On today’s Breakouts report, there are 37 stocks on the positive breakouts list (displaying with positive price momentum), and six stocks are on the negative breakouts list (with negative price momentum).
Discussed today is a stock that appears on the positive breakouts list - Hardwoods Distribution Inc. (HDI-T), a distributor of hardwood lumber and building products. This stock is a way for investors to play the strong U.S. housing market. Last week, the share price rallied to a record high on high volume. The positive price momentum remains intact. The stock has a unanimous buy call from five analysts.
A brief outline is provided below that may serve as a springboard for further fundamental research when conducting your own due diligence.
The company
Langley, B.C.-based HDI is a distributor of hardwood lumber and building products used in the residential, repair and remodel, and commercial construction markets. Management estimates that approximately 50 per cent of its products serves the residential construction market (new construction as well as repair and renovation). The other major market that HDI supplies is the commercial construction sector. The company is a market leader with 73 distribution centers located across North America as at March 11.
The company has a diversified customer base with over 40,000 customers. The largest customer accounts for less than 2 per cent of its sales. Historically, there has been seasonality in the company’s business with the second and third quarters typically the strongest.
In 2020, approximately 30 per cent of the company’s sales came from hardwood plywood, 25 per cent of sales consisted of high-grade hardwood lumber, 18 per cent of sales were decorative surfaces and composites including laminates and fiberboard, 16 per cent of sales were doors and related millwork, 7 per cent from composite panels, and the balance consisted of other diversified products.
In terms of geographical revenue breakdown, over 88 per cent of the company’s total sales came from the U.S. with the balance, just under 12 per cent, from Canada in 2020. As such, U.S. housing starts data is a key metric to monitor. Given that the company’s products are used in the final construction stages, there is a six to nine month delay between strong U.S. housing starts data and economic benefits realized by HDI. Effective Jan. 1, 2021, the company will begin reporting its results in U.S. dollars given that the bulk of the company’s revenue stems from the United States.
The company operates in a highly fragmented market allowing for acquisition growth opportunities. Management estimates that the company’s market share in North America is approximately 12 per cent. In 2020, the company completed three acquisitions, adding approximately $90-million in annualized revenue. Management continues to actively seek out strategic acquisition opportunities.
Quarterly earnings
Before the market opened on March 12, the company reported solid fourth-quarter financial results that sent the share price soaring by 7 per cent that day.
Sales came in at $308-million, ahead of the consensus estimate of $300.5-million. The gross profit margin was 19.1 per cent, just above its historical range of between 18 per cent and 19 per cent. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) was $24.27-million, well above the consensus estimate of $21-million. Adjusted earnings per share came was 49 cents, exceeding the Street’s forecast of 41 cents.
The company has a strong balance sheet providing it with the financial flexibility to fund additional acquisitions. At year-end, the net debt-to-adjusted EBITDA ratio after rent stood at 1.3 times.
In the earnings release, President and Chief Executive Officer Rob Brown provided a positive outlook, “I want to emphasize that our 2020 results were achieved without the benefit of significant increases in product prices. Because our products are used in the finishing stages of construction projects, we did not see the benefits of strengthening markets until after the year-end. This bodes well for HDI going forward. As discussed in our outlook, market conditions have strengthened significantly and we are entering the best macro-demand environment the industry has seen in years. Importantly, we are approaching this multi-year growth runway from a position of operational, financial and competitive strength. Together with a business model that enables us to capture and capitalize on organic demand, a robust acquisition program that accelerates our growth trajectory, and our long track record of translating topline growth into strong EBITDA and cash flow performance. We are very enthusiastic about what we can achieve in 2021 and beyond.”
Mr. Brown highlighted growing housing demand from millennials, noting: “The COVID-19 pandemic has further accelerated housing demand with more people working from home and many households seeking more living space. And millennials, who represent the largest segment of the population, are at the stage in their lives where they’re actively seeking home ownership. Forecasts suggest we’re entering a multiyear period of demand growth. At the same time, the outlook for the repair and renovation market is very positive, with North Americans spending more of their time and disposable income on their homes.”
Housing activity
In a report issued on March 31 from the Mortgage Bankers Association (MBA) showed a 2.2-per-cent decline in mortgage applications compared to the prior week as interest rate continued to edge higher. Associate Vice-President of Economic and Industry Forecasting at MBA Joel Kan stated, “After seven consecutive weeks of increasing mortgage rates, the 30-year fixed rate declined 3 basis points to 3.33 per cent, which is still almost half a percentage point higher than the start of this year. Mortgage applications for refinances and home purchases both declined, but purchase activity was still convincingly higher than the pandemic-induced drop seen a year ago, as well as up 6 per cent from the same week in March 2019. Many prospective homebuyers this spring are feeling the effects of higher rates and rapidly accelerating home prices. Record-low inventory is pushing home-price growth at double the rate from a year ago, and even above the 10 per cent growth rates seen in 2005. The housing market is in desperate need of more inventory to cool price growth and preserve affordability.”
In a report issued by the National Association of Home Builders (NAHB) on April 2, NAHB Chief Economist Robert Dietz stated, “Buyer traffic remains strong, consumer confidence is at a post-recession high and prospective buyers have increasingly accumulated additional savings during 2020 due to lack of service sector purchases. Nonetheless, as economic growth expectations increase for 2021, higher rates and higher input costs should be expected over at least the next 12 months. Additionally, a proposed large tax/spend infrastructure plan is a wild card in the outlook given possible impacts on the federal deficit.”
Last month, at a Raymond James institutional investors conference, the largest U.S. homebuilder D.R. Horton’s (DHI-N) Chief Financial Officer Bill Wheat said, “Starting mid-calendar ’20, really once markets began for reopening after COVID, we’ve seen a level of demand accelerate that has been as strong as we’ve ever seen. And it’s against a backdrop in housing where there’s limited supply on both the existing home market and the new home market and so it’s created a very healthy situation for homebuilders, including D.R. Horton.”
On March 17, leading U.S. homebuilder Lennar Corp.’s (LEN-N) Executive Chairman Stuart Millar also provide a bullish housing market outlook, “From a macro perspective, the housing market remains strong. Demand has continued to strengthen as the millennial generation, which had previously postponed its entry into the housing market, has now continued to drive family formation, while at the same time, the supply of new and existing homes remains constrained. Even though interest rates have moved higher, at the same time that home prices have moved higher, overall affordability remains strong. Interest rates are still lower than they were a year ago and personal savings for deposits are strengthening. Many American families have fortified savings, as vacations and recreational activities have been canceled or postponed, and stimulus money from the government continues to fill the remaining gaps.”
Investment thesis
- Booming U.S. housing market play. Strong industry fundamentals.
- Industry leader. HDI is North America’s largest distributor of architectural building products to the residential, repair and remodel and commercial construction industries.
- Rising earnings.
- Acquisition growth potential. Strong balance sheet to fund acquisitions.
- Positive price momentum.
- Dividend policy
The company pays its shareholders a quarterly dividend of 10 cents per share or 40 cents per share on a yearly basis. This equates to a current annualized dividend yield of 1.2 per cent.
Management is committed to returning capital to investors. The company has announced a dividend increase each calendar year since 2012. The latest dividend hike was announced in Nov. 2020.
Analysts’ recommendations
There are five firms actively covering this small-cap industrials stock with a market capitalization of $693-million, and all five analysts have buy recommendations.
The five firms providing recent research coverage on the company are: Acumen Capital, Canaccord Genuity, CIBC World Markets, Cormark Securities, and National Bank Financial.
Revised recommendations
In March, all five analysts revised their target prices higher.
- CIBC’s Hamir Patel increased to $38 from $32.
- Cormark Securities’ Jeff Fenwick to $41 from $33.
- Canaccord Genuity’s Yuri Lynk to $37 from $33.
- National Bank Financial’s Zachary Evershed to $40 from $39.
- Acumen Capital’s Nick Corcoran to $37.50 from $36.
Financial forecasts
The following financial figures are expressed in Canadian dollars. However, effective Jan. 1, 2021, the company will begin reporting its financial results in U.S. dollars.
The Street is forecasting EBITDA of $105.8-million in 2021, up from $97.5-million reported in 2020, and expected to rise to $110.4-million in 2022. The consensus earnings per share estimates are $2.25 for 2021, up from $2.06 reported in 2020, and anticipated to climb to $2.47 in 2022.
Earnings forecasts are rising. To illustrate, three months ago, the consensus EBITDA estimates were $100.6-million for 2021 and $104.8-million for 2022. The Street was forecasting earnings per share of $2.11 in 2021 and $2.32 the following year.
Valuation
According to Bloomberg, the stock is trading at an enterprise value-to-EBITDA multiple of 8.2 times the 2022 consensus estimate, above its three-year historical average EV/EBITDA multiple of 6.8 times. On a price-to-earnings basis, the stock is trading at 13.2 times the 2022 consensus estimate, above its three-year historical average multiple of 9.3 times but below is peak forward P/E multiple of approximately 15 times.
The average one-year target price is $38.70, suggesting there is over 18-per-cent upside potential in the share price over the next 12 months. Individual target prices are: $37, $37.50, $38, $40 and $41.
Insider transactions
Year-to-date, only one insider has reported trading activity in the public market.
Between March 18-22, president of the Rugby distribution business Drew Dickinson sold a total of 15,000 shares at an average price per share of approximately $31.26, reducing this specific account’s holdings to 51,166 shares. Proceeds from the sales exceeded $468,000, excluding commission charges.
Chart watch
On April 1, the share price closed at a record high, rallying over 3 per cent on high volume with over 170,000 shares traded. Liquidity for this small-cap stock can be low, which can increase price volatility. The three-month historical daily average trading volume is approximately 60,000 shares.
Year-to-date, the share price is up 29 per cent.
The share price has snapped back aggressively, more than quadrupling in value from its low in March 2020.
In terms of key resistance and support levels, the share price has initial overhead resistance around $35. After that, there is a ceiling of resistance around $40. Looking at the downside, there is initial technical support around $30, near its 50-day moving average (at $29.52). Failing that, there is support around $25, close to its 200-day moving average (at $24.24).
The Breakouts file is a technical analysis screen intended to identify companies that are technically breaking out. In addition, this report highlights a company’s dividend policy, analysts’ recommendations, financial forecasts, and provides a brief technical analysis for a security to provide readers with more information.
If a stock appears on the positive breakouts list, this indicates positive price momentum, and that a company may be worthwhile for investors to look at the fundamentals in order to determine if the recent price strength is warranted and will continue. If a security appears on the negative breakouts list, this indicates negative price momentum, and may be indicative of either deteriorating fundamentals or perhaps indicates a buying opportunity.
Securities screened are from the S&P/TSX composite index, the S&P/TSX Small Cap index, as well as Canadian small cap stocks outside of these indexes that have a minimum market capitalization of $200-million.
A technical analysis screen does not replace fundamental analysis, but can help identify companies worth having a closer look at.
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