Pool Corporation: A compounding market leader.
Pool Corporation is a company that has long been on my watch list as it is a compounding market leader. If you follow my blog, it is no secret that I like compounding market leaders. I just finished a great book called "The Intelligent Quality Investor" by Long Equity, in which Pool Corporation is listed as a quality company worth analyzing. Thus, it is what I decided to do.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since I have attended the workshop with Phil Town, I have decided to change the layout of my analyses a bit. I will do some more calculations and briefly describe the company and if it has a moat. I have changed the format of the analysis a bit to try to make it shorter and with less numbers. If you want to read more about how I evaluate a company, please go to "MY STRATEGY" on my website.
For full disclosure, I should mention that at the time of writing this analysis, I do not own shares in Pool Corporation. If you would like to copy my portfolio or see the stock in my portfolio, you can read about how to do so here. I don't own shares in any of their competitors either.
Pool Corporation was founded in 1981 in New Orleans and was then called South Central Pool Supply. In 1993 the company joined forces with a private equity firm and changed its name to SCP Pool Corporation. Pool Corporation is the world's leading wholesale distributor of swimming pool equipment, parts and supplies, and related outdoor living products. Pool Corporation operates over 410 locations worldwide and distribute their products to roughly 120.000 customers around the world. However, approximately 90 % of its business is in the Unites States. Pool Corporation primarily serves the contractor market as about 80 % of their sales are to contractors. Pool Corporation divide their sales into three segments: Retail and Maintenance Service (60 % of sales), New Pool Construction (20 % of sales), and Replacement and Refurbishment (20 % of sales). The large Retail and Maintenance services segment means that Pool Corporation receives a large amount of recurrent income. Being the world's leading supplier means that Pool Corporation has a brand moat as customers trust the brand.
Their CEO is Peter D. Arvan. He joined Pool Corporation in 2017 and became the CEO in 2019. Prior to joining Pool Corporation, he served as CEO of Roofing Supply Group, while previously serving in various management positions in SABIC Polymershapes. He has an undergraduate degree from State University of New York Institute of Technology. When he was presented as the CEO of Pool Corporation it was mentioned that his extensive experience in leading distribution businesses is one of his strengths. It is hard to find much information about Peter D. Arvan online but since he became the CEO Pool Corporation has managed to increase margins, which indicates that he has done a good job. Furthermore, when reading through the earnings call transcripts, I really liked how Peter D. Arvan and the rest of the management team were very frank in answering questions, while also not being afraid of taking responsibility in a challenging macroeconomic environment, stating that it is their responsibility to guide the company through these challenges in order for the company to produce strong financial results for many years into the future. Hence, despite the little information, I'm confident in the management moving forward.
I believe that Pool Corporation has a brand moat. I really like the management as they are not afraid to take responsibility to guide the company through challenging macroeconomic times. Now let us investigate the numbers to see if Pool Corporation lives up to our requirements for a strong moat. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number I will investigate is the return on investment capital, also known as ROIC. Ideally, you would like to see a ROIC above 10 % in all years. Pool Corporation has delivered a ROIC way above 10 % each year in the last 10 years. It is even more encouraging that Pool Corporation has managed to deliver a ROIC above 20 % each year since 2015. The ROIC shows that Pool Corporation is a great company that is continuously delivering a high ROIC, something that I really like to see as an investor.
The next numbers are the book value + dividend. In my old format this was known as the equity growth rate. It was the most important of the four growth rates I used to use in my analyses, which is why I will continue to use it moving forward. As you are used to see the numbers in percentage, I have decided to share both the numbers and the percentage growth year over year. While there are some up and down years between 2013 and 2016, Pool Corporation has managed to significantly grow their equity since 2016. It is even more encouraging to see that they have managed to continuously grow their equity year over year.
Finally, we investigate the free cash flow. In short, free cash flow is the cash a company generates after it has paid for operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has left remaining after paying all its financial obligations, I use the margin for it to make more sense. Free cash flow yield is the free cash flow per share a company is expected to earn against its market value per share. Not surprisingly, Pool Corporation has delivered a positive free cash flow each year in the last 10 years. Leveraged free cash flow is not as high as one would have wished but it is due to the kind of business that Pool Corporation is. Free cash flow yield is on the lower side but higher in 2022 than all other years except for 2019 since 2016. It could indicate that Pool Corporation stocks could now be bought at a better price, but we get back to that later in the analysis.
Another important thing to investigate is debt, and we want to see if a business has a reasonable debt that can be paid off within 3 years by calculation long-term debt to earnings. Doing the calculation on Pool Corporation, I can see that Pool Corporation has 1,83 years of debt. It is below the 3 years, so debt isn't something I'm worrying about when it comes to Pool Corporation.
Like every other investment there are risks when investing in Pool Corporation. One risk is related to macroeconomics. If we see a recession, we may see that people are down prioritizing their pools. It may mean that they do not maintain it as much as previously, which would hurt Pool Corporation. We also see less new pool installations, in 2021 there were 117.000 new pool installations, in 2022 the number was 98.000 and management expects the number to be around 80.000 in 2023. It not only hurt the New Pool Construction segment, but it could also hurt the Retail & Maintenance Service moving forward, as there will be less pools that need maintenance. Another macroeconomic risk is that inflation means higher expenses in wages, transportation, and real estate. They are susceptible to the weather. No matter how great management is, they cannot control the weather. Pool Corporation generated 59 % of their net sales and 67 % of their operating income n the second and third quarters in 2022. Unfavorable weather during these quarters would significantly affect their results. The same goes if spring comes late, as their customers would start to use their pools later, meaning it would take longer time for them to start maintaining their pool, which affects the sales of Pool Corporation. Dependent on maintaining a good relationship with suppliers. In their annual report, Pool Corporation mentions that for a distribution company is critical to maintain a favorable relationship with their suppliers. Their three largest suppliers account for approximately 38 % of the products that Pool Corporation sold in 2022. If one or all these suppliers decide to sell their products directly to retailers or other end users, it would affect the business of Pool Corporation.
There are also a lot of potential for Pool Corporation moving forward. Yearly new pool installations are far below the peak. As mentioned, when I wrote about risks, management expects that new pool installations will decrease further in 2023. But looking long-term new pool installations may be a great catalyst for Pool Corporation. New pool installations peaked in 2005 with more than 200.000 yearly installations, which is far higher than the most recent peak in 2021 with 117.000 installations. The reason why new pool installations could reach previous highs is that home improvement spending is increasing, and that pools and outdoor living consistently ranks among top features desired by homeowners. Increased pool content value. New pools are incorporating higher value, energy saving features, technology, and automation, which are products that old pools didn't use. Pool Corporation estimate that 70 % of existing pools, over 3,5 million, have no automation at all. Furthermore, the installed base average pool is over 22 years old, meaning that we could see many upgrading their pools moving forward. Once existing pools are renovated, they are upgraded with higher value content and automations. Upgrading Pool360. Pool360 is Pool Corporation's platform that allow their customers to receive pricing, product availability information and enter orders in real time. Pool Corporation recently released their new version of the Pool360 platform with new features that should benefit their customers even more, which will add to their competitive advantage as they can deliver a service none of their competitors can. Customers seem to like Pool360 as it now makes up 11 % of their total lines. Furthermore, Pool Corporation will also launch their Pool360 water solution software in 2023, which management expects will result in taking market share in the maintenance and repair market.
All right, we have gone through the numbers, potential and risk regarding Pool Corporation, and now it is time for us to calculate a price for Pool Corporation. To calculate price, we will need numbers that I have explained in the "MY STRATEGY" section of the website. I do not want to go through the whole calculation here. I chose to use an EPS at 18,7, which is the one from 2022. I chose an Estimated future EPS growth rate of 15 % (management expects to grow EPS by mid-teens long-term). Estimated future PE 30 (which the double of the growth rate, as the historically PE for Pool Corporation has been higher) and we already have the minimum acceptable return rate on 15 %. Doing the calculations by using the formula I described in "MY STRATEGY", we come up with the sticker price (some call it fair value or intrinsic value) of $561,00 and we want to have a margin of safety on 50 % , so we will divide it by 2 meaning that we want to buy Pool Corporation at price of $280,50 (or lower obviously), if we use the Margin of Safety price.
Our second way to calculate a buy price is the TEN CAP price, which is also explained at "MY STRATEGY". To do so, we need some numbers from their financial statements, keep in mind that all numbers are in millions. The Operating Cash Flow last year was 485. The Capital Expenditures was 44. I tried to look through their annual report to see, how much of the capital expenditures were used on maintenance. I couldn't find it though, so as a rule of thumb, you expect 70 % of the capital expenditures to be used on maintenance, meaning we will use 30,5 in our further calculations. The Tax Provision was 237. We have 39,069 outstanding shares. Hence, the calculation will be like this: (485 - 30,5 + 237) / 39,069 x 10 = $176,99 in TEN CAP price.
The last calculation is the PAYBACK TIME. I also described in "MY STRATEGY". With the Free Cash Flow Per Share at 11,30 and a growth rate of 15 %, if you want your purchase back in 8 years, the PAYBACK TIME price is $178,38.
Pool Corporation is a great company as it is a market leader in a sector that is expected to grow long-term. I believe that Pool Corporation has a great management, not only because of the results they have produced lately, but also because they seem very frank in earnings call, while they are not afraid of taking responsibility in guiding the company through a challenging macroeconomic environment. The macroeconomic environment is a short-term risk for Pool Corporation, and if we see a longer recession in the United States, it will impact the results of Pool Corporation. It is also a risk that the weather can impact their results as it is a risk that they can do nothing about it. However, there are many things that is in favor for Pool Corporation. In the latest earnings call management said that they continue to take market share, and if the Pool360 water solution software will result in taking market share in the maintenance and repair market, it will mean more recurrent income to the company. It is no secret that I like high ROIC companies, and I will open a position in Pool Corporation if it reaches my Margin of Safety price at $280,50.
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