The recent market crash has been cruel to small-capitalized stocks on the TSX. Regardless of their business operations, balance sheets, or corporate strategy, investors piled out of small-cap stocks. Perhaps rightfully so. Small companies often face greater risks, such as lower business scale, less institutional ownership, and less market liquidity to trade.
Yet, not every company was deserving of the punishment experienced in March. In fact, the TSX crash has presented some very attractive buying opportunities. One stock that stands out here is Hardwoods Distribution (TSX:HDI).
Over the past five years, Hardwoods has steadily expanded to become the top distributor of architectural building products in North America. While you may never have heard of Hardwoods, it is possible that its wood-style products are fitted in your home or workspace.
Growth through consolidation
Hardwoods has thrived from a growth-by-acquisition strategy. It has added 47 locations over the past seven years, including six locations in 2019. It has a five-year compounded annual growth rate of 21% for sales and 11% for adjusted earnings. Its sales mix is diversified with 50% exposure to residential, 40% commercial, and 10% mixed. Most of its expansion has been in the U.S., so around 90% of sales are derived there.
Many of those who sell architectural building products are small, independent retailers. This has given Hardwoods a great consolidation opportunity in the sector. It can add location quickly and find operational/distributional synergies through its larger network of locations.
Solid fundamentals
Hardwoods relies on North American housing starts and the overall lumber industry. It can face challenges when these industries are depressed. Despite some negative 2019 headwinds (low lumber pricing and delayed construction starts), Hardwoods increased sales by 3.3% to $1.2 billion and improved margins by 40 basis points to 18%. Overall, the company is better diversified and capitalized than it has ever been.
As of Q4, it had a net bank debt to capitalization of 27% and a bank-debt-to-adjusted-EBITDA ratio of two times. Of course, during the COVID-19 crisis, any amount of debt can be concerning, especially if the company is not operating.
Yet, management announced yesterday that its business meets the criteria of an “essential service,” allowing it to operate throughout the United States. Management indicated that March demand remained solid, and many of its customers and suppliers continue to operate. It fortunately has $69 million worth of credit facilities should the extra liquidity be necessary.
This stock is on sale
Since January, the company’s value has effectively been cut in half. Hardwoods is presently trading with a market capitalization of $202 million and price-to-earnings ratio of seven times.
Right now, Hardwoods is basically trading for the same value of its inventories on its balance sheet. At this price, you are, after all liabilities are settled, getting the company’s operating platform for free. It is presently paying a 3.7% yield, and management made no indication of cutting it.
Of course, 2020 will be a challenging year for Hardwoods. It, like many companies, will see its 2020 results impacted by an industry-wide COVID-19 slowdown. Yet, when considering the strength of Hardwood’s operating platform, I am confident it will persist.
2021 should present some positive tailwinds. Historic low interest rates will encourage U.S. consumers to start buying and building houses again. A strong U.S. consumer will likely help keep the U.S. dollar strong, which will benefit Hardwoods. Lastly, Hardwoods may garner expansion opportunities as smaller, financially/operationally stressed competitors require consolidation.
The bottom line
Investing in a cyclical name like Hardwoods Distribution is not for the faint of heart. However, at its current fire-sale valuation, you’ll pick up a quality operating business with long-term tailwinds. Be sure to monitor its investor communication and take your time building a position. I think you will be amply rewarded over a long horizon if you choose to buy Hardwoods.
