The following is a quick overview of the company Core & Main.
What do they do?
Core and Main (CNM) manufactures and distributes specialty products used in the maintenance, repair, and construction of water and fire protection infrastructure. They operate in 3 segments: Residential, Non-residential, and municipal. They make and maintain water infrastructure.
Why is the company interesting?
The company has an interesting history. It used to be part of Home Depot as part of their HD supply division. A lot of the management was involved in the company during this time. It was purchased by private equity in 2017. The company IPO’d in 2021. I think that water infrastructure in the U.S. has been ignored for a long time. Flint, Jackson, and countless other cities are feeling the consequences of these decisions. Core & Main is fit to capitalize on this.
Management
The CEO, Steve Leclair has been with the company (in all its forms) since 2005. He was head of the division when it was part of Home Depot. That’s a nice company to learn from, and if a manager has a long career with HD, they probably have done something right. Numerous other executives date back to the Home Depot days too.
Growth strategy
The company operates in a fragmented industry. There are countless small distributors scattered across the US. CNM has been on an acquisition spree. Their website actually has information if you want to sell your distribution business to them. They have completed 23 purchases since 2017. THese companies are bolt on acquisitions since they are essentially in the same business. CNM then brings the business up to its standards, and eliminates redundancies. The new company is almost immediately contributing to earnings.
The company also benefits from increased construction, both residential and commercial. This is actually a headwind for them as residential construction is slowing. Industrial and municipal construction has been holding up much better so far, but can also drop in a recession. Analysts are predicting a drop in earnings next year.
They are not dependent on new construction though. Fully half of their revenue comes from repair and replace work. These repairs would likely happen in any economy because their customers need water.
Gross margins are around 26%, and growing. Sales have increased at a 26% CAGR since FY 2019. Return on Equity is around 23%. Those are all solid numbers.
Do they have a moat?
Morningstar rates the company as having a narrow moat. I agree. As they add more businesses to their company it creates a flywheel effect allowing them to create an economy of scale. This allows them to become more efficient, offer better pricing, and thus enhance their further growth.
I will say that since this is a newer public company the moat hasn’t been tested and there isn’t a long established business history.
Risks
My biggest gripe with the company is their lack of GAAP reporting. They do, of course, report their GAAP numbers on the 10Q/k, but their press releases highlight adjusted EBITDA, which is not a real accounting figure. They adjust out equity based compensation, some debt restructuring payments, some acquisition costs, and IPO expenses. These aren’t egregious things to omit in my opinion, especially their debt and IPO costs. These are costs that should not be permanent for the company, but over adjusting on earnings releases is a pet peeve of mine.
The company does have a lot of debt. The latest figures I have are $1.7 billion in debt, however this is down from $2.1 billion in 2020. Management has made debt reduction a priority.
They have a two class stock system, which is another pet peeve of mine. This is a result of their time with private equity, and those people trying to retain special privileges. Not my favorite corporate setup.
Being a recent IPO, there also isn't a long history to go by. This makes it hard to judge how consistent the business will be.
Conclusions
I own no position in this company. It offers an intriguing value, trading at 11x earnings and EV/EBITDA around 10. Those numbers combined with 20% or more growth would make the stock undervalued, in my opinion. However, The company is expecting a decline in earnings next year. This is due to the economic slowdown as well as a regression to the mean after the covid building boom of 2021. FY 2022 should be out this month, and it will be interesting to see how the business is holding up.
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