TopBuild Corp. (BLD) Earnings Call Transcript & Summary

All right. This is Joe Ahlersmeyer from Deutsche Bank. I'm the homebuilders and building products analyst here. And we're here with Rob Kuhns from TopBuild, and we were joking earlier today in 1 of the meeting sessions that even though I've only covered the stock for, I think, now 10 months, this is our second annual fireside between Rob and myself. So we're really excited to have you here and appreciate your support. So I'm happy to sort of let you take it for the first minute or 2. Just maybe give some opening remarks, if you'd like, and then we can hop into questions.

Yes, sure. So for those of you that aren't familiar with TopBuild, we're a $5 billion revenue installer and distributor of insulation and insulation-related products, we're made up of 2 segments. We've got our installation segment, which is about $3 billion in revenue, our distribution segment, that's about $2 billion in revenue. We've been a public company since we spun off of Masco back in 2015, and a tremendous growth story since then over the last 4 years alone we've doubled our revenues and tripled our EBITDA. We've expanded our EBITDA margin by 690 basis points to close out at 18.8% last year. This first quarter, we had a really strong first quarter, grew sales on both the resi and commercial side by 8%, and we're also at that 18.8% EBITDA. So off to a strong start for the year.

That's great. Look, you've been in the role while now. I think -- are we coming up on 2 years or if we past 2 years?

We're almost 1.5 years.

Okay. So you've been in the role for a while now, and I appreciate your approach to the role externally, I find you accessible, I find you helpful. And I think that's the Rob that people see externally, but a lot of the job is also internal. And so I'd like to hear sort of what your -- what you see as your greatest achievement internally so far, and how you feel like that's helped enable the business.

Sure. So about a year ago, we did an Investor Day presentation, it was shortly after I took over as CFO, and I talked about my top priorities as CFO. And as I look back at those now, the top 1 was to continue our growth story, right, and to continue to help drive the growth of the company. We're coming off our strongest year of growth in 2022. So we feel really good about that. One of the other priorities was to make sure we achieved the synergies we signed up for with DI, the acquisition we did in late 2021, the largest acquisition we've done as a company, $1 billion acquisition, that we were integrating just as I took over. I'm happy to say sitting here today, we're at the high end of the run rate synergies we signed up for $35 million to $40 million, and that deal has been an absolute home run for the company. The other priorities are kind of the constant focus on people and focus on technology, I'd say, right? So trying to build a strong team. I was lucky enough to be a part of TopBuild for 4 years before I took over as CFO, my predecessor, John Peterson, who retired, I got the study under him, work with him, build out a really strong team. That's something we're focused on every day, right? And you got to keep building the team, keep making it stronger, especially when you're growing like we are when you double in revenue in 4 years, you got to be looking for new talent all the time. I'm always looking for new talent right now. I mean I partner with Investor Relations over there, Tabitha. She's announced her retirement, right? So she's been a great asset to our company, since we spun, but unfortunately, she's retiring. So if you guys know of any great IR people or you met any good ones here at the conference, let them know about TopBuild. We've got a great story, but that's part of what we got to do, right? It's a constant focus on talent, bringing it in. And then on the technology side, it's all about trying to improve what we do with technology, whether it be back-office processes in the field, whatever we can do there. We've come up with a new tool Lead App, which I'll probably talk more about later. So those are really the top priorities I talked about 4 years ago, we're still working them, but feel good about the progress after 1.5 years.

Absolutely. And I did see that announcement. I didn't want to preannounce anything for you, but let me add my congratulations, and thanks for all of your hard work in the recent years. Look, TopBuild is 1 of my top picks as a stock. And some of that is category specific, but a lot of it is about the end market views that I have around new residential. But much of it is also related to what I see as a strong investment case around TopBuild specifically with through-cycle growth and diversification, right? And not necessarily management's job philosophically to pitch the stock, but 1 question I'd like to ask is, what are the main reasons as you see it to own the stock over the next 3 to 5 years, kind of knowing we'll get into the next to 2 months in further questions.

Yes. I really think -- I mean we have a unique business model, right? So we're the largest player in the 3 end markets we serve, residential building insulation, commercial building insulation, and mechanical Insulation, we're the largest player in all 3 end markets, right? So with that size and scale, it's very unique. We have -- that gives us strong leverage with our suppliers, but then we're selling on the residential side at least, to homebuilders, right? That's the biggest chunk of our business, about 65% of our revenue is residential. And on that side, we make up about 2% of the cost of the house with what we do. And the work we do comes right before a critical inspection for the builder. So really good place to sit there in the supply chain. I'd say what else makes us unique is our culture. We have a very entrepreneurial culture that we drive throughout the organization. We pay our branch managers off of their bottom line results, which gets them engaged with running their business because the builders at the end of the day, these decisions on buying are made locally in the local markets, and we've got to really encourage that. And then the third thing that makes us unique is our common ERP system that we have, and we leverage across our entire platform. So that's been a huge advantage to us in the last few years where we've dealt with tight material, tight labor and high inflation. We've been able to share material share labor across our footprint, and we've been able to control pricing so that when people are out in the field quoting, if they're not meeting our margin thresholds, we kick those bids out and send them for approval. So that's been a big advantage to us as well. So that's the unique part, right? I think our cost structure is also unique in that we're 70% variable cost, primarily material cost, and the direct labor of installing the insulation. So that makes us be able to adjust in any environment up or down very quickly, very low capital requirements, right? We're not a manufacturer. So we're installing the insulation. So our CapEx runs 1.5% to 2% of sales, working capital requirements are 12% to 14% of sales. So with a model like that, we're generating a lot of strong free cash flow, and as a result, we take that free cash flow and we reinvested in this model in M&A, right? So we've done 25-plus acquisitions over the last 5 years, integrated them into our platform, drive synergies, operational synergies. We're great at going out and working with these folks on making their labor more productive, the material synergies we get being the largest player in the field. We leverage that as we do acquisitions. So that's been what's driven our growth, and it's just been a great business model for us.

Absolutely. You make it sound so simple on the acquisition. Go ahead. Maybe dig in, if you would, a little more on that about the strategy, just the mechanics of how you go about doing that. And also, -- has it become more difficult in the current environment for 1 reason or another to get some of these, I guess, more roll up smaller bolt-on type deals done, whether it be arguing over the multiples or deciding what's the right earnings base, just given sort of the fluctuations in earnings in the industry?

Yes. No. I mean it's been a key part of our strategy. We've got a dedicated team across the board that deals with M&A. So on the front end, we've got folks out that are every day talking with acquisition targets, making relationships there, bringing those in, when we bring them in, we look at them from a financial perspective, right? We're very disciplined on that side of things, making sure the IRRs pencil out greater than our cost of capital, which is around 9% or 10%. And with most of these deals, our IRRs are mid-teens pre-synergies and upper teens to low 20s post synergy. We model those for downside scenarios because, obviously, there's uncertainty in the market just to make sure. And to your point, there's a lot of negotiation that goes on price, a lot of people with good results here in the last 12 months, so we're pushing hard on multiples where we can. But those synergies that we can drive give us plenty of flexibility, too. So we're definitely very bullish on the long term for the end markets we serve. And we see M&A as a growth mechanism for us here in the coming months. I'd say the last year, we hit pause a little bit last year. I mentioned the DI acquisition we did at the end of 2021, the largest in our history, we focused on getting that integrated, getting those synergies realized last year. We did 5 small tuck-in acquisitions last year. But we're really ramping up on that side right now. We've got a really good pipeline going and that's going to be our #1 capital allocation priority.

Great. Thinking about that diversification, it's not so much a deemphasis on the single-family business because that has continued to grow even as it has shrunk as a proportion of the overall business, because of the growth in commercial, but also because, as you mentioned, of this acquisition of Distribution International. So both the nonresidential as well as the industrial end markets are expected to be good this year, and you're expecting growth in those businesses. And the question always becomes what about next year. And I think on the commercial side, the nonresidential side, people look around at the credit conditions, and they're worried about that end market. But maybe just kind of talk to that, not in any sort of specifics, but how you're thinking about nonresidential into next year, and whether you also feel like industrial is potentially a risk, too.

Yes. Now across -- there's certainly some risk out there if credit tightens that projects on the commercial or industrial side, the funding there could be impacted. It's something we're obviously watching closely. We've seen no signs of that so far. Our bidding activity, quoting activity on those types of projects is still strong. Our backlogs are strong. There's -- our end markets there across, we say, commercial, industrial, but it's such a diverse group of projects we deal with there, oil and gas, liquid natural gas, we've got marine boats we do. We've got manufacturing. We've got food and beverage, chemical plants. So there's just a wide array of projects going on in that space, a lot of mega projects right now going on in that space? So we're cautiously optimistic there for growth, not only this year but on the years to come.

And maybe this is a good way to transition to single family. But if I think about the nonresidential end market, I think about it as sort of following on from single-family expansion and construction. And so if we have a strong finish to the year in terms of starts, we'll get into the completions math and the volumes in this year in a further question. But if we know that if we believe that single-family is improving throughout this year and into next year, if 1 does believe that, does that mean that nonresidential should be considered equally strong and that the risk from credit conditions might actually just be a constraint on demand other than -- rather than an actual weakening of demand itself.

Yes. I think for sure, we would say what we call light commercial follows residential, right, to light commercial to us is anything like restaurants, strip malls, things that when you insulated are going to look more like a single-family resident in terms of the insulating process. And our branches that do new residential construction, they also do -- they do single-family, multifamily new construction, but they also do like commercial. So to your point, if a single family takes off here, light commercial should follow that. We're actually benefiting from that right now, as we speak with single-family starts down, we're still working through that backlog, but getting ahead of that, we've seen that slowdown coming, and we got ahead of it by building up our backlogs on light commercial and multifamily, and those are things that can help us here in the back half of this year if there is an air pocket on the single-family side of things.

Yes. So let's shift to residential, which I believe at this point is between 60%, 65% of the business, by revenue. And we're also seeing and hearing the same things, the positive commentary from builders, at least somewhat of an improvement so far in starts, not really a collapse in completions. Just maybe walk us through how you're thinking about a lot of the data that we see, the commentary that we hear relative to what was your guidance at the beginning of the year in February, that you also reiterated in early May.

Yes. So we guided to revenue this year between $4.7 billion and $4.9 billion, which would be a slight decrease from last year, driven by the reduction on the single-family side of things. The way we were looking at it coming into the year, we saw single-family starts down year-over-year and versus completion north of 20% in the fourth quarter. We've seen that same trend through the first quarter, even though things have picked up on that side, they haven't gone back to the level that completions are at today, obviously, a lot of optimism from the builders right now, which is great. So any significant uptick from where we are today from a starts perspective should be upside to that guidance moving forward. But we're sitting here today with starts on an annualized basis in the 850 type range and completions north of $1 million. At some point, those 2 are going to get back in line. And certainly, if you hear what the builders are staying, it sounds like starts are going to pick up and help that out. And like I said, that should be upside for us. But what we baked into our guidance at the beginning of the year was that completions would eventually come in line with it starts on the single-family side, we'd be able to offset some of that with multifamily and light commercial work, but that was the logic we had there. On the multifamily side, we were looking at our backlogs at the beginning of the year, and we could see we're going to have enough work to get us through the full year on that side of things. So we should see modest growth on the multifamily side this year.

And so this convergence of completions and starts and you've gotten this question throughout the day in your meetings. And it really comes down to what your view is of the backlog, right? Because the sort of the mathematical side of it where the backlog is still elevated on the single-family side and certainly on the multifamily side. But let's just take single family for a second, why should it be that sort of halfway through the year here where we haven't seen the single-family backlog come meaningfully back down towards where it was that your backlog has sort of come to the point where you're going to see that convergence between starts and completion? Is there something about the build cycle that we should appreciate.

Yes. I think it really has to do with the bottlenecks in the build cycle. So if you go back a year or so ago, the builders were dealing with bottlenecks throughout the build cycle. And then as starts slowed, as rates went up and they slowed starts, obviously, the front-end trades could get caught up quickly because they didn't have new starts to work on. So things improved on the front end or the last couple of quarters seeing that work come through our volume for sure, but we're not seeing it come through the completion data yet, right? So what's happening is the builders are still dealing with some bottlenecks on the back end of things. And so I think there is a disconnect between our volume and completions that's not normally there. And so what we would normally consider, typically, if you looked at the census data and you looked at the units under construction, like our ballpark way of looking at it was to say, hey, our work comes roughly halfway through the construction cycle. So our backlog should be roughly 50% of that, right, or our share of 50% right? I would tell you today, I think it's a little bit less given where the bottlenecks have moved in the process.

Yes. That makes a lot of sense. And what would follow from that then is if we did see an uptick in starts sort of in the end of the second quarter, into the third and throughout the fourth that because you are now unconstrained in your part of the build cycle, we should see that lag from the start to your volumes actually be relatively in line with normal historical data, right?

Yes. No, I definitely agree with that. I mean the reality is these scenarios we're talking about kind of at a macro level, they're playing out market by market across the U.S. So it's going to be different in every market, but 100% agree with.

Yes. And certainly, what is going to muck up the numbers a little bit is the multifamily, which has been strong, which tying your volumes on multifamily to the completions is going to be a full there, and just simply because of how it's recorded, and just the timing of those projects as well. So maybe talk about what you have seen happen timing-wise, with the strength building in multifamily, we see the starts, we see the backlog building. We see obviously that it helped you in the first quarter, but maybe contextualize that a little bit more in terms of when it started and how long you expect it to last?

Yes. I mean the backlog there coming into the year was a record amount of multifamily units and starts have still been pretty strong on that side of things. like I said, with this downturn that we've seen coming on the single-family side, we've really gotten out ahead of it, built our multifamily backlog, we're starting to see that shift in units from single family to multifamily. And I'd say that's another potential upside to our guidance, right, is that if we're able to offset more of the single family with multifamily, we definitely assume we'd get some offset there, but it's better than we anticipated, that could be upside to our guidance.

Okay. So you have sort of volume upside from potentially quicker recovery in single fam based on starts. You have potential upside from multifamily, just altogether being stronger and helping to offset weakness or complement the strength that you might see in single fam, but then on the commercial and industrial side, given the length of the backlog, there's not really necessarily upside to the guidance there. It would then be a future upside.

Yes. I mean, the timing on the commercial industrial, it's a much trickier business to try to forecast. So the starts and completions data we have on the census is very helpful. On the residential side of things, on the commercial and industrial, like I was talking about the end markets are so diverse. The projects are so different. The amount of insulation that goes into each of those projects is different. Some of them are very large projects. So over the long term, we expect that revenue base on the commercial side to be less cyclical than what you would normally see on commercial and industrial. And the reason for that is that mechanical insulation has to be replaced over time. But typically, over a 5-year cycle, you're going to have to replace that mechanical insulation. And so that gives us a little bit of a recurring revenue stream that helps normalize the revenue over that cycle. But in the short term, because those projects are so big, you've heard us talk about it on some of our calls. We had a couple of really good quarters where we said, okay, it may not last as long as Q1 was -- or no, it was Q4 was a little lighter, on the mechanical side. So by quarter, it can be a little lumpy due to the size of the projects. But over the long term, we expect to do better than what the commercial industrial cycle would be.

Great. My pocket is buzzing and I think it's people wondering why it is 25 minutes and I haven't asked about pricing. So let me transition to that. Two part of question really. One, how is it that the pricing environment has remained so resilient throughout a period where it starts have declined. I mean part of that is obviously the completion is not falling, but there's got to be some level of capacity contribution to that. And then as we look forward from here, if we do believe that there's going to be volume upside, we know there's not really a lot of capacity coming on. There's some next year, but it's a low single-digit percentage of the industry. Maybe just talk about then in the second part, your expectations for pricing generally going forward.

Yes. So as we think about pricing, I mean, we're coming off a record couple of years of price increases, which we've done a really good job of managing as a team, as I mentioned, our ERP system is very helpful with that. As we look out, right, there was a -- we still had a price increase still looking back, I guess, looking back Q1, we had a price increase beginning in Q1 that had some stickiness that we were able to successfully push, and as we look forward, right, we still see things very tight on the fiberglass side of things. We do see the potential slowdown in single-family coming, which could free up some capacity there. But a lot of these fiberglass lines have been running full out as well. So we wouldn't be surprised if there's some maintenance take in the back half of the year that keeps supply tight. So between potential increase in starts, increasing demand and potential maintenance impacting supply, I anticipate fiberglass is going to stay tight through the rest of the year, and wouldn't be shocked if we saw another price increase.

That makes sense. And maybe just talking a little bit about capacity with respect to the longer term, and then maybe let's kind of take it in the direction of these tax credits, right? It seems like if we have higher requirements in terms of content per home, that would obviously be a higher volume requirement for the same level of starts. And if we were on allocation, just not so far from these levels, it feels like we're going to run up against the capacity constraint before we get to sort of these big double-digit increases in volume. So maybe 2 parted question. One, what is sort of the potential content increase from these more stringent energy regulations. And then also, if we're not going to necessarily get to these really strong growth rates, or increases in content, do you see the balance of that sort of coming out in price because we're going to be in an even tighter environment?

Yes. So the energy code is an interesting topic, getting a lot of questions on that at the conferences, definitely a tailwind to our industry, right? I mean everything from a code perspective is moving towards more insulation, you got to remember we've got different climatic regions in the U.S., so the codes are different, and they're all managed by municipalities. So adoption can be slow, when we go out with the builders, we typically offer a good, better and best option in terms of insulation and what meeting code, the minimum to meet code something better, you can go for the ENERGY STAR rating, that's probably the highest level, and so definitely, I think that's going to be a tailwind with the IRA, they extended the 45L tax credit that's available for the builders. That was previously $2,000, I think, now $2,500 and $5,000, but the standards they have to meet are a little bit more stringent. So that's going to require higher R value material, potentially shifting to spray foam might be another way to get that our value, right? So it's not always just more insulation because you can put more in the attic, but behind the walls, there's not always more space, right? You got to go with a higher R value there. So I don't know if it's going to create a dramatic impact on industry capacity, as you mentioned. And the reality is those changes, it takes time, right? So I think a number we heard thrown out was 30%. There's going to be a 30% increase in the amount of insulation per home. I think certainly, that's not in the short term, right? I mean that may be if you're comparing '06 requirements today, but the reality is most people have been moving up from those '06 standards and to get the 45L credit that was available before they had to be at a higher standard than that. So the new 45L requirements will certainly get us higher R value, more expensive insulation, potentially more insulation potentially move into spray foam. So it's all, like I said, tailwinds for the industry, but it's going to take some time to happen.

Yes. And you participate in that through the obvious way because you're installing and supplying the installation, but these homes also need to be sort of certified from that perspective, right? So maybe you could talk about the part of your business that participates not just on the delivery and install of the product, but also the certification side?

Yes. So within our install segment, we have something called TopBuild Home Services. So we have the most per raters in the country in terms of that go out and do that testing for the builders. So if you're going to get ENERGY STAR certified, you've got to have a tester come out and do that testing for you and give you the certification. So that's a piece of our installation business. So obviously, as things move in that direction and more people are interested in getting those certifications, that should also be a tailwind for that piece of our business.

With most things, there's nuances to every dynamic. And I think with respect to your business, labor is 1 where I sort of see that playing out. The other side is obviously the tight capacity because of stronger demand for multifamily right now. And so on the labor side, I'd be curious to sort of hear you talk about the strategy you employed throughout when you sort of are preparing for a downturn or a slight air pocket or whatever it may be, you're making decisions with respect to your staffing, you don't want to obviously let your best employees go, but there's sort of also some natural turnover. And so it's not as simple necessarily maybe saying we're going to cut labor just across the board. And then on the multifamily demand side, it also kind of feels like the product types that go into those are sort of a different mix of the same product, the bats and rolls versus loose-fill, a different mix than what might go into a single-family home. And so maybe you could talk about these 2 nuanced topics and sort of help people understand why they're not just as simple as they seem.

Yes. So I'll talk a little bit about labor definitely a challenge in the construction industry, right? I'd tell you, I think we've done better than most in that area. I think if you talk with the builders you're not going to hear insulation come up as 1 of the top bottlenecks they've had around labor. One of the unique things about our business, I talked about it being unique. One of the unique things is we paid the majority of our installers on a piece rate, so they get paid or the amount of insulation they do on a square footage basis every day. And so that gets their incentives aligned with us, right, in terms of the more they do, the more they get paid. And that's really helped us with fighting labor inflation as well, right? The more productive we can make our guys the more money they make, the less we have to do on the rate side of things. So that's been a big help to us. We also came up with a friends and family program to help recruit labor into our staff. So come an installer and I bring Joe in and get Joe to come on board. I'm going to get a bonus every 6 months for a couple of years, if Joe stays with the company, right? Now I'm incentivized to make sure Joe's successful. I'm going to pick them up, make sure he gets to work on time. And so we've seen a much better retention on that side of things. I mean it's -- it's hard work to work these guys do. So we do have a lot of turnover and it's something we've seen less turnover with our friends and family. But for sure, labor is unique, but it is fungible within single-family, multifamily, light commercial. So we are able to shift that labor around. The second part of your question was on.

Multi loose-fill and bat roll.

The product mix. So there is a -- we've been on allocation for a long time on fiberglass. It's been so tight. Things are loosening up a little bit, I'd say, particularly on the bat side of things. Things have gotten a little looser, blow is still pretty tight. And what Joe is referring to there is that there's a little bit different mix in multifamily. So you got to insulate the mid floors, which we blow insulation into, so you're going to see a higher blow content on the multifamily side than you did on the single-family side of things.

Makes sense. I heard you earlier mention a third leg of the stool with respect to industrial. And I kind of thought of that in terms of the end market exposure. But I think maybe in this context, you were referring to as part of your overall acquisition strategy, and clearly, those deals are going to look different from the roll-up of the single-family and multifamily installed businesses that you go after. So maybe you could just sort of maybe first lay out the industry landscape, what is sort of the -- 1 of the next biggest players in the industry look like in terms of size and just maybe describe sort of how you're thinking about the acquisition pipeline within Industrial?

Sure, sure. So on the industrial or mechanical insulation side of things, we estimate that total addressable market to be about $5.5 billion. We're the largest player in there. We're a distributor. We don't do the install on the mechanical. It's a different install than what we do on the residential side, but we distribute that product. And we're the largest player there with 10% share, the next 5 players or so, they're all privately held, our best estimate on their revenue, probably $200 million to $700 million in revenue. So a few chunkier deals in that space than what we have on the resi side, which is attractive. After that, it's pretty highly fragmented like we see on the residential side of things. The DI, the company we acquired in the mechanical space, they had been doing a roll-up in that space, right? So we've seen the multiples they paid on deals, the types of returns they were able to generate. So we think it's going to be a pretty similar strategy than what we had on the residential or what we have on the residential side. And like you said, it's a nice third leg to our to our growth stool.

Sounds fantastic. In the limited time we've got left, I want to ask about the install side of industrial, which you -- as you mentioned in the previous answer, you -- you don't do that. You have on the single-family and multifamily residential side, a big part of your value add is the install and you've even mentioned in the past like this is part of the pricing strategy, too, is there's 1 price to the builder, you're able to price to the value that you -- overall value that you provide. And it would just seem to me that even if it is more of a highly skilled person that's going in and installing some of these things, maybe the labor rates are several times the amount of what's going on in a single-family home, that feels like an opportunity for additional margin and price. And so maybe you could just explain what are the additional considerations that we may not be thinking about?

Yes. I mean we get that question quite a bit. I think I mean 1 thing is you look at like an ExxonMobil or some of those big companies, they'll have their own staff. So they do that themselves. We still want to service them. And then the people you're talking about the mechanical installers, right, those are our customers. And so if we started moving into that space, we're starting to compete with our customers, which is going to create some conflicts out there in the market for sure. So while we kind of live with that conflict today on the building insulation side, it's kind of -- there's a lot of legacy behind that back to the Masco days, it doesn't come up as much now, but to try to create that same model on the mechanical side from where we sit today, I think would be a challenge.

All right. That's very helpful. So I think we have to leave it there. Any closing remarks?

No. Thank you, Joe. We -- being here, and I appreciate.

All right. Thank you.