Builders FirstSource (BLDR)

Builders FirstSource is a manufacturer, distributor, and installer of building materials and construction services. On the manufacturing side, Builders FirstSource designs, and builds customized roof and floor trusses, wall panels, windows, millwork, and engineered wood. These value-added prefabricated products help homebuilders, contractors, and consumers save time and money. On the distribution side, Builders FirstSource is the scale player in building materials distribution in the United States. From a network of 590 locations in 43 states, Builders FirstSource accrues cost advantages due to scale, network density, and breadth of products that are then passed on to thousands of suppliers and more than 115,000 customers. On the installation side, Builders FirstSource provides framing, window, and millwork installation services for labor constrained homebuilder customers.

Builders FirstSource at its core is a services business. From an established base of strong customer relationships, Builders FirstSource works with homebuilders to review blueprints and configure product and service packages. From there, Builders FirstSource’s product scale and distribution footprint provide logistics and installation services which shorten production cycles for customers. These services provide a capital light royalty stream on an otherwise capital-intensive housing value chain. After transforming from a subscale, cyclical, commodity exposed business to the largest value added vertically integrated manufacturer, distributor, and installer of building products (and having reduced half of the shares outstanding in the last four years), Builders FirstSource is on the cusp of meaningful shareholder value creation. We see five main steps on this path.

First, Builders FirstSource has meaningful operating leverage that is set to emerge. This hidden operating leverage is the result of a transformed business amidst the fastest Federal Reserve driven housing slowdown on record. Mortgage rates topping seven percent and an undersupplied housing market have pushed home affordability to record lows. In response, homebuilders have focused on smaller, less complex, cheaper houses by using lower cost materials and taking out basements, garages, and bonus rooms. For Builders FirstSource, this has translated into sales and gross profit dollar pressure, despite market share gains and margin expansion. Upon any normalization in mortgage rates, housing starts, or home size, complexity or material quality, Builders FirstSource has substantial operating leverage, that, because of its growth, margin expansion, and share count reduction over the last four years, is meaningfully mispriced.

Second, under the cover of end market housing pressures, Builders FirstSource has established a long runway for earnings growth in value-added manufactured products. Value added manufactured products include factory-built roof and floor trusses, wall panels, windows, millwork, trim and engineered wood that are built specifically for each home. With labor accounting for nearly half of any given home project’s construction cost, moving specialized engineering and construction from the job site to the factory improves homebuilder cycle time and costs significantly compared to conventional on-site stick-built construction methods. In addition to improving cycle times for homebuilders, Builders FirstSource’s prefabricated products improve the structural integrity of homes, while creating a safer (less ladder and cutting time) work environment. Demand for these value-added manufactured products is set to accelerate. When one considers the increasing labor scarcity amidst a changing political environment (26% of construction workers are immigrants), such labor cost and cycle time improvements only become more advantageous for homebuilders. As Builders FirstSource expands its value-added manufactured product offering, there is a long runway to infill and scale out its nationwide footprint. With the margins on such products substantially greater than the sales they replace, this steady growth provides meaningful opportunities for earnings growth.

Third, Builders FirstSource stands to benefit from growing tailwinds of its own volition in turnkey services. Builders FirstSource’s field led customer service culture is driving the expansion of services from a historical focus on guiding design, product selection and process management to more strategic installation partnerships with customers. Currently, Builders FirstSource generates 17% of its revenue from installation services taking place in 33% of its footprint. Expanding services throughout its geographic footprint represents a meaningful opportunity. Beyond just infilling existing installation services in framing, doors, windows and millwork, there is a substantial opportunity to expand the breadth of offerings to additional value-added services. The driving force of installation services growth comes from the willingness of customers to pay for services. As skilled labor challenges worsen, Builders FirstSource has an unparalleled opportunity to use its distribution footprint, technical knowledge of structural design, key supplier relationships, and 115,000 strong customer list to grow its offerings and penetration of turnkey services.

Fourth, Builders FirstSource is driving digital transformation of the building products value chain. Currently, nearly all building product ordering is of an analogue nature. Customers call distributors, wait on hold, and sales representatives write down their respective orders. The antiquated nature of the procurement process means that data is not cohesive, which then creates problems throughout the building process. As the industry’s scaled distributor, Builders FirstSource is uniquely positioned to drive digital adoption by manufacturers and builders. In driving digital adoption, Builders FirstSource aligns project participants by integrating structural design, material and value-added product procurement, and installation and construction of the home. As we have seen before in financial and marketplace businesses, driving analog to digital transformation accrues meaningful shareholder value from the capture and application of “data exhaust”. In this instance, as more analogue information is turned into usable intelligence, it can then be presented, analyzed, and shared to provide operational benefits and cost savings for all participants. In doing so, this enables ecosystem partners to draft, build, configure, render, and align material and labor flows at the job site, ultimately creating the standards that players coalesce around. As we have also seen in numerous technological shifts, those who create the standards extend their own competitive advantage runways and protect the duration of earnings power growth.

Fifth, Builders FirstSource has a long runway for earnings growth from accretive acquisitions. Despite its position as the industry leading firm in most of its distribution footprint, Builders FirstSource only has a low single digit share of the $800 billion building product distribution market. The more than 10,000 local market building product distributors provide ample opportunity for Builders FirstSource to use its proven ability to acquire and successfully integrate large and small acquisitions alike. This proven ability to drive accretive acquisitions is backed by a systematized playbook of expanding product offerings, adding manufacturing facilities for value added products, and integrating operations onto its centralized platform. In doing so, processes are standardized across distribution and logistics, pricing, and margin management. The scope and scale of Builders FirstSource existing footprint, customer base, and logistical capabilities means that such operational improvements, when replicated across an expanding network, yield substantial profit margin expansion.

In Builders FirstSource, we are invested in a scaled industry player with underappreciated near-term catalysts from end market normalization and long-term catalysts from continued growth in value added manufactured products, services, digital transformation, and industry consolidation. We believe these opportunities are underappreciated in the short term and long term.