Investor Essentials Daily

How the forgotten home expenses lead to successes for this market player

March 18, 2021

Despite approaching a year since the At-Home Revolution has impacted the globe, investors are still missing out on some of the home tailwinds powering companies through 2021. This company provides an essential home need that will continue to be in demand through the year.

Using GAAP accounting, it appears today’s company has failed to profit from this trend, while Uniform Accounting tells a different story.

Also below, the company’s Uniform Accounting Performance and Valuation Tearsheet.

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It has been around a year since the pandemic flipped the world on its head. Today, as world leaders are working to distribute vaccines as soon as possible, citizens are looking to put the pandemic behind them.

However, the spending patterns that quarantine and the pandemic have shifted will not be going away anytime soon.

The pandemic kickstarted the millennial generation’s move to the suburbs en masse. Millennials’ delay in home ownership has been an often-discussed economic impact to a plethora of industries.

Home sales have continued to climb through 2020 into 2021, ignoring the usual seasonality of the market dipping in the winter. This means the industries dealing with home building and home ownership will continue to benefit.

People will continue to be putting money into maintaining homes they are spending more time in along with renovating recently purchased homes.

The big four cost sinks for homeowners are the foundation, HVAC system, water system, and roof. All of these systems are taken for granted by homeowners, but can result in huge costs if they go wrong.

This means during the At-Home Revolution, there has been record investment into all four of these areas. One of the big suppliers to this surging demand is Beacon Roofing Supply (BECN).

The company is one of the top three biggest roofing distributors in the U.S. Beacon has been steadily consolidating its industry to become the dominant player through its strong national footprint and best-in-class inventory management.

Investors would assume being such a key player in an essential industry for homeowners would mean Beacon Roofing has been thriving the past few years.

And yet, using GAAP accounting, it would appear the company has failed to capitalize on its growth strategy.

Over the past six years, as-reported return on assets (ROA) has fallen from 5% to just 2% as the company pursued an aggressive growth strategy. It looks like a typical overinvestment story has ruined profitability.

However, this picture does not reflect the real earnings power of Beacon Roofing. Distortions in GAAP accounting around goodwill, amortization, and other line items have suppressed the firm’s profitability.

When looking through a Uniform Accounting lens, we can see the true earnings power of the firm.

Rather than below cost-of-capital returns, Beacon Roofing has seen ROA trending up since 2015. It turns out using the correct data, this aggressive growth strategy and economic tailwinds have pushed returns up to 21% in 2020

Simply put, investors who stuck to using GAAP metrics only have totally missed the prior success of this company, seeing declining returns instead of an improving business.

Furthermore, with demand for home building and renovation set to continue through 2021 and 2022, investors are disregarding a winning company wholesale and leaving investment opportunities on the table.

SUMMARY and Beacon Roofing Supply, Inc. Tearsheet

As the Uniform Accounting tearsheet for Beacon Roofing Supply, Inc. (BECN:USA) highlights, the Uniform P/E trades at 16.1x, which is below the global corporate average of 25.2x, but around its own historical average of 13.9x.

Low P/Es require low EPS growth to sustain them. In the case of Beacon Roofing, the company has recently shown a 16% Uniform EPS growth.

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, Beacon Roofing’s Wall Street analyst-driven forecast is a 5% EPS shrinkage in 2021 and a 15% EPS growth in 2022.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Beacon Roofing’s $54 stock price. These are often referred to as market embedded expectations.

The company is currently being valued as if Uniform earnings were to shrink 2% annually over the next three years. What Wall Street analysts expect for Beacon Roofing’s earnings growth is below what the current stock market valuation requires in 2021, but above that requirement in 2022.

Furthermore, the company’s earning power is 3x the long-run corporate average. Also, cash flows and cash on hand are almost 2x its total obligations—including debt maturities, capex maintenance, and dividends. All in all, this signals an average credit risk.

To conclude, Beacon Roofing’s Uniform earnings growth is in line with its peer averages but the company is trading below its average peer valuations.

Best regards,

Joel Litman & Rob Spivey

Chief Investment Strategist &
Director of Research
at Valens Research