Description

Executive Summary:

BlueLinx is a two step building product distributor. BlueLinx is positioned for asymmetric returns in a lower interest rate environment with limited downside due to the strength of its balance sheet.

The homebuilding surge in 2020-2022 led to a once-in-a-lifetime windfall for BlueLinx. BlueLinx entered this period with negative book equity and now boasts $650 million in equity after returning $145 million through share repurchases. Book value per share is $76.50. Liquidity, measured by cash on hand and revolver capacity, is $98 per share. BlueLinx can double their working capital/sales and still hold excess capital. The question is how BlueLinx deploys this war chest. Management guided to M&A and greenfield geographic markets to grow its topline while maintaining a price sensitive buyback. 

In the current market environment, I believe BlueLinx earnings power is ~$12 of EPS. I believe there is material upside to this number, but it is path dependent (i.e., macro, M&A, pace of buyback). Given the strength of the balance sheet, I do not see a scenario where capital experiences a material impairment. 

What I Expect

• Capital Allocation
  • Repurchasing stock – Current pace is ~5% per year dependent on stock price
  • Greenfield markets – Currently evaluating real estate to organically grow into new markets
  • M&A – Team and balance sheet are ready to transact should an attractive opportunity arise
• Reinvigorated Private Builders
  • Market share gains by public homebuilders is limiting demand for BlueLinx’s services which are disproportionately utilized by small and custom homebuilders. Public builders represent more than 50% of closings in 2023 compared to 37% in 2019 and 25% in 2006. 
  • Lower interest rates will improve smaller builders’ cost of capital and should bring more diverse sources of housing supply which will increase demand for BlueLinx’s services. 
  • BlueLinx’s business maintains a high fixed cost base. Each incremental dollar of revenue will drive margins higher lifting margins as revenue grows. 
• Specialty Sales
  • BlueLinx’s balance sheet provides the ability to play offense. Historically, BlueLinx was constrained by their lack of capital and liquidity. 
  • Expanding supplier relationships and developing private label products when profitable. 

Balance Sheet

Capital availability and liquidity are no longer constraints on BlueLinx’s operations. The Company is flush with cash, and its 6% $300 million debt isn’t due until 2029. 

Expected Improvement in Private Builders

I think BlueLinx will do fine in the current market environment. However, I expect a significant increase in earnings power when small and custom homebuilders increase their activity from current trough levels. When this eventual increase occurs, BlueLinx stands to benefit.

Of course, there is the risk that private builders fade into the sunset as they are out competed by large private builders. Offsetting this risk is the repair and remodel business and the custom homes business where large builders do not compete. The repair and remodel business is ~45% of BlueLinx’s sales. Higher rates are depressing activity in this end market as well. 

5/1/2024 Q1 2024 Earnings Call - “It is important to note that while single-family housing starts have been showing strong numbers the past few months, that strength has mostly been driven by the large builders that can use their size and scale to buy down mortgage rates, offer more attractive deals to consumers and buy direct from manufacturers to support their production schedules. 2-step distributors like BlueLinx tend to correlate more closely with smaller and custom homebuilders and therefore, do not participate as much in the large production builder market. Given the macroeconomic environment we described, we expect this pattern to continue for the remainder of 2024.” 

Earnings Power

BlueLinx has a sizeable fixed-cost base. As with any fixed cost business, operating margins are driven by volume. As volume increases, operating margins grow closer to contribution margins (selling price less variable costs / selling price). I estimate contribution margins for structural at 5-6% and specialty at 13-16%. When activity from small and customer homebuilders returns, I expect margins to expand from current levels.

BlueLinx benefits when inflation in building products is greater than the inflation of its cost base (e.g., labor and fuel). Higher average selling prices for building products drive margin dollars assuming a static gross margin percentage. For the rest of 2024 BlueLinx will work through the headwinds of building product deflation which should abate in 2025. 

Capital Optimization 

As evidenced above, liquidity is far more than what BlueLinx needs today. This cash is earning ~5% interest largely offsetting the 6% coupon. BlueLinx will deliver upside to earnings power when it deploys capital (i.e., M&A, greenfield, buy backs). 

DISCLAIMER: This does not constitute a recommendation to buy or sell this stock. We have a position in this company, and we may buy shares or sell shares at any time.

Catalyst

https://www.youtube.com/watch?v=mcSK6MWOfiM 

Non-member: Who's this guy?

Tallguy: Oh, that's Blue. An old net net who hangs around other building product distributors a lot. Don't worry. He crushed it during Covid. He is legit.

Non-member: He looks like he's about to be disintermediated and you want to go long?

Tallguy: You kidding me? Old man’s balance sheet is solid and private builders are close to the trough.