? Or you mentioned piece rate type of compensation, so if you could maybe talk to that a little bit.

Yes. I think it's important from our perspective, we haven't seen as much labor inflation as probably some others, right? And that's because of the way we pay people on the piece rate, right? So with our installers, which is the biggest chunk of our employee base, the average installer can make $60,000 a year, right, which is a good wage for a low-skill job and comes with the full benefits package 401(k). And because we pay them on a piece rate, the way we offset inflation is by trying to make them more productive, right? So all the things we can do to get them on the job site faster, working more efficiently, training them, putting GPS in the vehicles to get them to the job sites faster, those are all things that help us make more money as a company and help them as employees make more money as employees. Now obviously, in certain markets, we have had to take up piece rates to stay competitive, but it hasn't been a significant cost pressure for us, and we've certainly been able to offset it on the price side of things.

Okay. On, I guess, the M&A side, you guys have been very acquisitive, especially over the last few years. How are you thinking about that going forward? And again, kind of pointing to a little bit slower environment, do you kind of keep the foot on the pedal, do you dial it back, what's your approach to M&A as we look forward?

Yes. Yes. As we think about -- I'll take it as capital allocation broadly, right? As we think about capital allocation, our #1 priority is always to maintain a healthy balance sheet, right? And we certainly have that today with adequate liquidity and net debt leverage of 1.49x. So we feel very comfortable with that, where we're at today. And even in downside scenarios that we're looking at, we don't get anywhere near our debt covenant of 3.5x. So we're very comfortable in that 1 to 2x net debt leverage, and we've even taken it up above that for some of the strategic deals we've done. And we've quickly delevered from that, and we're very comfortable doing that. So then as we continue to think about capital allocation, after a healthy balance sheet comes growing the company, right? And first in that bucket is investing in our existing business, and that's CapEx, which luckily for us is we're a capital-light business, runs about 1.5% of sales. So that doesn't eat up a significant amount of money each year. And then the best avenue for growth for us has been through M&A, especially in a period of time where we've been on allocation makes it difficult to grow organically. So we've grown a lot through M&A. And we think we've developed a really good model for doing that. Because of the scale and buying power we have, we're typically buying a lot more at a better price than the folks we acquire, which makes the synergies low risk when we do those deals. So we like the returns we get there. Typically, we're paying 5 or 6 times multiple on those. And after synergies, it's about 3 or 4x. And then knowing that -- we wish there was more M&A out there for us to do. But knowing it can be lumpy, we do look to return capital to shareholders. And so far, we've used buybacks for that. We've bought back $200 million this year, which is a little higher than normal for us, but we've been very focused on the DI integration this year. So we've done 5 M&A deals this year, adding about $20 million in revenue. But I think you'll see us moving forward with a similar strategy. Like I said with our high variable cost model, low CapEx, we're going to continue to generate strong free cash flow in a downturn. And we see that as an opportunity to invest in additional M&A, hopefully see some more folks come to the table. And ultimately, for us, we'll come out of this downturn with a larger share of the market and as a stronger company.

And can you remind us what is the -- I know you're pretty capital-light, but what is the kind of the goalpost for CapEx as you think about this year and next?

Yes. Yes. The guided range we've typically said is 1.5% to 2% of sales. This year, we're trending definitely towards the low end of that. And in a downturn, we'll tighten that up and keep that close to the 1.5% as well.

Got it.Okay. I guess on the -- as we look at both sides, you do have distribution and installation. So how do those 2 sides of the business perform differently in a tougher environment?

Yes. On the residential side, it's been a while since we've seen a downturn on the residential side. I mean we're, I think, on a 10-year growth pattern here. And the last downturn was The Great Recession, which was definitely a different time than now. But what we saw back then on the distribution side, if you think about our legacy business and distribution there that we're doing they were selling to mom and pops. And sometimes during growth cycles, those mom-and-pops get big enough that they can start going direct to the manufacturers and get a better buy price. So typically, in the up cycles, they won't grow as fast as our install business. They won't grow quite in line with completions. But in the downturn, it's the opposite, right? So on the downturn, they won't shrink as fast either because some of those mom-and-pops that were going direct before will come back to distribution from a cash flow perspective because they don't have the volumes anymore to support the direct shipments. That's at least what we saw in the last downturn. We'll obviously, if we're heading into another one, be monitoring that closely, but we think we'll have a nice offset there.

Okay. And on the install side, it seems like that's been an area where if I look back historically, going back well before COVID, it seemed like the margins on the distribution business were a little more stable and the opportunity was kind of on the install side as you got more leverage on your fleet and your people and things like that. As you look at the margin profile of both of those, is one maybe a little bit more volatile than another as we're kind of looking at these different scenarios?

Yes. Yes, I think as we get -- if we get to a point where there is price pressure in the market, I think the install side things -- price tends to be a little stickier because there we're quoting a combined package of labor and material. And so while labor is tight, that helps us out in that market. On the distribution side, particularly in our legacy business, it's more box in, box out. So if there's more material available in the market, other distributors will quickly react, I'm sure, and there'll be some price reductions there. I mean that's the good news with the DI side of the distribution business, right? With the value-added products they do on that side of the business, that has a little bit stickier price on that side as well as the fact that they're serving the commercial and industrial side of things.

Right. Got it. Any last questions from the audience? I pretty well made it through my list. We're pretty efficient with this meeting. So thank you very much. Thanks, everybody, for your time. And thank you, Rob, as well.

Yes. Thank you, Trey.