Rating agencies missed big-time with this serial acquirer
2022 was a year of uncertainty for the U.S. economy due to rising inflation and interest rate pressures. The recession concerns further triggered fear as companies refrained from expansion.
These issues caused uncertainty in the market and as a result, mergers and acquisitions (“M&A”) activity saw a 41% decline from the prior year.
In addition, these macroeconomic headwinds made rating agencies more sensitive to risky growth strategies like acquisitions. That is why rating agencies started to view highly acquisitive companies less favorably, which resulted in lower credit ratings for these types of businesses.
SiteOne (SITE) was one of these companies. It engages in the wholesale distribution of landscape supplies and is a serial acquirer.
Today, we’re going to have a look at SiteOne’s credit risk profile using Uniform Accounting and see if rating agencies were overly concerned with the business or not.
We can use Uniform Accounting to put the company’s real profitability up against its obligations and decide for ourselves the true risk of this business.
Also below, a detailed Uniform Accounting tearsheet of the company.
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Acquisitions can be a great strategy to growth for some companies, but they may create disadvantages during economic downturns and market conditions with high uncertainty.
As interest rates rose, the cost of debt increased significantly. On top of that, a looming recession in the near future creates an overall risky business environment that could lead to failed acquisitions.
Nonetheless, it does not mean every acquisition during a volatile period is going to be unsuccessful. Thoughtful acquisitions can even allow the company to thrive when its peers are stagnant.
SiteOne (SITE) is a great example of this. The company is the largest wholesale landscape supplies distributor, serving both residential and commercial customers. It offers various durable products such as hardscapes, nurseries, and irrigation equipment.
The company is also a serial acquirer. Its strategy focuses on acquiring top-performing local retailers to consolidate the highly fragmented landscape supplies market and expand its geographic reach.
This helps SiteOne get a larger scale to maintain its competitive advantage as the leading company in the market and become more efficient and profitable in its operations.
This acquisition strategy seems to be successfully implemented by the company as it has been able to increase its Uniform return on assets (“ROA”) consistently from around 8% a decade ago to 24% last year.
Aside from its success with acquisitions, the company has significantly benefited from the At-Home Revolution trend as well.
Since the pandemic, people started to spend more time in their homes and outdoor spaces became highly popular as a much-needed escape. This trend has substantially helped increase demand for the company’s products.
As the largest one-stop-shop for landscape products, SiteOne took advantage of this trend and its earnings and cash flows rose massively in the last few years.
However, it looks like rating agencies are missing the company’s improved profitability and increased earnings, and just see the company as a high-risk serial acquirer despite the tailwinds it has.
For instance, S&P gives SiteOne a “BB” rating. This rating suggests a huge risk of default, around 11% over the next five years. It also places the company in the risky high-yield basket.
Here at Valens, we think it deserves a much safer credit rating considering its proven acquisition strategy and its current financial position.
We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.
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).
The CCFP chart shows that SiteOne’s cash flows are more than enough to serve all its obligations going forward.
The chart suggests that the company has a strong financial footing and should be able to meet its obligations without difficulty going forward.
It only has two debt maturities in the next five years which doesn’t seem concerning when taking into account its huge cash flows.
Additionally, as it continues to scale up with the highly successful acquisition strategy, its profitability could rise even further.
Due to these factors, we think that SiteOne is not facing a significant risk of default, as opposed to the rating agencies’ assessment.
Thus, we are giving an “IG4+” rating to the company. This rating ensures it is in the safer investment-grade basket and implies a risk of default of around just 2%.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
To see Credit Cash Flow Prime ratings for thousands of companies, click here to learn more about the various subscription options now available for the full Valens Database.
SUMMARY and SiteOne Landscape Supply (SITE:USA) Tearsheet
As the Uniform Accounting tearsheet for SiteOne Landscape Supply (SITE:USA) highlights, the Uniform P/E trades at 27.1x, which is above the global corporate average of 18.4x and around its historical P/E of 26.8x.
High P/Es require high EPS growth to sustain them. In the case of SiteOne, the company has recently shown a 7% 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, SiteOne’s Wall Street analyst-driven forecast is for a 21% EPS shrinkage and a 16% EPS growth in 2023 and 2024, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify SiteOne’s $157 stock price. These are often referred to as market-embedded expectations.
Furthermore, the company’s earning power in 2022 was 4x the long-run corporate average. Moreover, cash flows and cash on hand are above its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 150bps above the risk-free rate.
Overall, this signals a moderate credit risk.
Lastly, SiteOne’s Uniform earnings growth is in line with its peer averages and is trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research