Patrick Industries: Serial Acquirer With Attractive End Markets (NASDAQ:PATK)

That is an article a part of an ongoing primer collection on nice and undercovered corporations at engaging valuations. These items will present in-depth evaluation of enterprise fashions, financials and valuations. All figures in US {dollars}, except in any other case famous.

Introduction

Patrick Industries (NASDAQ:PATK) is a US producer and distributor of parts for the next 4 industries: leisure automobiles (RVs), marine, manufactured housing (MH), and industrial. PATK was based in 1959 to fabricate parts for the MH business, and till 2007 that was principally the one enterprise of the corporate. In 2007, PATK acquired Adorn Holdings, an Indiana-based producer and provider of inside parts (laminated wall paneling, cupboard doorways and different inside parts) for RVs, diversifying thus PATK’s revenues. Since then, PATK has grow to be a textbook case examine of large wealth creation for shareholders by way of a really aggressive (and very well-executed) M&A coverage that has diversified PATK’s income streams much more. The share worth has lately fallen as a result of PATK’s finish markets have been clear beneficiaries from Covid, as a result of incapability of many Individuals to journey overseas. Really, the inventory worth is under the degrees it reached 5 years in the past, although PATK has saved compounding worth throughout these years, being now a way more priceless firm than again then.

The principle level of the thesis may be summarized as follows:

• PATK’s finish markets (RVs, powerboats, and MHs) are area of interest, cyclical markets, with steady oligopolistic constructions, and no competitors from overseas. Within the case of the RV and powerboat industries, each finish markets have delivered lengthy and constant track-records of stable worth creation for shareholders.
• The manufacturing strategy of parts shouldn’t be extremely automated, so economies of scale from greater manufacturing ranges are modest, at finest. However, the sheer variety of totally different merchandise manufactured by PATK makes OEMs reluctant to change suppliers. OEMs function with just-in-time inventories and lean value constructions, so any delays within the provide chain could have outsize results on their profitability.
• PATK’s observe file in M&A has been phenomenal, with a string of bolt-on acquisitions in adjoining merchandise and getting into new markets. Only for the audio merchandise within the marine section, administration has indicated an extra $3-5bn deal alternative.
• PATK’s valuation could be very compelling. At $57 per share, the corporate has an EV of roughly $2.5bn, which implies EV/NOA 2Q’22 and EV/NOI LTM multiples of 1.1x and 6.3x, respectively. [1] On a levered foundation, PATK trades at 1.5x P/BV and a 3.8x P/E. Provided that PATK’s common return on web working belongings (RNOA) has been round 18% during the last decade (ROE of 34.5%), and that it has been rising financial earnings (earnings after the price of capital) at a wholesome clip, the extent of low cost is just too massive to disregard it. [2] An 8% (EV) low cost price and a 2% development price in residual earnings, assuming a lot decrease future RNOAs (13%), would yield a goal worth of $130, implying fairness returns of 17% at perpetuity.

PATK’s historical past

As beforehand talked about, PATK was based in 1959 to fabricate parts for the manufactured housing business, turned public in 1968, and till 2007 that was principally the one enterprise of the corporate. The years from 2001 to 2007 have been very tough for PATK. As an illustration, in 2001 over half of the corporate’s gross sales got here from MH, an business that suffered a deep disaster throughout that interval. In 2007, PATK acquired Adorn Holdings, an Indiana-based producer and provider of inside parts (reminiscent of laminated wall paneling and cupboard doorways) for RVs, diversifying thus PATK’s revenues. The acquisition additionally introduced on board Todd Cleveland, who was Adorn’s CEO (he had been with Adorn for 17 years), and who would grow to be PATK’s COO in 2007 and CEO in 2009. Since then, PATK has grow to be a basic textbook case examine of large wealth creation for shareholders by way of a really aggressive, and very effectively executed, M&A coverage, which has diversified PATK’s income streams in two extra verticals (marine and industrial).

PATK’s acquisitions during the last decade have been quite a few, so I’ve determined to focus on probably the most related and up to date milestones as follows:

• 2014 (June): PATK acquires Precision Portray, an Indiana-based enterprise with three full service exterior full physique portray operations that additionally supply inside refurbishing and portray for each OEMs and current fleet homeowners. Buy worth was undisclosed, and Precision Portray’s ’14 revenues have been $28M.
• 2014 (June): it acquires Foremost Fabricators, an Indiana-based fabricator and distributor of fabricated aluminium merchandise, fiber bolstered polyester sheet and coil, and customized laminated merchandise primarily used within the RV market. Buy worth was undisclosed, and Foremost’s ’14 revenues have been $75M.
• 2015 (February): it acquires Higher Approach Companions, an Indiana-based producer of fiberglass parts primarily used within the RV, marine and transit automobile markets. Buy worth was undisclosed, and Higher Approach’s revenues for 2015 have been $50M.
• 2015 (September): it acquires North American Forest Merchandise, a Michigan-based producer of main producer and distributor, primarily for the RV business, of profile wraps, customized moldings, laminated panels and molding merchandise, in addition to panels, trusses, bow trusses, and industrial packaging supplies. Buy worth was $85M, and North American’s LTM revenues have been $165M.
• 2017 (Might): it acquires Leisure Product Enterprises, a Florida-based firm that designs, engineers, and manufactures CNC plugs, composite molds (open and closed), and CNC molds for fiberglass boat producers. It additionally produces gelcoat and fiberglass components and assemblies for each the marine and industrial markets. Buy worth was $73.5M, and LPE’s ’16 revenues have been $75M.
• 2017 (November): it acquires Indiana Transport, an Indiana-based transportation and logistics service supplier primarily to OEMs and sellers within the RV market (it makes use of independently contracted drivers to haul journey trailers, fifth wheels, gooseneck trailers and utility trailers from RV OEM crops to seller heaps throughout the nation). As well as, during the last a number of years, Indiana Transport had expanded its service choices to incorporate the transportation of leisure watercraft. Indiana’s ’17 revenues have been anticipated to be $100M, and buy worth was undisclosed.
• 2017 (November): it acquires LMI, a California-based designer, fabricator, and installer of specialty glass, mirror, bathtub and closet constructing merchandise to residential housing and business high-rise builders, basic contractors, retailers, and RV markets. Buy worth was 81M, and LMI’s ’17 revenues have been $75M.
• 2018 (Might): PATK acquires Dehco Inc., a distributor and producer of components and equipment primarily for the RV markets in addition to the manufactured housing, marine and different industrial markets. Dehco’s main merchandise embody flooring, kitchen and bathtub merchandise, adhesives and sealants, electronics, home equipment and equipment and LP tanks. The corporate operates one manufacturing facility in Indiana and 4 distribution facilities in Indiana, Oregon, Pennsylvania and Alabama. Buy worth was 53M and Dehco’s ’17 revenues have been $88M.
• 2018 (December): it acquires LaSalle Bristol an Indiana-based provider of plumbing, flooring, tile, lighting, air dealing with, and constructing merchandise to the manufactured housing, RV, and industrial markets. Buy worth was $54M, and Bristol’s LTM revenues have been $230M. The corporate operates a nationwide community of 11 distribution facilities, one manufacturing facility, and three mixed manufacturing amenities and distribution facilities.
• 2019: Andy Nemeth succeeds Todd Cleveland as CEO of the corporate. Previous to assuming the place of President in 2016, Nemeth was Govt Vice President of Finance, Secretary-Treasurer and CFO from 2004 to 2015, Vice President of Finance, CFO, and Secretary-Treasurer from 2003 to 2004, and Secretary-Treasurer and CFO from 2002 to 2003. Nemeth joined PATK in 1996.
• 2021 (Might): it acquires Alpha Techniques, an Indiana-based producer and distributor of parts to the RV, marine and housing business. Alpha’s primary merchandise are adhesives and sealants, roofing membranes for RVs, roto/blow and injection molded merchandise, butyl tape and shutters. Alpha’ LTM revenues have been $158M; buy worth was undisclosed.
• 2021 (November): it acquires Moist Sounds, a designer, fabricator, engineer, and distributor of audio methods and equipment, together with amplifiers, tower audio system, soundbars, and subwoofers. Moist Sounds sells each to OEMs and the aftermarket. Moist Sounds’ revenues in 2021 have been $55M; buy worth was undisclosed.
• 2022 (February): it acquires Rockford Company, a producer and distributor of premier, high-performance audio methods and parts, primarily serving the powersports, marine, and automotive markets and aftermarkets. Rockford’s revenues in 2021 have been $155M; buy worth was undisclosed.

After such a string of acquisitions, it’s no marvel that PATK’s content material per unit (the primary KPI utilized by PATK’s administration to observe enterprise efficiency) has steadily elevated throughout its three primary finish markets:

What can we find out about PATK’s acquisition technique?

First, one frequent denominator is that PATK leaves the administration crew in place. Many of those companies have been personal and family-owned, they usually seem to see PATK as a pure pathway to monetization however on the identical time conserving their involvement within the enterprise. In flip, PATK brings to the desk relationships with OEMs, distribution capabilities, and new capital to the enterprise to develop.

Second, the transactions have been quite a few and small in nature (bolt-on), lowering integration danger. Additionally, the profile of the acquisitions shouldn’t be turnarounds, however companies with a track-record of profitability.

Lastly, PATK has nonetheless wholesome alternatives for extra M&A. Though it already instructions excessive market shares within the RV market (a metric not disclosed by the corporate), the marine section will convey extra candidates. As an illustration, administration held the next trade with an analyst within the Q&A session of the acquisition of Rockford:

Simply on the powersports market that is a more recent one for you guys. I assume what is the scope of the chance as you see it there and the way targeted is the M&A pipeline going to be there?

The scope we estimate market is one thing north of $20 billion by way of alternative. The chance for us inside that the audio area there’s most likely $3 billion to $5 billion alternative given the premium degree product they could use and so we see good runway we see the chance to additionally take into consideration from a pipeline standpoint, there’s gamers which have come to us that is one of many issues that is inherent worth strategically with these acquisitions as these guys are plugged in on the aftermarket. They see the merchandise which can be shifting, and so we have had alternatives come to the desk already. And for being considerate and the way we method that is an early step into this. And we’ll get additional and additional by way of the training curve and higher appreciating {the marketplace} in being guaranteeing that we’re choosing the right accomplice. So, we be ok with what we will do there. And we additionally be ok with the alternatives organically with our manufacturing capabilities all through the nation in our metallic forming, in our thermoplastics, thermoforming of plastics for various parts on this. We see an inherent alternative, as we take into consideration plugging with manufacturers by way of acquisition, an natural solution to increase the presents be a wide range of merchandise. And once more, utilizing that very same push and pull sort mindset. We have the flexibility to have this community take an array of merchandise to {the marketplace}.

Understanding PATK’s enterprise mannequin by way of the lens of the 7 Powers

At this level it’s attention-grabbing to elucidate why I feel PATK is a wonderful enterprise and why it has not been acknowledged by the market thus far.

PATK is a small B2B firm, in order a shopper it’s tough (if not unattainable) to make an evaluation of their merchandise and distribution capabilities. Moreover, the corporate operates in a distinct segment business the place analyst protection has been small (Financial institution of America lately launched protection on the title). For these causes, I feel {that a} rigorous strategic evaluation can shed some mild on the character of the enterprise. I’ll use Helmer’s 7 Powers framework to be able to reply the query: why is that this a very good enterprise?

On the coronary heart of Helmer’s framework, popularized in his 2016 e-book 7 Powers: The Foundations of Enterprise Technique, there may be the idea of Energy, outlined as “the set of circumstances creating the potential for persistent differential returns”. For Helmer, such returns are these obtained above the price of capital, so his methodology hyperlinks properly with the valuation framework I’ll use later. It’s price mentioning that Helmer’s framework differs from Porter’s in that the previous tries to reply the query of why this enterprise is healthier than opponents (“differential returns”), whereas the latter focuses on the benefits and downsides of an total business. Though I can’t use Porter’s on this thesis, some remarks on PATK’s finish markets might be made later.

For one thing to be a Energy, it must have each a profit to the powerholder and a barrier to the challenger. In keeping with Helmer, the 7 Powers is a complete framework and encompasses all of the doable aggressive benefits {that a} enterprise could have. A enterprise does must have all of the 7 Powers to generate differential returns: truly, it’s just about unattainable to give you a enterprise that shows the 7 Powers on the identical time. If the enterprise has simply one among them in nice portions, shareholders ought to do effectively over time.

Helmer’s framework utilized to PATK yields the next conclusions:

• Scale economies: “a enterprise through which per unit value declines as manufacturing quantity will increase.” PATK has some slight benefits over smaller opponents because of its logistics capabilities, and in addition when coping with suppliers (buying economies). Moreover, the enterprise could have modest studying economies. Nevertheless, PATK’s enterprise has a really low share of mounted prices, because the manufacturing course of is essentially guide, so scale economies because of manufacturing volumes are virtually nonexistent.
• Community economies: “a enterprise through which the worth realized by a buyer will increase because the put in base will increase.” PATK’s enterprise doesn’t have any community economies.
• Counter-positioning: “a newcomer adopts a brand new, superior enterprise mannequin which the incumbent doesn’t mimic because of anticipated harm to their current enterprise.” PATK’s enterprise is essentially much like its opponents’ (i.e., LCI Industries), so it doesn’t exhibit any counter-positioning Energy.
• Switching prices: “the worth loss anticipated by a buyer that may be incurred from switching to an alternate provider for extra purchases.” Switching prices for PATK’s clients are excessive, because of a number of causes. First, most merchandise produced by PATK are low-priced gadgets, so there may be little incentive to change. Second, OEMs function with just-in-time inventories, so the chance of supply-chain disruption is excessive. Lastly, OEMs seemingly discover it extra handy to barter with one provider to be able to coordinate all the provide chain. The next footage seize the extent of PATK’s product portfolio within the RV section ( readers can discover the remainder of PATK’s in depth portfolio within the appendix of its company presentation):

• Branding: “the sturdy attribution of upper worth to an objectively similar providing that arises from historic details about the vendor.” Most of PATK’s merchandise should not have any model (with the doable exception of some merchandise within the marine section) and are largely undifferentiated from opponents.
• Cornered useful resource: “preferential entry at engaging phrases to a coveted asset that may independently improve worth.” The enterprise doesn’t personal materials patents, preferential entry to inputs or differential cost-saving manufacturing strategies.
• Course of energy: “embedded firm group and exercise units which allow decrease prices and/or superior product, and which may be matched solely by an prolonged dedication.” PATK has a confirmed enterprise mannequin through which acquisitions have been seamlessly built-in and profitability metrics have improved over time. Moreover, the administration crew tenure has been lengthy, and its observe file is powerful.

Conclusions may be summarized as follows:

Concerning the business, PATK operates in a number of industries, so it’s tough to make basic observations about their attractiveness. I’ll give attention to two industries, RV, and marine, and can solely make some high-level feedback which will add some worth to the 7 Powers evaluation carried out above.

It’s well-known that each industries are cyclical, as they take care of discretionary merchandise with high-price tags. Each industries have benefitted from the pandemic with whole offered models effectively above earlier historic information, and with favorable long-term developments in demand. Clients (i.e., OEMs) are extremely concentrated (as an illustration, as of the top of 2021, THOR had a market share of 40.8% within the towable market, whereas Forest River had 36.6%, Grand Design 10%) leaving each industries with rational gamers. Lastly, these industries are manufacturing companies with no competitors from overseas, which I feel is an usually underappreciated optimistic attribute.

Valuation

After being seen as a transparent pandemic beneficiary, PATK’s inventory has fallen in tandem with the remainder of the buyer discretionary sector. The inventory worth is again to round its 2017 by way of 2019 ranges, though PATK is a bigger and extra diversified firm now, as I’ve proven within the historical past part. In different phrases, PATK’s inventory worth has suffered a large a number of contraction that doesn’t mirror the power of the enterprise.

PATK’s historic monetary statements are introduced intimately on the finish of the article. I’ve additionally reorganized the accounts to provide a transparent view of the working and monetary actions. As a way to body the inputs of the valuation, the next desk provides a pleasant sketch of what the corporate has delivered since 2011:

From 2011 till 2Q’22, PATK has grown revenues at 32% CAGR, whereas web working belongings have been rising at 44%. Though revenues have been significantly helped by the numerous acquisitions described above, it’s reassuring to see that NOAs have solely grown barely quicker, suggesting that PATK has not overpaid for its acquisitions normally. General, the corporate has earned since 2011 a mean RNOA of 18%, pushed by a 5.5% margin and an asset turnover of three.4x.

It’s price stressing once more that the enterprise has delivered constant returns on capital during the last decade regardless of the cyclicality of its finish markets. Even in 2019, which was a troublesome 12 months for the RV business, PATK generated a RNOA above its value of capital (assuming an 8% threshold price). On prime of that, the stream of financial income has additionally saved rising as extra capital has been deployed into the enterprise by way of acquisitions:

At this level, it’s price stressing {that a} chunk of latest income will revert again to decrease ranges. However not all of it, because the market is implying. First, PATK has been investing during the last three years in automation and different manufacturing effectivity initiatives, and administration has hinted that that’s going to have a everlasting impact on gross margins. As an illustration, the next trade from the 1Q’22 earnings call is indicative of what we will anticipate going ahead:

Is there a way that you could keep 20% gross margins at this level?

There’s. And we do, Mike, and there is a few items to that. And definitely, the pliability and nimbleness of our manufacturing platform lends to that, which helps us keep margin in up and down markets. But additionally, you requested an ideal query in regards to the sturdiness of a few of this enchancment we have seen. And whereas we actually acknowledge there’s a component of absorption that comes together with elevated manufacturing ranges, we have got — as I discussed, somewhat little bit of headwinds from uncooked materials enter pricing in addition to the freight in, and I feel people are feeling that typically throughout the board. However we expect 100 to 125 foundation factors of that total elevate we see that resonates by way of each gross margin, working margin is attributable to our productiveness enhancements which take a number of totally different varieties, however lend off the CapEx spending we made final 12 months, which is why we’re targeted on persevering with that pattern this 12 months as talked about, $100 million is our planning quantity for 2022. We expect, once more, that is 100 to 125 foundation factors of sturdiness in that margin elevate.

Second, PATK’s portfolio has moved towards higher-end merchandise (and aftermarket) after the acquisitions of Moist Sounds and Rockford, lifting margins (though miserable asset turnover). Lastly, during the last three years, PATK has spent quite a bit on M&A ($343M in ’18, $56M in ’19, $306M in ’20 and $508M in ’21), so a big portion of latest revenue will increase comes from M&A, not simply from a greater macroeconomic surroundings.

PATK’s historic metrics may give us a valuation vary for the enterprise. For an (EV) low cost price of 8%, a development price in residual earnings of two%, and a return on web working belongings of 13% (or $115M of financial income yearly) on PATK’s asset base of $2.3bn, the EV could be round $4.2bn, implying a 128% upside, or $130 per share. At that worth, PATK would commerce at 1.8x EV/NOA and 14x EV/NOI. It should be emphasised that I regard a 13% price of return as a really conservative assumption over the long run, given PATK’s historic observe file beforehand mentioned.

However, if we assume financial income of $70M (the typical of 2017-’21), the goal worth would drop to $97 per share – which implies that the margin of security is ample:

There’s one other helpful solution to body the present valuation low cost: by way of inside charges of return. Given the present EV of $2.5bn. (EV/NOA of 1.1x), and assuming that our ahead RNOAs are appropriate (11% for the bear case, 13% for the bottom case, and 15% for the bull case), future unlevered returns will annualize 10%, 12%, and 14%, respectively; which after making an allowance for the leverage of the corporate, will increase to 14%, 17%, and 21%, providing thus robust return prospects for long-term buyers:

Draw back dangers

• Producers in PATK’s primary finish markets have grow to be more and more consolidated over time, particularly the RV business. Though the connection between OEMs and their suppliers could be very shut and has been good thus far, additional upstream acquisitions by THOR may erode PATK’s bargaining place.
• Labor is a large chunk of whole prices. Further wage pressures may influence PATK’s profitability down the street.
• After such a string of acquisitions, PATK’s listing of potential candidates is shorter, which may result in unhealthy capital allocation choices by the administration crew.
• PATK’s monetary leverage is greater than its opponents’ and will stress the inventory worth if the downturn in PATK’s finish markets is longer (and deeper) than anticipated.

Upside dangers

• The financial cycle shouldn’t be as unhealthy as it’s feared.
• Future share repurchases are carried out at present or extra engaging ranges.
• PATK is ready to supply extra acquisitions at engaging valuations.

Appendix I: Patrick Industries reorganized monetary statements (2010-2021)

Reorganized revenue assertion

Reorganized steadiness sheet

[1] EV/NOA: Enterprise worth to web working belongings. EV/NOI: Enterprise worth to web working revenue. Internet working belongings are computed as fairness (together with minority pursuits) plus web monetary debt. Internet working revenue is computed as EBIT after statutory taxes, much less different complete revenue working gadgets (reminiscent of forex translation changes). EV/NOA and EV/NOI, are, in impact, the unlevered measures of P/BV, and P/E, respectively.

[2] Return on web working belongings (RNOA): web working revenue divided by web working belongings.

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