Howdens Joinery is a bargain
Business overview
Howdens Joinery is a supplier of construction materials that sells explicitly to tradesman in the UK. That means they don’t serve the typical DIY customer that you would often see at Home Depot or Lows but instead they only serve tradesman (pro customers). The category of products they sell are what I would call ‘finish construction’, although they’d call it kitchens.
Construction is basically broken up into two phases, rough and finish construction.
Rough construction is comprised all the stuff you don’t see in the finished product and is usually more structural in nature, (erecting walls and installing plumbing, wires and HVAC into the foundation, walls and attic)
Finish construction is comprised of the installation of all products you would actually see when you walk into a finished home. These items include things like cabinets, doors, appliances, windows, trim, flooring, sinks, countertops, lights, decorative stuff, and so forth. These are some of the products that would be found at Howdens Joinery and they are usually sold at somewhat of discount to pro customer.
Howdens typical pro customer is a small residential remodeler/renovator or a maintenance crew working for a property management company (37% of homes in Uk are rented)
Business model and strategy
Howdens business model is somewhat comparable to Home Depot’s but it has a few key differences. First, each of their depot’s are less than a tenth of the size of your average Home Depot or Lowe’s and second, as I mentioned before, they only sell finish type products to pro customers.
Manufacturing
They manufacture some of their own products such as base board (skirting boards) cabinets and countertops (worktops). The rest of the products are sourced from a variety of different suppliers. So there is a little bit of discernment needed when deciding which products to manufacture and which ones to buy. Apparently they revisit this from time to time, to understand what makes the most sense.
Distribution
After the products are sources or manufactured they’re delivered to their 850 depots via their in-house distribution operation. This is important because their “in stock” model hinges on their distribution and supply chain capabilities, which affords them the ability to have stocked shelves all the time. In construction, especially the remodel market, it’s very important that pro’s are able to get items on demand or at least relatively quickly, this is one away that Home Depot has really created an enormous value proposition and moat around their business.
Another somewhat interesting part of their business model is that they use a “decentralized” strategy where store management is given more responsibility to make high level decisions.
This reminds me of Floor and Decor who also laid out a similar strategy as one of their competitive strengths (below)
Howdens managers are called “entrepreneurial depots managers” and the implication is that local managers are incentivized to run the depot as if it was their own by creating long lasting, fruitful relationships with customers and employees which ultimately drives better unit economics at the individual store level.
Kitchen Growth drivers
They’ve outlined a few key growth drivers in the kitchen and joinery market.
There are currently 29 million homes in the United Kingdom of which 18 million are owned and 11 million rented.
More people are having professionals do work and giving up on DIY projects. (probably because aging population)
The average age of the housing stock is 70 years old and the population is estimated to grow 5% by 2030.
Healthy balance sheets and an aging population with significant purchasing power.
Recent data suggest less people are relocating and more people are staying in their current homes which incentivizes people to renovate.
The global construction market is estimated to grow at 4.8% per year between now and 2032 and the UK is set to grow at 3.5%.
Growth strategy
Just because the construction market isn’t growing very fast that doesn’t mean they’re doomed to slow growth. They are expanding their store count, (roughly 3.5% in 2022) and they expect to take market share from competitors in the future. They have 824 depots in the UK including Northern Ireland, and believe they can grow that number to 1,000. They also have 67 depot internationally and plan to continue expanding into new markets.
Their basic growth strategy is to build new stores, drive more sales per store, build relationships with pro customers, improve their supply chain and products selection, and develop their digital platform.
These are all very reasonable and expected from a retailer and they seem to have done them successfully so far.
Key performance indicators
They tend to focus on pretax earnings as one of their main KPI’s. According to their website they have 824 depot’s in the United Kingdom and 67 internationally for a total of 891. They’ve also stated the average size of their depot’s are 10,000 square feet which is actually very small.
For comparison, the average Home Depot is 104,000 square feet and the average Floor and Decor is about 79,000 so we’re talking about a relatively small store. Below is rough sketch of the unit economics on a per store and per sq. ft basis. Then converted into USD and compared to Lowes, Home Depot, and Floor and Decor.
In 2022 their pretax earnings were about £460k per store and £46 per square foot which equates to about about USD$560k per store and and USD$56 per square foot.
They also did £2.6 million in sales per store and £260 per square foot which equates to almost USD$3.2 million dollars per store and USD$317 per foot.
This impressive considering they beat Floor and Decor on a sq. ft. basis and beat Lowe’s on pretax basis. I did a comparison with Home Depot but I would take it with a grain of salt because they own a few subsidiaries that could skew their unit economics.
I suspect that Howdens economics are better simply because they have smaller stores and serve only pro customers who have proven to be big ticker customers. For example, Home Depot’s “pro customers” make up around 10% or less of their customer base and yet they generate 50% of their revenue. Think about that for a second, 10% of Home Depot customers generate around $75 billion of their revenue and the other 90% generate the other $75 billion.
Howden Joinery essentially has a compact depot model that’s only serves the big ticket customers and by doing this they’re able to focus on getting the most out of every square foot of their stores.
Management
The company was founded by Matthew ingle in 1995 after left school at age 16 to go work in the timber yard. He eventually founded Howdens and faithfully led the company until 2018 When Andrew Livingston took over. The fact that he isn’t involved with the company anymore is a small risk in my opinion. I personally like to see founders involved with high ownership.
Their current CEO Andrew Livingston is incentivized with an annual bonus and a performance share plan (PSP), which is based on key performance indicators like pretax earnings, returns on capital and total shareholder returns measured against other relative, peer companies.
Risks
The first and most obvious risk to me is that this is a foreign company that operates in a foreign market that I have zero experience in.
The other obvious risk is that this company operates in a cyclical market prone to small booms and busts. That doesn’t mean I wont product great returns it just means they’ll likely be more lumpy than other industries.
Competition is probably also a small risk even though they didn’t specifically state this in their annual report.
Financials and valuation
Financials
I like what I’m seeing in Howdens financial statements. First and foremost, the company is debt free and has £308 million in cash on the balance sheet. They generated £395.3 million in operating cash flow and spent £140.8 million in capex leaving shareholders with £254 million in FCF, which is basically a 6% FCF yield at the current price.
A few key things from the last 10 years
Median ROIC and ROE was about 40%
Median ROA was 23%
EPS CAGR was 17%
Median FCF margin was 10%
Valuation
I’m going to be relatively conservative for my 2023 growth assumptions. 2022 was a great year for them and they mentioned that this year would normalize and probably not grow much against that backdrop. Their 10 year average revenue growth has been around 10% however, for the next 5 years I want to assumer something a bit lower like 5-7% because construction tends to be slower in tough macro environments.
I’m also assuming and end multiple between 12-16x which is inline with their historical multiples. They currently pay a 2.77% dividend and they’re also returning cash to shareholders via buybacks, I’m unsure how much they’ll return via buybacks in the future but they currently generate enough cash to probably return more than what Im accounting for below (1%-1.5%)
Final thoughts
Going through Howden’s annual report there was a lot of things I really liked. The more I read about it the more I think this could be a special company that has some kind of competitive advantage. Although admittedly, I don’t know the UK’s construction/Home Improvement market well enough therefore I’d want to study it more before investing. This is defiantly a company that I’ll put on my watch list for now.
Thanks for reading!