Builders FirstSource: Housing Market Begins to Implode (BLDR)

Contractor standing on custom kitchen building frame grading into finished product

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Builders First Resource (New York Stock Exchange:BLDR) is a supplier of building materials (wood and finished products) to home builders, subcontractors, remodelers and consumers. Examples of its products include wood and board products, wood floor and roof trusses, siding, windows, doors, siding, exterior trim, and more.

My rationale for shorting BLDR is that it is a “leverage” of the housing market and new construction. Like homebuilders, BLDR’s revenue and profit margins soar when the market is hot. But when the pendulum swings in the other direction, as it is now, revenue and profits quickly dry up. BLDR’s numbers benefited from price inflation and several “roll-up” acquisitions that inflated revenue growth and doubled its debt load.

BLDR revenue actually started to decline in 2018 and 2019. Then in 2020, revenue rose 17.5% year over year due to a boom in new home construction and rising commodity prices (both a product of Fed monetary policy).

From 2020 to 2021, BLDR’s revenue more than doubled through the acquisition of BMC West. Of course, its long-term debt load has also nearly doubled. Revenue in the first quarter of 2022 grew 36.1% year over year. But 58% of that gain was attributable to the BMC acquisition and price increases.

The company acknowledged that demand for single-family homes drove its revenue growth. But, as we’ve seen with new home sales, home sales have started to head south. Because of this, I believe BLDR’s sales growth and profitability will slow rapidly during 2022.

Compounding the issue, BLDR’s debt load increased by another 15.9% in the first quarter of 2022. In addition, the company burned through $1.7 billion in cash to repurchase shares in 2021 and another $354 million in repurchases (instead of paying down debt) in the first quarter of 2022.

There are also some financial red flags on its balance sheet:

BLDR Balance Sheet

BLDR Balance Sheet (author)

First, inventories have increased by 34.6% in the first quarter since the end of 2021. BLDR has been a big beneficiary of price inflation. Over the past few years, it has been able to sell inventory at prices well above the cost of building it.

But as demand for new homes declines, and with single-family starts, BLDR will face considerable pricing risk. Recall the massive inventory write-downs that homebuilders made in 2008 and 2009. The same dynamic applies to BLDR.

Another red flag is the considerable asset value allocated to goodwill and intangible assets, which account for nearly 40% of BLDR assets. The $3.39 billion figure allocated to goodwill is particularly troublesome. Goodwill is the amount paid for an acquisition in excess of the fair value of the assets acquired. 76% of this goodwill number was the result of the BMC acquisition.

Goodwill is basically the value given to various intangible “assets” acquired, such as brand names, customer relationships, any know-how, etc. This is great when stock values ​​are rising and the economy is strong.

But goodwill can also be viewed as an amount that the acquiring company may overpay for the acquired company. At some point, as the economy of BLDR’s business model deteriorates, this huge goodwill plug will be a source of write-downs and income statement charges.

The same goes for “intangible assets”. BLDR’s intangible assets are listed on the 10-K as value allocated to customer relationships, trade names, subcontractor relationships, non-compete agreements, and developed technology.

While goodwill is not amortized, amortization expense for intangible assets is calculated on the income statement. But when the housing market and the economy deteriorate, these “intangible assets” shrink in value and become another source of write-downs.

BLDR’s book value (shareholders’ equity) is $5.1 billion. But $4.8 billion of that book value consists of goodwill and intangible assets. Thus, the tangible book value of BLDR is only $300 million. With a debt load of $3.4 billion, BLDR has a debt-to-tangible book value ratio of 10 times. While this provides the company with earnings leverage in good times, it will be a source of considerable financial stress when the cycle turns.

Also, BLDR doesn’t have much room to incur inventory, goodwill, and intangible write-downs until its book value goes negative (trust me, that will come eventually). Receivable write-downs also occur when a smaller custom home builder goes bankrupt and BLDR becomes an unsecured bankruptcy court creditor.

The more I dig into BLDR’s 10-Q/K, the more I like it as a short idea. Assuming my views on the housing market are correct, and I believe my thesis has begun to unfold, BLDR’s stock price will fall rapidly.

BLDR and DJUSHB

BLDR and DJUSHB (author)

BLDR’s share price nearly doubled from mid-July 2021 to the end of 2021. Since then, its value has fallen 29.4% through Friday. In the graph above, I have plotted the BLDR against the Dow Jones Homebuilding Index (DJUSHB) in the past five years. Until July 2020, BLDR was closely related to DJUSHB.

I believe that for the rest of 2022, BLDR will substantially “catch up” to DJUSHB, at least in part. Based on DJUSHB’s current levels, this implies a target price of $30 for BLDR. But between now and the end of 2022, DJUSHB will continue to decline. I can see BLDR falling to $20 by the end of the year. Remember, the March 2020 price is $10.

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Editor’s Note: The summary bullet for this article was chosen by Seeking Alpha editors.