TopBuild Corp. (BLD) Earnings Call Transcript & Summary

Welcome to the TopBuild fireside chat. I'm lucky to be joined by CFO, Rob Kuhns, and then Tabitha Zane, IR, is here as well. So Rob, thanks for joining me. I think just to start, can you just give sort of a quick summary of TopBuild to those that aren't -- that are newer to the story.

Sure. Sure. So TopBuild, we're a $5 billion in revenue company. 2 segments. We handle installation of primarily insulation and then we do distribution of insulation as well and insulation-related products. So about $3 billion on the install side; about $2 billion on the distribution side. So we're installing and distributing that both into residential and commercial end markets. So on the install side of the business where about 84% of our revenue is tied to residential, primarily new construction; and then about 16% is tied to commercial. Roughly half and half, what we would call heavy commercial, big projects, airports, stadiums, et cetera and then the other half light commercial, things like restaurants, strip malls, things of that nature. And then on the distribution side, we're about 60% commercial industrial, where -- there we're distributing not only the envelope insulation that we do on the install side, but also mechanical insulations that we're distributing the insulation that goes around the pipes in a large manufacturing facility or an oil and gas facility. So that's about 60% of the revenue on that side of things.

I think my favorite end market is the aircraft carrier that they have in their Investor Day. So I mean that actually given the really diverse sort of end market exposure you have, you have a good perspective. Just what are you seeing in the residential and nonresidential demand kind of compared to your expectations coming into the year?

Yes, really on the residential side, we, as a business, have really benefited from the backlog of activity that was out there, right? So we're coming off a record first quarter, great sales growth in the quarter. So the slowdown that the builders have seen hasn't made its way to us yet on the residential side of things. We obviously see that coming, right? We see that starts are running 20% or below where completions are running. And so we're preparing for that. Our guidance for the year, we guided to residential revenue down mid- to upper single digits for the year. As of right now, things are playing out about as we expected, I would say, right? So single-family housing starts are still hovering in that 800,000 to 900,000 range, down from where they were -- down about 20% or more from a year or so ago. Like I said, we're working through the backlog, still busy, but that dip is going to come for us, probably the back half of this year is our best estimate. So one of the things we've been doing, getting ready for that, right? We saw -- we've seen this coming. We've been building up our backlog on the multifamily side, building up our backlogs on the light commercial side. So we're going to do all we can to offset as much of that downturn as we can. And then in addition, a lot of optimism from the builders recently, which is great to hear. So if that comes through in the starts numbers going forward that should be upside to the forecast we got out there. And then on the nonresidential side, what I can tell you is, we guided to low to mid-single-digit growth for the year. We had a good strong 8% growth number in Q1. So off to a strong start there. Our bidding activity and backlogs are strong. So we're cautiously optimistic on the commercial side as well.

I think you're the first one to say, downturn so far in this conference. So just kind of going back to some of the comments on the residential side. If we start to see, I think, a lot of the builders have spoken about starts potentially accelerating here just because of the higher velocity of sales. If we start to see that, how -- when would that start to be reflected in our business? And how is that relative to your guidance?

Yes. Yes. So typically, for us, our work in a normal construction cycle is roughly halfway through the new residential construction cycle. So on average, that's probably 3 or 4 months after the house has started. So if we do see this upturn in starts here in the next couple of months and it's sustained, we should get that benefit in late Q3 and Q4 of this year and that would be upside to the guidance we've got out there.

And then within insulation, both kind of serve on the resi and nonresi side. Can you just talk about some of the long-term trends that you're seeing in terms of like the greater focus on energy efficiency, more stringent building codes, like how does that impact insulation? And then how is TopBuild sort of positioned for those trends?

Yes. And no major trends in the products at this point. I'd say, we're seeing a little more specking of spray foam on the commercial side of things. Spray foam typically has a little better insulating properties than fiberglass. For sure, the code changes and the Inflation Reduction Act and the tax incentives that are baked in there will be tailwinds to our industry. So everything is moving towards more insulation. The tricky part there is that the codes are managed by municipalities. So it takes time for those changes to happen. But like I said, for sure, it's a tailwind to the industry.

So kind of sticking with the resi insulation side. You've gained really significant market share over time. Can you just talk about where your share is today and then where it could go over time? And just what are some of the key drivers to that market share gain?

Yes. So as we think about the residential installation side of the business. That business, it's about total addressable market, probably about $6 billion. We're getting to probably about 30% of that through our install business and probably touching another 10% through distribution. Our next biggest competitor probably has roughly 25% share and then it's pretty highly fragmented after that, right? So a lot of our share gains over the past few years, especially as material has been tight and on allocation, a lot of that share gain has come through acquisitions, which we have a great track record on acquisitions. We've done 25-plus deals in the last 5 years and it's become a core competency of the company, right? So we've got great advantages with having 30% share in that market. And when we go and acquire companies, we obviously have significant buying advantages. We've got great operators in the field that go in and share best practices with those companies when we buy them. And so like I said, we've got a great track record there of M&A. So we continue to see great opportunities there, right? So with 30% share today, we think we can continue to do roll-ups in that space and continue to grow it. It's highly fragmented. So there's a lot of smaller deals. But like I said, it's a great use of capital to get those deals. Typically, we're paying 5x or 6x EBITDA and 3x or 4x post synergies. So it's a great use of capital for us.

Can you talk about some of those synergies that you're using to drive that multiple down by a turn or 2.

Yes. I mean the biggest is our buying advantage, right? We're the largest purchaser of insulation in the country. So when we're buying smaller companies, we know we've got a significant buying advantage there, and we can validate that before we do the deal, right? It's a low-risk synergy when you can go as part of your diligence, verify their buying costs and on our side then we know what our cost is. So that one is a [ low cost ] synergy. And then like I said, we've got this relentless culture of constant improvement throughout the company. With 400 branches across install and distribution, there's always this bottom quartile that we're focused on in terms of sharing best practices, how do we make our labor more efficient. And we take those same practices we use every day in running our business and bringing up that bottom quartile. We share that with those acquisitions in terms of getting those guys running as well.

So those are sort of the advantages from your perspective of a better scale. What about to your customers? What are the advantages of working with TopBuild versus one of the smaller competitors?

Right. Yes. I mean if you're a builder, right? I mean what we do makes up roughly 2% of the cost of a house. So it's a small piece of what they do. What they want us to be able to do is have the material, have the labor, be there on time, get the job done, so they can keep their project moving, right? And so the step we do comes right before a critical inspection for them as well. So I think that's really the advantage of TopBuild to the builders is they know we've got the material, they know we've got the labor. We're reliable. They want to get us in, get us out and keep their project moving.

Definitely, one of the themes of the conference is the rising soft cost of homebuilders and slower -- longer build cycles have significant costs. So that makes sense. Kind of pivoting sort of to the nonresidential side, can you just talk about some of the -- like can you give a rough breakout of commercial versus industrial versus mechanical? And obviously, those end markets are very different, so just giving us a picture of what you do.

Yes. Yes. So like I said earlier, on the install side, commercial is about 16% of our revenue, roughly 50% big heavy commercial projects versus light commercial projects. I'd say there's no end market we're over-indexed to, we do everything, airports, stadiums, commercial buildings like this, which obviously, there's not a lot of these office buildings going up right now but it's not a big piece of what we do. Like I said, our revenues on that side of the business were up in the first quarter, around 8%. So doing well there. On the distribution side, it's even a wider array of industries because we've got the mechanical insulation piece. So if you look at that commercial exposure, I'd say it's about 50% light commercial, 25% heavy commercial and then 25% mechanical insulation, right? And there, you're doing a lot of different industries. And the great thing about that mechanical insulation is it comes with a recurring revenue stream, right? So when you are insulating the pipes at a facility, at a manufacturing facility, over time, those things are exposed to high temperatures. They're exposed to the elements in some cases. And so what you don't want is corrosion getting under the insulation because that becomes a very costly repair. And so those things have to be repaired and replaced over time. So typically, the cycle times around every 5 years, those products have to be replaced. So that's become a nice recurring revenue stream for us as well.

How much of your -- do you have a rough sense of how much would be that MRO...?

Yes. So it's roughly 50% of that mechanical insulation stream, which is about 25% of our commercial revenue on the distribution side.

And then can you talk about sort of the visibility of that business going forward? The backlogs that you have? So obviously, it's a very different bidding process for some of these large -- in some cases, they sound like they're mega projects. And then obviously, there's a lot of focus now on the more recent nonresi trends just given the kind of the tightening credit environment, just what you're seeing more broadly on the forward outlook?

Yes. Yes. So the bidding process on that side, like you said, is a lot longer. We're bidding projects right now into 2025. Our backlog is really good for this year and into 2024 as well. We're bidding a lot of projects in 2024. There's a lot of big projects going on, electric vehicle projects, electric battery -- the batteries for the electric vehicles, facilities for that. You've got some onshoring of manufacturing going on. So a lot of big, mega projects, which should be good for us going forward. It's a more difficult business to forecast, I'd say, than residential, right? There's diverse end markets that I talked about, the fact that these projects really vary in size greatly. And then the insulation that goes on these projects can be significant. So over the long term, we expect it to be less cyclical than the industry because of that recurring revenue stream. But between quarters, it can be chunky because these big projects as they ship the timing between quarters can be significant.

Kind of pivoting to margins here. Can you just sort of talk about the incremental margins for both the installation and distribution businesses?

Yes. So margin expansion has been a big part of TopBuild story. Over the last 4 years, we've expanded our EBITDA margins by over 700 basis points. And so we guide -- we're today running at about 18.8% EBITDA margin and our guidance is around 22% to 27% is the range we give. I'd say, the distribution business will be more towards the low end of that down towards the 22% and installation more towards the high side, the 27%. But if you looked at our history, as we've grown, we've done a really good job of managing price costs, really good job of managing our fixed costs. Like I talked about, a really good job of driving productivity with our installers and focused on the bottom-performing branches. That's what's really helped us with that EBITDA expansion.

So in the downturn, how variable is that cost base? What sort of level of decremental margins would you anticipate? And if you see kind of a pullback in the market, but you view it as temporary, it sort of seems like this might be a very short pullback. Would you be willing to sort of accept like higher decremental margins to keep your labor force so you're in position to take market share coming out at the other side. Just how do you think about managing through a slowdown?

Yes, I mean one of the -- another one of the great things about our model is the cost structure, right? So we're 70% variable cost and about 30% fixed/semi-variable costs, call it. So in a slowdown scenario, right, we're going to variabilize that variable cost quickly. The biggest piece of that is our material costs. So we stop ordering. That cost goes away. The other piece of the variable cost is our installers, the majority of which are paid on a piece rate, so they get paid for the work they do. So the less work they do, the less they're going to make, so we can variabilize that cost quickly. And then the other 30% of our cost, the semi-variable or fixed cost, that's primarily people cost, it's back-office support. The next biggest piece after people cost is our rent, which runs less than 5% of our total cost. So really, in a downturn, our playbook is around reduction of labor at the end of the day. And so we went through this when COVID hit, our sales dropped 20% that first month. We thought it could be a lot worse than that. So we laid out our plans in terms of who are the A players, B players and C players, and you start obviously cutting the C players as things slow down. Luckily, with COVID, that turned out to be a short-term downturn and we ended up growing after that. But we'll have a similar playbook in a downturn here. If we cut costs like we plan in those 2 parts, we should be able to have decrementals in that same 22% to 27% range on the downside. I'd say that's our long-term target. To your point, in the short term, if we believe the downturn is more of an air pocket, we're going to hold on to some of that labor longer knowing that labor has been tight. And when things come back, we want to be ready. So that's actually what's baked into our guidance. If you look at our guidance, it implies a decremental closer to about 38%, I think.

Just following up on that. What are you seeing in terms of labor availability and wage inflation?

Yes. On the availability side, it obviously varies across the country in the different markets, but it's still very tight. Like I said, we're still very busy in our business working through the backlog. I think we've done better than most with labor. Like I talked about, we pay on a piece rate, which I think is an advantage. Ultimately, the installers -- our average installer can make -- our average installer is making over $60,000 a year, with full benefits, 401(k) for a pretty low skill trade job and the really good ones are making over $100,000 a year. So their incentives are aligned with ours in terms of being productive and I think that's helped us on that front. As you've heard the builders talk about all the supply chain and labor issues, I don't think insulation probably makes the list of the top 10 in terms of challenges they've had. I think what we've done on the labor front there with how we pay people, the benefits as well as the recruiting efforts we've put in place, we put in place a friends and family program that pays bonuses. So if I bring you in as an installer, every 6 months, I'm going to get a bonus if you stay with the company. And we found that that's really helped with retention as well because now I'm going to pick you up for work. I'm going to make sure you're there every day, I'm going to make sure you're productive. And so those are the things we've done to help on the labor front. I'd say on the inflation side of things, we've seen some labor inflation. We manage the piece rates locally in those markets. And we really try to fight inflation on the productivity side of things, right? So that's where paying by the piece rate really helps us because at the end of the day, if I can get them to be more productive, I'm putting more into their paycheck without taking up their pay increase or their pay rate.

You don't want to bring me in as an installer...

You don't want me to train you, I figured that.

So then just thinking about capital allocation here? I mean what are the priorities? Historically, it's been M&A. Has that changed at all because of the current environment? Or is there anything or multiples? How do you think about your priorities and M&A in this environment?

Yes. No, capital allocation has been a big part of our strategy. I mean we've got a great business model that spins off a lot of free cash flow. Our CapEx investment is very low at 1.5% to 2% of sales. Working capital runs 12% to 14% of sales. So not a lot of capital tied up there. So the free cash flow conversion is very high. And from a capital allocation priority standpoint, I mean having a healthy balance sheet is always top of the list, right? And we have that today with our leverage at 1.15x. We've got over $800 million in liquidity, so we feel really good about the balance sheet. Second priority is growth. And like I said, internal growth doesn't require a lot of funding, just 1.5% to 2% CapEx. So M&A by far, as I talked about before, the advantages we have there with the synergies we can generate gets us the best return on our dollar. So that's still top priority. If we could reinvest all of our cash flow in M&A, we would. But one, we don't control when the assets come for sale; and two, we are disciplined in our process to make sure we don't overpay. The third priority then has been returning to shareholders, which we've done through buybacks historically. Last year was a good example -- I think we've bought back about $680 million since our spin back in 2015. And last year, we bought back $250 million. We're a little less focused on M&A last year as we were focused on integrating and realizing the synergies of the biggest acquisition we did, which was at the end of 2021 , the Distribution International that we acquired. But now with that heavy lift behind us, we're going to focus more on the M&A front. We'll continue to be opportunistic on the buyback front. And so really no change in our capital allocation strategy.

So when you think about -- can you just talk about between -- you spoke a lot about the installation side with the M&A environment like typically 5x to 6x. How about on the distribution? And as you go into some of these more nonresi segments, like what are you thinking about in terms of parameters of what multiple you'll pay, how large of an acquisition could you digest? And then how high would you be willing to take your leverage on a short-term period for a deal?

Yes. Yes. So historically speaking, our leverage typically sits between 1x and 2x. But with the 2 larger acquisitions we did, we did USI back in 2018, which was the third largest player in residential. And then we did Distribution International in 2021, that was a $1 billion deal. Both cases, we took our leverage up, went up 2.6, 2.7-type range, and we quickly delevered from there. So for the right deal, we're definitely comfortable going higher than where we are today. It's one of the things we liked about the DI deal, got us into the mechanical insulation space. And there's definitely a few chunkier deals in that space, the next handful of players -- we're the largest, but the next handful. Best estimate, they're all private. Best estimate, they're probably $200 million to $700 million in revenue. So a little less fragmented than the residential space. From what we've seen from the DI before we acquired them was doing a number of acquisitions. The smaller acquisitions are going to be similar-type multiples that 5x and 6x. And there could be some other larger ones where we may pay a little more like we did on DI or USI. I mean when we think about -- I mean we definitely look at the multiples, right, but we really are focused, I'd say, on the IRR side of things and what -- making sure we generate returns that are higher than our cost of capital. And when we do that, we're looking not only at our forecast based on how we're thinking about residential and commercial, but we also look at downside scenarios, knowing that there's uncertainty out there right now. We evaluate that side of things as well.

Should we see if there are any questions from the audience? Yes. Well, the mics right behind you. Yes.

So I've been using you guys since you're part of Masco, Bill Christie used to live there. Are you focused on -- I got -- I ask this question only -- I've always wanted to ask somebody like you this question, are you focused on just buying everybody in an MSA so that there is no competition. Is that a focus?

No.

Livermore is a great example of buying everybody in an MSA, right, California, Richmond in all those areas. But that isn't really the goal...?

No, I wouldn't say we're going for a monopoly, right? I'd say we're looking for opportunities where we can get good returns on the capital we invest and...

Also, and I guess you're still pretty focused on core business, which is what garage and insulation, right?

We do garage doors in some of our branches.

Compared to IBP who -- they seem to be everywhere like closets, garages, whatever...

Yes, I'd say that was probably a lesson learned from the Masco days, right? We were in a lot more products than I think. When the downturn came, the financial crisis, the company really had to rationalize both their footprint, their product offering. And as we've come out of that, our CEO now, Robert Buck, was really the architect of that when that happened. And as we've now grown for the last 10-plus years, we've really been disciplined in making sure that the growth we have is profitable growth, right, and making sure what we do is where we have advantages, the core of insulation is where we see advantages. If we have branches that do garage doors or gutters and they make good money at it, we continue to do that, but our main focus is on the insulation side.

That separates you from IBP. One last question. So are you anticipating issues around the 2019 IECC and updated building codes that are more difficult with fire caulking, level 1 insulation installation, things like that, that are going to get harder and harder as you go through. I guess it makes you more money because we're putting more stuff in the ceiling, right, in the walls...?

That's why I say, I mean the code changes for us....

I might have missed that, I'm sorry.

Are good things, right? It should be tailwinds to us, right? There could be complexities. But you're probably familiar with our TopBuild Home Services Group that helps the builders in terms of figuring those things out, and they're the ones that do the testing then ultimately for the builders on the back end.

So a question on the -- on tuck-in M&A, 5x to 6x. Is that pretty similar multiples you paid pre-COVID? And then following up on that, sellers, what are the reasons sellers are selling now versus pre-COVID? Are they similar reasons or different reasons?

Yes. I would tell you the multiples haven't changed dramatically, right? We're always pushing to get them lower where we can, right? And that 5 to 6 is definitely an average, right? Some are higher, some are lower over time. The reasons people sell, a lot of times, it's more personal than anything. It's the timing -- these are a lot of times family-owned businesses. It's the right time for that family. Our pipeline is really good right now, I'd say. And are more people come in to the table now because of the uncertainty that's out there? That would be my best guess. I don't have a lot of facts to put to that, but we definitely do have a good pipeline right now.

Just a follow-up on that. Do they -- when you make an acquisition, do they usually stay on and run the branch? Like can you talk about the integration process of some of these tuck-ins?

Yes. No, I think good point is -- on the M&A side, I think one of our biggest advantages, right? If you look at our business, both of our business unit presidents are former business owners, they both ran insulation branches that were acquired by Masco. Throughout our business, I talked about 25-plus acquisitions. I don't know the exact number, but I'm sure it's north of 15, probably closer to 20 of those owners are still in the business, right? They like the way we run the business in terms of -- we're going to -- we're a public company. You got controls, you're going to go on our systems. But at the end of the day, the decisions they make are local decisions, they're running their business locally, working with the local builders, and we're going to pay them off of their profitability, right? So they feel like an entrepreneur. They've just taken their risk off the table. So on the M&A side, I think that's an advantage for us. A lot of the folks out there hear that. They like that. The guy that runs our M&A right now came to us through an acquisition. We bought his dad's business. His sister runs a region for us in Texas. He's now sitting on the other side of the table from folks. He can tell them about the advantage of selling to TopBuild. Here's what it's going to do for you. Here's what it did for me. Here's what it did for my sister. Here's what it's going to do for your people, right? Typically, we're buying smaller, family-owned businesses. The benefit packages aren't going to be as good for the employees, bonus programs not as good, no 401(k). So there's a lot of advantages that the sellers here, for their people as well, which is important to a lot of the folks when they're selling their business.

Just following up from the previous panel. Do you mind discussing your cost outlook and your price outlook, please?

Yes. So we definitely -- we were coming from the -- I wasn't at the last panel, so I didn't hear all the discussion, but I'll tell you our price cost outlook -- we're coming off 2 years of record inflation, right? So pretty much quarter after quarter, 8% to 10% announced price increases. And so it's been a lot of price pressure. There was another price increase in Q1, which definitely had some stickiness as well. The back half of this year, I expect it to be definitely slowing down the frequency with -- like I was talking about the slowness from the starts perspective. But if starts pick up like the builders are talking about and if any of the manufacturers take maintenance, which could keep supply tight, I wouldn't be shocked if we have another price increase in the back half of the year.

And then just on those price increases that you've been getting, have you been able to fully pass that along? Have you been able to pass that along plus a little bit more? How does that just flow through your P&L?

Yes. No, I think we do a good job of managing that, right? We work hard on both ends to make sure with the suppliers that when there's an announced price increase, we're negotiating hard on that side of things. And then with the builders, like I said, they value the work we do. The work we do is critical to them. And so we do our best we can to price on that side. I mean one of the advantages we do have is our ERP system. So we've got across our entire footprint, and this is definitely a differentiator for us is we've got a common ERP system, right? And that allows us to do a number of things. One, we can share material and labor. So when material and labor are tight, we can shift it between branches. And two, the last couple of years with this record inflation, we're able to manage pricing in the system, right? So like I said, all the relationships and bidding is done locally. But we've got parameters in the system that if they're not meeting our margin expectations, those bids will get kicked out for approval. So that process has really helped us in managing price and cost here over the last 2 years.

Any final questions? Okay. Great. We'll leave it there. Thank you. I appreciate the time. Thank you.