TopBuild Corp. (BLD) Earnings Call Transcript & Summary

I'm Phil Ng, Jefferies building products analyst. We're delighted to have the TopBuild team with us today. Representing the firm, we got Robert Buck, the CEO, CEO of the company; as well as Tabitha Zane, who heads up Investor Relations.

Well, Robert, you guys have been awfully busy on the M&A front. This latest acquisition seems like a really, really good fit, and you had great success on DI. Why don't you talk about the opportunity with SPI, what you guys can do and how do you think about that business going forward?

Yes. So super excited about SPI. It's pretty much a mirror image of a company we bought late '21 called DI, really main player in the mechanical industrial space, all insulation related. So we're the #1 player in this space with our DI acquisition, and this really brings together with SPI, 2 of the leaders in the specialty distribution space. It's about $700 million in revenue, about 100 locations, both in the U.S. and Canada, and really focused in that mechanical industrial insulation space, a little bit of play in the residential space as well. SPI brings along with a lot of great characteristics as the DI, both around fabrication and really a great reputation around service and around customer relationships as well, again, both the U.S. and Canada. So I think what you saw us what we were able to do with DI, with bringing the company on board, integrating them into TopBuild, both bringing operational improvements as well as synergies to the business, I think we're very confident as to what we would be able to do with the SPI business. And it really builds upon our Specialty Distribution platform. If you look at that business, our Specialty Distribution business, after the SPI acquisition, we'll be about 46% of our mix of business. And if you look at the commercial industrial space, it will get us to about 39%, 40% mix in the commercial industrial. So it really starts taking -- we've already been diversifying from residential into commercial industrial. We think SPI gives us that next a couple of steps ahead with that. And we're in a great company, great leadership and talent there, very good culture fit to TopBuild. So we look forward to completing that acquisition here in Q4.

Does having scale and having some fabrication component really puts you in a better spot when you compete with some of the smaller guys? Or this is pretty fragmented and scale matters a little less?

Well, it's definitely very fragmented, but having the capabilities from a fabrication perspective in a very diverse footprint across U.S. and Canada, it definitely gives us an advantage. And then I also say there's a big piece of this business on the mechanical industrial side and SPI. About 50% of that business is MRO or recurring revenue. So having the fabrication capability to service an Exxon or a Shale or these large mechanical contractors is definitely an advantage. And again, between what we have with our current DI business and SPI really gives us that unrivaled footprint across both the U.S. and Canada both from an MRO perspective, but also from a day-to-day new construction perspective in commercial industrial.

That's helpful. Well, Robert, I probably should have kicked off with this question. Since you guys have actually spun out of Masco, while you're levered to pretty cyclical end markets and your stock will whip around on sensing around housing, the free cash flow and earnings power has been pretty explosive. I mean even in a down year for housing, you're going to grow earnings. So talk to us since spinning out of Masco, what are some of the things you guys have done structurally, whether it's a portfolio or cost side of things that allow you to kind of deliver such consistent earnings power and free cash flow?

Yes. We got this question earlier. And as you think about a spin-off from a large company like a Masco, it, obviously, brings the management team to focus on our core business. And our core business has been and is insulation. And we just continue to focus in our core of insulation. Obviously, we're the largest in our 3 end markets, that residential, commercial, industrial. And as we just continue to focus now, and our core insulation business is about 83%, 84% of our total mix of business. So we're very focused on our core of insulation, but then we diversified in that core. And what I mean by that is just not just being focused in residential but now continue to grow that commercial industrial mix of our business as well. So again, as I mentioned, after the SPI acquisition closes, we'll be in that, call it, 40% range of our commercial industrial piece of our business. So we've diversified the business and then also created this kind of multiple avenues for growth around residential, but commercial, industrial and then even with in commercial, light commercial and heavy commercial. So we're able across our footprint, light commercial is like your local Hampton Inn Hotel, your local Panera bread, your kind of wood-frame structure similar to residential home. We do that work across our footprint. And then heavy commercial is like in the large metropolitan areas, the high rises, the stadiums, we do that work as well. So we've really been able to diversify the business, these multiple avenues for growth. And then I think as we spun off, became our own company, just what we've been able to drive a simplification in the business, improving processes, improving systems. One thing you hear us talk a lot about, Phil, is that in our industry today, we're about 450 locations across the U.S. and Canada and leaders in our space, but we're the only business that has a fully integrated technology platform, starting with our ERP system across all those businesses. So the ability for us to drive productivity, to drive efficiencies, to drive simplicity across the businesses has a huge advantage for us. So -- and I think by doing that, how we really drive local empowerment, we believe in the local business. We believe in really driving the entrepreneur spirit in the business. It's really helped us bring a lot of talent back into our business that may be left at one time, but then also attract new talent to the business as well. So it's really shown through, I think, in the results and what we've been able to accomplish as a company. And we see a lot of white space for the future. I mean, by diversifying the company, we've been able to grow our total addressable market to a little over $17.5 billion in that residential, commercial and industrial space. So we've got a lot of white space, both organically and through acquisitions. And I think one competency that we've built has been around M&A. We've done a lot of transactions over the past 5 or 6 years. We definitely have a core competency around M&A, but also M&A integration into the business. And really, you've seen us expand margins nicely on the companies that we've acquired over time. As we think about the acquisition perspective, most of the previous owners that we bought their businesses, they're still part of our business today. As a matter of fact, our M&A function is ran by a previous business owner today. So he's got a great story to tell about what it means to become part of TopBuild. So a lot of changes in the past 6, 7 years as we spun out with Masco, and we see still a lot of room to drive the business in the future as well.

Super. Obviously, the last, call it, 3 to 4 weeks, anything that touches housing, investors has been hyper focused on perhaps a higher interest rate environment. Talk to us how your conversations with your customers if that shifted? How does that kind of position you looking to 2024? Certainly, a lot of the homebuilders have brought down mortgages to kind of offer incentives kind of drive up that demand backdrop. But just kind of walk us through what you're seeing out there and how you think about higher rates as we look out to 2024?

Yes. Our conversations with the builders, especially the large production builders, regional builders, I'd say they're still optimistic. We're still seeing specs come out of the ground at a rate that we haven't seen in the past 2 or 3 years. So I think even to look at their activity on the land side, you can see that the larger builders are so optimistic. Obviously, with single-family, you've seen some nice improvement in the starts around the single-family side. And I think, obviously, that's driven by you don't see a lot of resales on the market. People have these low mortgages today, so they're not going to get into a new mortgage given some of these elevated rates. And so new construction has really been the only game in town in many, many markets across the U.S. So I'd say midterm, long term, we're still very optimistic. We've been underbuilt for a decade. And there's still plenty of opportunity and pent-up demand out there. Relative to the builders buying down mortgage, hard to say. But I would just say they continue to be optimistic, and I think you see that in some of their activities. And they're smart in their business model. They're obviously doing things to address affordability and continue to work that angle as well as they realize some of the challenges with the homebuyer today.

Super. Based on some of the actions you guys have taken your line to outperform starts and completions, what are some of the great things that you guys are doing on that front to kind of manage this shock we've seen at least at the start of the year on the completion side of things? And when do you see volumes bottoming out and ideally inflecting for your portfolio overall?

Yes. So it's definitely about this multiple avenues for growth that you hear us talk about. Again, we were heavily, heavily residential latent business, if you look back in '16, '17, '18, and we really shifted that. Again, we're going to be after the SPI acquisition, you're going to see us about 54% installation, about 46% Specialty Distribution. So we've diversified from that perspective. And then you see our commercial industrial segment of our business getting up to about 39% to 40%. So this multiple avenues for growth has really derisked our business of what can be cyclical in the residential side. And as we look across those different segments, as I mentioned before, our residential businesses can do this light commercial work. So if you look at our results, I think like in Q2, as an example, record profitability, but from a sales perspective, how we grew the business, I think we were up 22%, 23% from a commercial perspective. So if things do stumble from a residential standpoint, we've diversified the business with these multiple avenues to continue to grow our overall base of business as top build. So as we look out, we think that's a great thing as we made investments in the business, we're constantly feeding our branches, leads to new work so that we're making sure we're driving that productivity overall, including that sales productivity. And again, we think that multiple avenues for growth is really a great model for us in the future just to continue to leverage and continue to drive both organic and M&A growth.

Super. From a pricing standpoint, we've seen a handful of all the fiberglass insulation manufacturers announced a price increase for this fall. Any thoughts on whether or not one that would stick and two, in this current environment, you have the ability to kind of push that price in a margin-enhancing fashion?

Yes. I think it's going to -- as far as it sticking is going to be really the equation of supply and demand. You've seen the multifamily starts decline, but you've seen some nice single-family start volume in the past couple of months. I think we had $1 million in the month of May, and we've been in the $900,000 here in the past couple of months. So I think it's really going to be depending on those single-family starts to finish up 2023. The industry is off allocation, which means today, there's plenty of material available. So I think that supply and demand will drive the stickiness of the price increase that's out there. Obviously, that dynamic can change depending on those starts. You probably saw a lot of you saw Owens Corning took down a plant. And Arizona in the past few weeks, not a dramatic impact on capacity, but some impact. There's still maintenance to be happening at these plants as they've been running full out in the past 3 years. And there's really no new capacity coming on until Knauf, One of the top 4 manufacturers opens their new plant in Texas, probably towards the end of Q2 in 2024. That being said, if there's the ability out there, you've seen us perform very well in the inflationary environment. I think if you look back our margins in the past 5 years, we've improved our margin by 800 basis points. So we've proven through a combination of our operators in the field, the ability we have through our technology platform that we performed very well in that environment, and we execute well whenever that exists.

Okay. So it sounds like it's an environment that's favorable from a pricing standpoint for you guys...

Yes. I think, again, [indiscernible] that as starts trail.

From an M&A standpoint, as you kind of highlighted, I'd say a good avenue for growth and you guys have a strong capability. How should we think about that algo as it relates to the commercial industrial side of things with the DI and SPI? I mean historically, you go buy some of these smaller bolt-ons and you pay 5x, 6x, you get synergies out of the gate. Is that algo any different on the distribution side for commercial industrial?

That's a great question. So we definitely, from an M&A perspective, we still see a lot of opportunity in that space. There's some chunkier acquisitions in that mechanical industrial side of the business. whereas the residential side, they're still very fragmented as well, but super fragmented on the mechanical industrial side with some chunkier acquisitions. But the same formula works relative to if you think about the main supply chain elements, the same supply chain partners, both on the residential side and commercial industrial. We're still partnering with the same folks in that business as well. And I think the one part of maybe the story about TopBuild that's been underappreciated is just what we've driven from an operational improvement's perspective in the businesses we've acquired. If you look at the accretive margins that we produced and you look at what's happened to our M&A integrations, we've often, I'd say, most always exceeded the numbers that we've put out there. And I really think it comes from both the synergies we talk about on the supply chain side, but definitely the ability to drive operational improvements in those businesses that we acquire. So I think the same formula definitely does work. And I think the fact that we have a dedicated resources around that side of the business. And again, how we're -- I think there's a real spirit in our company that lives with driving improvements. We talk a lot about bottom quartile. You can always look at bottom quartile of anything, bottom quartile of branches, customers, products, labor, anything like that. And so we're constantly working those elements of the business. And again, I think it's shown through and how we've driven the improvements in the business. I think when we bought the DI business, that was about a 10% business. And I think at the end of '22, within about the first 12 months of ownership, we drove about 600, 700 basis points of improvement in that business. So we're very confident in the synergies that we talk about. Very confident in the synergies we delivered on DI. We delivered above the upper end range of our synergy estimates.

Super. Your margins have been stellar, right? I mean from an incremental margin standpoint, you guys generally outpunch what you guys guided in the mid- to high 20% range. When we kind of look forward, assuming a normalized demand environment, how much more runway do you have to go? And what are some of the big buckets? I know operations and technology is a big passion for you, Robert, but kind of talk to us what that opportunity could be in some of the big buckets that you saw in front of me?

Yes. I mean we're -- I go back to that spirit in the company and what's driven the results around really driving improvements. And I would say we still see plenty of room to drive improvements across the business, and we feel very comfortable with that 22% to 27% that we guide on. Distribution may be at the lower end of that installation at the upper end of that range. But we still see opportunities for improvements in driving operational excellence throughout the company. We've obviously been on a great trajectory. If you look at the margin, we don't expect that we're going to continue that steep trend that we've seen in the past few years here. But we still see room to improve the business. If you look at our guidance, we -- how we're guiding the margins for the rest of the year, there -- we'll see what the opportunities exist there and we see how the environment plays out from that perspective. But we just continue to drive improvements around your points, productivity. This is the example I always give. So we have 10,000 installers today across the U.S. installing an insulation. And if we can drive 10 minutes of productivity in that group a day, it's millions, tens of millions of dollars on the bottom line for the company. So you're right, we're using technology. We're working processes and stuff to continue to drive labor productivity. And then one thing that we introduced about a year ago is around how we're able to distribute leads in a very proprietary way out to all of our branches in that commercial, industrial space as well. So we're driving sales productivity and labor productivity, and we see more opportunities to do that. Again, we've been proud of the margins that we delivered. Our operators have done a great job as well as our back office folks have done a great job, and we'll continue to look for those opportunities.

How are you guys positioned to capitalize on some of these mega projects we've often heard about? And then certainly, on the LNG side, what are some -- how are you positioned? And how should we think about that ramping up? There's different acts out there, there's CHIPS Act, IRA Act. So just kind of give us a little flavor how do you kind of see that ramping up and the visibility in that business?

Yes. So it's definitely a big part of the advantage of having our leadership position from a DI perspective and as we're looking to close SPI. So those businesses have a great footprint to service that work, again, both the U.S. and Canada. Great capabilities relative to how they service the customers. As a matter of fact, the companies are known for that customer service element, but then also that fabrication capability as well. So if you think about some of these projects, whether you think on the commercial side, medical, some of the higher education perspective, if you think about on the industrial side, you talk to LNG, some of these semiconductor plants, EV plants, we really have that capability to service that across the footprint and given some of our unique capabilities that we have on the fabrication side of the business. So we think we're in a great position to not just service it but to provide solutions because it really does come down to -- there's a lot of different types of solutions for some of those bigger projects. And then given our expertise both in the business as well as some of the engineering factor that goes into it, we're in a great position to support that, in a great position to grow with it as well.

Super. Any questions in the audience? All right, Robert, I'll continue then. We've talked about how the housing cycle from an inventory standpoint we've underbuild pretty materially. There need COVID-boomers starts were explosive. The completions kind of peaked up in that 1 5 range. Talk about how you think about these bottlenecks could impact the industry from a growth standpoint? And do you see that easing over time in the next few years for the broader industry for housing?

Yes. I think that you talked about completions. I think the metric has definitely changed over the past 3 years, right? Everybody used to look at starts, but now you definitely have to look at completions to understand what's happening single-family versus multifamily. We seem to have -- for a couple of months, we had about a 1.5 million completions rate, but it seems like that 1.4 million to 1.45 million is probably more the norm from a completions perspective. I think you see builders making investments to improve productivity. I think you definitely see those in the building products space and service providers looking for things to do that. But I think construction labor will be either constrained, I think as supply chain pressure has eased have you seen other building product materials bring on capacity and stuff, I think it does go back to the labor component of it. So I think that can be the governing factor in the future feel is on labor productivity and labor in the construction industry. But I think you see companies like TopBuild, I would say that's become a strength of ours, how we've recruited new folks into our business, our training programs, how we get folks up to speed from a productivity perspective. So I think companies working on the labor side, whether it be skilled trades and how you get others into this industry, that will really be the factor that can help us get above that completions rate of 1.45 million, if you will, for the future.

That's great. Recurring revenue is growing as a percentage of total revenue with the expansion of the SPI. Can you talk us -- talk about how the MRO piece of the business impacts and how growth margins compare to the overall business?

Yes. That's one thing we do love about the mechanical industrial business, even some of our legacy service partners business. So pre the acquisition of DI, we would say we were in that probably teens percentage of some recurring revenue. With DI, that got us into about 26% recurring revenue. And now once we finish the SPI acquisition, that gets us to about 33% recurring revenue. So it does reduce some of that risk of the cyclicality is more normal demand that we can plan on. And if you say what's driving that MRO business in the mechanical industrial space, if you think about some of the environments where those products are installed in refineries, even outdoors at times, some of the extreme conditions relative to the flow of materials or liquids through that, high temperatures, low temperatures. And then I'd just say from a kind of an environment of corrosion, those types of things, it drives regular replacement of a lot of the insulation, insulation parts, whether it be fiberglass insulation, rubber pipe insulation, even some of the metal jacketing as well. But that MRO also exists and we talk about our marine business as well. So aircraft carriers, cargo ships, that type of thing, there's constant replacement of insulation in those elements as well. So it is a good margin business because a lot of that comes with fabrication. Some of those are contracts that we'll have as well because you can think about there's going to be unique fittings in some of these refineries or some of these food and beverage type of plants. And then beyond just the elements that happened, some of this is industry regulated as well where there's got to be a replacement driven there. So that really drives the mechanical industrial side. And in our traditional business, you've got things like safety supplies as an example that are constantly reoccurring also. So it's going to give us a real boost in that recurring revenue across our Specialty Distribution business. Again, we'll end up being about 1/3 recurring revenue after the SPI acquisition.

From a secular standpoint, insulation certainly is very sustainable. Can you talk about some of the different regulation, legislation that has transpired from a code standpoint or just adoption whether it's IRA Act, how that could impact your growth profile for insulation to demand?

Yes. So definitely see it as a tailwind for sure. As building codes have become stricter across the U.S., although they're adopted locally, they're obviously talked about at the state level. That's definitely provided a tailwind. You see certain areas of the country do better job than other. I mean the state of California has done a great job with some of their Title 24 work to have conditioned space, which definitely drives higher insulation demand or even kind of better solutions, if you will, from an insulation perspective. But then now with the Inflation Reduction Act, you're seeing like the tax credits for the builders, they're more lucrative. I'd say they're also more complex because now you're not just talking about one element, you're talking about a system that includes HVAC, appliances, windows as well as installation. So we think it's definitely a tailwind for the industry, definitely talk around lowering carbon footprints. If you think about industrial spaces, mechanical and commercial, as you think about ESG factors and stuff as well has definitely created some tailwinds for the industry, hard to quantify. But if you think about inherently what we do at TopBuild, and that is either supply an insulation or installing an insulation, that whole element of driving energy efficiency and stuff that's right at the core of what we do every day in our business.

Okay. Great. Well, Robert, we're going to stop here. Thanks for all the great insights, and I appreciate your time as always.

Great. Thank you.