Builders FirstSource Builds A Better Near-Cross-Over Credit Rating, While Equity Markets Expect ROA Improvement

Moody’s is overstating the credit risk of Builders FirstSource, Inc. (NASDAQ:BLDR) with its B3 rating. Our fundamental analysis highlights a much safer credit profile for BLDR, whose strong cash flows cover all operating obligations through 2020. Moreover, their robust expected cash build would allow them to service all obligations including debt maturities through 2022. We therefore rate BLDR four notches higher at an HY1 credit rating, or a Ba2 equivalent using Moody’s ratings scale.

Meanwhile, cash bond markets are understating the firm’s credit risk with a cash bond YTW of 6.308% relative to an Intrinsic YTW of 7.268% and an Intrinsic CDS of 539bps.

Meanwhile, BLDR is trading at a 20.7x V/E’, which is high relative to past valuations. However, their V/A’ of 1.8x is at the lower end of valuations since the company’s ROA’ inflection in 2013. The market is expecting ROA’ to modestly improve from 10% in 2015 to 11%, with low 2% Asset’ growth going forward. At these valuations, the market appears to be pricing in a relative steady operating environment with modest benefits from the ProBuild acquisition. However, considering that expectations are for ROA’ to fade to the higher end of historical levels, if synergies are not found, the company could disappoint market expectations, leading to equity downside.

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