Equity Research July 7, 2006 Mario Ricchio www.zacks.com 155 North Wacker Drive Chicago, IL 60606 Beacon Roofing Supply, Inc. (BECN-NSDQ) Current Recommendation Hold Prior Recommendation Buy Date of Last Change 05/03/2006 Current Price (07/05/06) $22.16 Six- Month Target Price $22.50 SUMMARY DATA 52-Week High $28.21 52-Week Low $16.87 One-Year Return (%) 28.24 Beta Average Daily Volume (sh) 832,178 Shares Outstanding (mil) 44 Market Capitalization ($mil) $970 Short Interest Ratio (days) 12.99 Institutional Ownership (%) 94 Insider Ownership (%) 6 Annual Cash Dividend $0.00 Dividend Yield (%) 0.00 5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%) P/E using TTM EPS 23.6 P/E using 2006 Estimate 19.4 P/E using 2007 Estimate 17.2 Zacks Rank 1 OUTLOOK We expect Beacon Roofing Supply (BECN) to report third quarter EPS of $0.37, a year-over-year increase of 37%, amid strong sales growth and lower operating costs (as a percentage of sales). BECN is well positioned for double-digit earnings growth based on the potential for market share gains, a scale driven reduction in purchasing costs, and continued pursuit of accretive acquisitions. Nevertheless, the stock already trades at a significant premium to the industry and market, which adequately reflects the overall positive fundamental outlook. We reiterate our Hold recommendation on shares of BECN. Risk Level Type of Stock Mid-Growth Industry Bldg Prd-Rt/Whl Zacks Rank in Industry 1 of 6 ZACKS ESTIMATES Revenue (in millions of $) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2005 199 A 172 A 248 A 231 A 851 A 2006 340 A 322 A 428 E 409 E 1,499 E 2007 405 E 349 E 1,663 E Earnings per Share (EPS is operating earnings before non-recurring items) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2005 $0.21 A $0.06 A $0.27 A $0.25 A $0.80 A 2006 $0.31 A $0.11 A $0.37 E $0.35 E $1.14 E 2007 $0.33 E $0.12 E $1.29 E FY06 EPS includes $0.03 of stock option expense. EPS figures are adjusted for 3:2 stock split. Zacks Projected EPS Growth Rate - Next 5 Years % 19 Copyright 2006, Zacks Investment Research. All Rights Reserved.
OVERVIEW Founded in1928, Beacon Roofing Supply (BECN) is one of the three largest roofing materials distributors in the United States and Canada, with over 90% of its sales coming from the U.S. While Beacon sells roofing materials-- asphalt shingles and single-ply roofing-- to the residential and non-residential markets, it also sells complementary building materials such as vinyl siding, doors, windows, insulation and waterproofing systems. The company operates 148 branches in 30 states and 3 Canadian provinces, serving 30,000 customers. More importantly, no one customer accounts for more than 1% of sales. The competition comes primarily from local and regional roof supply distributors. Local contractors, involved in the business of roof replacement, make up the bulk of its sales. After having a few owners, seven branches and only $72 million in revenue, BECN was purchased in 1997 by the private equity group, Code, Hennessey, and Simmons. Using this company to consolidate a fragmented industry, the newly managed Beacon acquired nine companies, opened 18 new branches, and expanded revenue to over $850 million by the end of FY05. In September of 2004, Beacon went public by selling 8.5 million shares at a price of $13.00 per share. The company used the proceeds to pay down debt and continue active pursuit of external and internal growth through acquisitions and through new branch openings. Since going public, the stock price has more than doubled. BULL STORY Beacon s branch-based business model optimizes revenue and minimizes cost. The operating model consists of two interwoven strategies. One, it centralizes functions such as IT, accounting, financial reporting, and purchasing to drive scale efficiency and lower costs. For example, centralizing the procurement of products through its headquarters enables lower purchasing costs relative to its competitors. As it acquires size and aids in industry consolidation, economies of scale helps drive down purchasing costs. In this way, the operating structure is there for BECN to rapidly expand market share though new branch openings and acquisitions. And two, the operating model allows each branch to tailor product and service offerings in-line with the needs of the geographic market. This allows for greater customization and better product pricing. During the second quarter alone, prices increased 6% relative to the same period a year ago. Finally, management spends heavily on employee training related to sales techniques, management skills, and product knowledge. With regard to greater product knowledge, this fosters closer business ties with large manufacturers as well as local roof contractors. With a solid business model in place, the company executes on its strategy to grow externally through acquisitions and internally through branch openings. The results speak for themselves. During the second quarter, acquisitions accounted for 72% of the growth in net sales. Since FY05, the company has acquired the Supply Companies (roofing distributor in Mississippi and Alabama), Pacific Supply Company (distributor of roofing and other building products having four facilities in Southern California), Shelter (roofing and building products with 51 branches in 14 states), JGA (branches in Georgia and Florida), and other assets from Easton Wholesale and Insulation systems. The acquisition of Shelter is part of a strategy to buy market leaders, and thus expand, in geographic regions where it sees growth and did not currently serve. The other type of acquisitions made is in areas where it already has exposure such as the Mid-Atlantic region through the purchase of Easton. The Beacon story goes beyond merely acquisitions. There is true organic growth. During the second quarter, organic growth was $41.5 million or 24.1% on only seven new branch openings since March 2005. Management noted strong demand for non-residential roofing demand in all regions of the country and higher residential roofing demand on the East coast. Historically, a large part of overall residential roofing demand comes from maintenance (re-roofing) than it does from new home construction. If this trend continues into the future, it would be a positive development since we envision a greater slowdown in housing starts. The roofing industry is expected to Zacks Investment Research Page 2 www.zacks.com
grow at an annual pace of 3.5% out to 2008. We believe BECN can outpace industry growth on account of pricing power, purchasing scale, and market share gains. As for long-term demand trends, BECN notes that over 30% of the U.S. housing stock was built prior to 1960 and the median age of a home is 30. An aging housing stock increases demand for roofing materials. On the non-residential side, the most promising trend is in the healthcare sector. The aging baby boomer population is a catalyst for dramatically higher spending on the nation s healthcare infrastructure. Another promising trend is the ability of BECN to leverage its fixed costs over higher sales. We have to look no further than the second quarter results. From existing markets, operating expenses as a percentage of sales fell to 18.1% from 20.8% in the same year-ago period. This, in turn, helped boost operating margins 280 basis points to 6.0%. The rise in margins came despite higher spending on branch openings and employee training. BEAR STORY While we like the BECN growth story, it is not without risk. Firstly, the company has heavily relied on acquisitions to drive scale and revenue growth. Even though the industry is fragmented and made up of many small local players, management may have trouble finding suitable acquisition candidates that provide synergies in existing markets and upfront earnings accretion. If acquisition growth slows, it would prevent BECN from growing profits as fast as it has been able to do in the last couple of years. Secondly, re-roofing demand has less cyclical fluctuation than does roofing from new homes. However, the company derives a growing share of profits from the sale of complementary building materials. If house price appreciation moderates or reverses and provides less equity to tap for repair, we could see end users delay project repair work on items outside of roofing such as doors, windows, and siding. In that case, the growth rate of complementary building materials would fall below that of residential roofing. Finally, the valuation on BECN is anything but cheap and leaves the stock vulnerable to a negative earnings surprise. On a P/E basis, the stock currently trades at 19.4x forward earnings. In our view, the valuation suggests a large part of the near-term growth story is baked into the stock price. We see less than 10% upside potential in the shares. As a result, we reiterate our Hold recommendation on BECN. RECENT NEWS On May 10, 2006, Beacon reported diluted net income per share for the second quarter of $0.16 in 2006 compared to $0.09 per share in 2005, a 77.8% increase. The company achieved record second-quarter net income of $4.8 million in 2006 compared to net income of $2.4 million in 2005, an increase of 97.5%. The annual income tax rate of 40.5% for fiscal 2006 was lower than the rate of 43.6% provided for in last year's second quarter. The annual fiscal 2005 income tax rate was 40.0%. Second quarter sales increased 87.3% to a record $322.4 million in the second quarter of FY06 from $172.1 million in the second quarter of FY05, reflecting robust internal growth of 24.1%, with strong sales in all three major product lines: residential roofing, non-residential roofing and complementary building products. Shelter Distribution, acquired in mid-october 2005, along with the other companies acquired since the second quarter of 2005, contributed the remaining sales increase. The company also opened nine new branches since last year's second quarter. Gross profit increased 87.9% to $77.8 million in 2006 from $41.4 million in 2005. Gross margin increased slightly from 24.0% to 24.1%, helped by a 24.3% gross margin from the acquired companies. The gross margin in existing markets was unchanged at 24.0%. Existing markets exclude branches acquired in the year prior to the start of the reporting period. Zacks Investment Research Page 3 www.zacks.com
Interest expense increased $3.1 million to $4.3 million in 2006 due to higher borrowings (utilized to finance our acquisitions) and higher interest rates, partially offset by the benefit from the successful public sale of two million shares of our common stock in December 2005. In connection with the acquisitions in January 2006, the company and its lenders amended the revolving lines of credit and term loans to, among other things, increase the revolving lines of credit and term loans to totals of $280 million and $90 million, respectively. The net proceeds from the December public offering totaled $51.6 million, which were used to pay down revolver borrowings. VALUATION We have valued Beacon Roofing Supply on a P/E multiple basis. At its current price, the stock trades at 19.4x forward earnings and at a premium to the industry and the market. We believe BECN s strong competitive position in the roofing distribution business warrants a premium. Going forward, the company can grow faster than its peers based on scale-driven reduction in operating costs relative to sales and its ability to take market share. Management invests heavily in its human resources through employee training whose greater product knowledge cements long-term relationships with its manufacturers and end users. The main risks to earnings growth are a lack of acquisition opportunities or a delay in project work due to a collapse in the housing bubble. The current high P/E multiple, relative to the industry and market, adequately reflects the overall positive fundamental outlook. We see no reason for a significant multiple expansion at this time. Our target price of $22.50 is 19.7x our FY06 EPS estimate at $1.14. Industry Comparables Pr Chg P/E CFY EPS Gr Price/ Price/ YTD 5Yr Est Book Sales BEACON ROOFING 18.5 20.8 18.5 5.1 0.9 Industry Mean 12.4 15.1 16.5 2.9 0.8 Industry Median -0.6 13.1 15.6 2.3 0.3 S&P 500 2.6 15.6 8.0 4.2 2.6 BUILDERS FIRSTS -7.3 7.3 15.0 3.5 0.3 HUTTIG BLDG PRD -8.5 7.8 19.0 1.4 0.1 Zacks Investment Research Page 4 www.zacks.com
PROJECTED INCOME STATEMENT Beacon Roofing Supply, Inc. Income Statement (Dollars in millions, except EPS data) 09/04 09/05 09/06E Sales 653 851 1,499 Cost of Goods Sold 487 644 1,134 SG&A 121 146 258 Stock-based compensation expense 10 1 1 Interest expense 12 5 9 Other expenses 28 1 2 Income Tax expense 10 22 45 Zacks Adjusted Income before NRI 11 33 50 Net Income -15 33 50 Diluted EPS before NRI 0.43 0.80 1.14 Reported EPS -0.57 0.80 1.14 HISTORICAL ZACKS RECOMMENDATIONS Zacks Investment Research Page 5 www.zacks.com
DISCLOSURES The analysts contributing to this report do not hold any shares of BECN. Zacks EPS and revenue forecasts are not consensus forecasts. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Buy- Zacks expects that the subject company will outperform the broader U.S. equity market over the next one to two quarters. Hold- Zacks expects that the company will perform in line with the broader U.S. equity market over the next one to two quarters. Sell- Zacks expects the company will under perform the broader U.S. Equity market over the next one to two quarters. The current distribution of Zacks Ratings is as follows on the 1125 companies covered: Buy- 21.0%, Hold- 74.6%, Sell 4.4%. Data is as of midnight on the business day immediately prior to this publication. Zacks Investment Research Page 6 www.zacks.com