On March 21, 2022, the management team of Huttig construction products (NASDAQ: RAP) announced that it had reached an agreement to sell itself to privately held Woodgrain Inc. in an all-cash transaction worth $10.70 per share. In response to the move, the company’s shares rose about 13.5%. While this represents a premium to where the stock previously traded, investors in the company should view this transaction as a lowball given the company’s recent performance. Although there is always a risk that the company will revert to weaker performance, in which case this transaction would seem appropriate. Changes made by the company over the past few years suggest that strong performance in the future would largely continue. For this reason, investors in the company should be happy to receive some sort of bonus. But overall, they would be right to feel aggrieved by management’s decision.
A look at the case
According to a press release issued by Huttig Building Products, the company has agreed to sell itself to Woodgrain Inc, which is a private company that focuses on the woodworking business, with six different operating divisions and more than 30 manufacturing and supply facilities. warehousing in the United States and South America. The deal values Huttig Building Products at $10.70 per share, which management says implies a total buyout price, including debt, of approximately $350 million. Unless the company has paid off some of its debt since the end of its last fiscal year, that number seems a bit off. Based on the number of shares currently outstanding, the redemption price implies a market capitalization of $292.4 million. The company also ended its last fiscal year with net debt of $68.1 million, bringing the implied enterprise value of the business to $360.5 million. With the end goal of being as conservative as possible in my analysis, I will use my own calculations on the management of the $350 million figures provided.
For Woodgrain, this transaction makes a lot of sense. After all, Huttig Building Products is a big player in the joinery business. In its 2021 fiscal year, the company generated 44% of its revenue from this particular activity. It generated another 47.8% of sales, meanwhile, from building product sales. And the remaining 8.3% of revenue came from wood product sales. Of course, since Woodgrain is not a publicly traded company, there is no point for Huttig Building Products shareholders to delve into the pros and cons of the acquisition for the acquirer. But it helps to understand the company’s incentive.
Historically speaking, Huttig Building Products has not been the largest operator. Although revenue grew steadily between 2016 and 2020, sales grew from $839.6 million that year to $792.3 million at the end of 2020. On top of that, the company has generated net losses in four of those five years, with operating cash flow negative in two. of those five years and, after adjusting for changes in working capital, operating cash flow was negative for three of those five years. However, due to a number of circumstances, the fundamental state of Huttig Building Products began to change significantly in 2020. In the face of the pandemic, management decided to shift away from commoditized to non-commoditized products.
The reason for this change is that non-commoditized products often have higher markups than products that can be made by anyone. Management never really provided much detail on what those product specifics would be, but the results we’ve seen so far have been impressive. To see this, just look at the performance in fiscal 2021. According to the company, for the full year, revenue was $937.8 million. This represents an increase of 18.4% over what the business generated in 2020. Management attributed the increase to a number of factors, including a favorable pricing environment and strong demand for its products. But to understand the value the company is delivering now, we need to dig deeper. For the full fiscal year 2021, the company’s net profit was $48.5 million. It is the first time since 2016 that the company has generated a net profit. Operating cash flow, meanwhile, was just $28.3 million. But if we adjust for changes in working capital, it would have been $53.8 million. That’s more than triple the $16.6 million reported in 2020. And the company’s EBITDA was $62.5 million. It’s also more than triple the $20.1 million reported a year earlier.
When you really dig into the company’s financial statements, you find a number of interesting things. Management says moving away from commoditized products and shifting to non-commoditized products, combined with efficient pricing, helped the company’s gross margin increase from 20.1% in 2020 to 22.2% l last year. At first glance, this may not seem like much. However, based on sales made last year, this would imply an increase in pre-tax profits for the company of $19.7 million compared to if the gross margin remained unchanged. For a low-margin industry, this is a significant increase in profitability. The company also saw its operating expenses increase, but as a percentage of sales, operating expenses fell from 18.4% to 16.6%. Although the company saw its compensation costs increase, the company benefited from higher sales volume spread across a fixed asset base that remained largely unchanged. This leverage helped add another $16.9 million to the company’s pretax profits.
Another factor to consider is how the business accounts for its inventory. The company uses a LIFO inventory model where the most recent item that comes in is assumed to be the item that goes out first. In an inflationary environment, this can have a big impact on declining margins, as the company keeps low-priced inventory on its books while selling higher-cost ones. Management says the impact of LIFO caused margins to decline by $18.3 million. Ultimately, this is noteworthy because if the rise in inflation is permanent, it likely means that the actual value of the company’s inventory is higher than what it says is on the books. By how much are we guessing.
Given current market conditions, I would generally be hesitant to assume that the good times will last for the company. If they do not, the purchase by Huttig Building Products will likely have been deemed a fair price. On a price/operating cash flow adjusted basis, the multiple paid for the company would be 17.6. And the EV/EBITDA multiple would be 17.9. This is based on the 2020 results management reported. However, given the results achieved in 2021, the company is trading at a price/earnings multiple of 6, a price/adjusted operating cash flow multiple of 5.4 and an EV/EBITDA multiple of 5.8. . In these valuations, I base this price on the implied buyout price agreed to by management.
To put the price of the company into perspective, I also decided to compare it to the same five companies I reviewed the last time I wrote about the company. On a price/operating cash flow basis, these five companies ranged from a low of 14.5 to a high of 232.9. Using our revised numbers for 2020, we would see that only two out of five companies were cheaper than our prospect. Meanwhile, the EV to EBITDA approach would have resulted in a range of 7.4 to 30.3. In this case, four out of five companies were cheaper than Huttig Building Products. However, using the 2021 results used for the company, our outlook was the cheapest in both valuation scenarios.
|Company||Price / Operating Cash||EV / EBITDA|
|Huttig construction products||5.4||5.8|
|Hudson Technologies (HDSN)||232.9||7.4|
|Lawson Products (LAWS)||65.9||16.9|
|Alta Equipment Group (ALTG)||35.5||9.9|
|DXP Enterprises (DXPE)||14.5||15.5|
|MRC Global (MRC)||17.2||30.3|
Do not mistake yourself. I believe some of the inflationary and demand factors for the business are transitory due to supply chain issues and the resulting inflation. But given the company’s improved margins, especially as the company moved to sell higher-margin products, I think at least some of the improvement is here to stay. That’s why, in an article published in December last year, I came out rating the company as “Buy”. Since then, the shares are up 4.2% compared to the 4.7% loss recorded by the S&P 500. It’s great to see the company outperforming the market in general. But I think the upside potential is greater than the implied redemption premium that would result in a profit for investors of 3.4%.
All things considered, I believe Huttig Building Products today offers limited prospects for investors due to the stock’s proximity to the implied redemption price. But if the company weren’t selling at the current price, I’d argue that the stock has even more potential. Many of the changes the company has made over the past two years should prove to have a lasting positive impact for shareholders. Admittedly, some of its improvements are probably transitory. Determining which is which is impossible. But given the price of stocks today, even if earnings returned to levels seen in 2020, this clearly offered a favorable risk outlook to reward. For this reason, investors in the company should not be excited about the current deal. It’s great to see a nice rise in value in the short term. But management appears to be selling the company at a price slightly below what investors are likely to demand. Given that the shares are currently trading above the agreed repurchase price, the market might agree with me.