GCP Applied Technologies is riding the homebuilding surge, but some are calling for a bankruptcy
What was once a sleepy, cyclical industry is now experiencing historic tailwinds.
While homebuilding is historically hot, this company is still being rated by the credit rating agencies as a risk to investors. Let’s review the homebuilding industry’s tailwinds and dive into the company’s Credit Cash Flow Prime to see the bigger picture.
Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.
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The building product industry has historically been cyclical, as it provides various chemicals and materials for the homebuilding and infrastructure businesses.
That cyclicality exists because typically, the industries related to construction and building experience periods of moderate strength, followed by periods of moderate weakness at a fairly typical cadence.
Today’s company, GCP Applied Technologies (GCP), has historically been tied to this cycle.
Much of GCP’s catalog uses proprietary chemical intellectual property, including concrete mixtures for structural and decorative purposes, water resistant and vapor controlling chemicals, roofing membranes, and other building essentials. However, the credit rating agencies are hesitant to rate it as safe, similar to any other building products company.
The culprit is the aforementioned cyclicality. Given that most of these businesses have fairly low margins, they have high sensitivity to overall macroeconomic movements.
If these businesses are just hanging on to the whims of the building cycle, why tell investors that their credit is safe?
What the rating agencies have failed to recognize is that the cyclical nature of the building industry has been upended by the pandemic.
The At-Home Revolution has fundamentally changed how people view their physical assets. This has led to a housing boom that is likely to persist for a number of years, as work-from-home trends endure and fundamental advancements in technology have made at-home life more convenient than ever.
Companies like GCP, that provide roofing chemicals, concrete mixtures, and weather-proofed coatings should ride this wave alongside the homebuilders.
But S&P still rates GCP as a “BB,” implying that the firm has a 10% chance of defaulting on its debt in the next five years.
A closer look at its actual cash flows and obligations paints a much safer picture. Using our Credit Cash Flow Prime (“CCFP”) analysis tool, we can see that GCP has no debt coming due in the next 5 years. Although it does have a hefty $347 million maturity slated for 2026, the company has $489 million of cash on the balance sheet and annual cash flows that will continue to grow this buffer.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
Take a look.
This CCFP demonstrates that GCP has ample headroom to pursue its initiatives while presenting no default risk to its creditors. Hence, we rate the firm as an investment-grade “IG3+”, equivalent to an S&P “A+”, which implies that the chance of default over the next 5 years is less than 2%.
The CCFP analysis is a crucial element of Valens’ stock picking process for our institutional clients and the Conviction Long List. All of the great equity investors are great credit investors, as understanding a holistic picture of risk for a business is key to valuing it. This is why we make it easy for readers to understand a credit picture at a glance.
Click here to learn more about getting access to the Valens Research App, which includes CCFP analysis for over 25,000 companies.
SUMMARY and GCP Applied Technologies Inc. Tearsheet
As the Uniform Accounting tearsheet for GCP Applied Technologies Inc. (GCP:USA) highlights, the Uniform P/E trades at 14.6x, which is below the global corporate average of 24.3x and around its historical P/E of 20.9x.
Low P/Es require low EPS growth to sustain them. In the case of GCP Applied Technologies, the company has recently shown a 42% Uniform EPS decline.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, GCP Applied Technologies’ Wall Street analyst-driven forecast is for 191% and 1% growth in 2021 and 2022, respectively..
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify GCP Applied Technologies Inc.’s $22.36 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to remain unchanged over the next three years. What Wall Street analysts expect for GCP Applied Technologies’ earnings growth is above what the current stock market valuation requires in 2021, but below that requirement in 2022.
Furthermore, the company’s earning power in 2020 is equal to the long-run corporate average. Moreover, cash flows and cash on hand are 6x its total obligations—including debt maturities and capex maintenance. However, intrinsic credit risk is 130bps above the risk-free rate. All in all, this signals a low dividend but moderate credit risk.
Lastly, GCP Applied Technologies’ Uniform earnings growth is well above peer averages, while the company is trading below its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research