Value Investing Letter Recaps: More Q2 2022
This week we feature FERG, CDMO, and EVBG
“When we find our treasure, we forget where we put our picks and shovels.” – Bert McCoy
Our Value Investing Letter Recaps keep things simple.
Each email focuses on three value investing hedge fund letters, three ideas, all digestible in three minutes.
Within each idea we answer four main questions:
What does the business do?
Why is it a good bet?
Why does the opportunity exist?
What is the prize if you’re right?
Quick housekeeping note that nothing you read is investment advice and please do your own due diligence before investing. Also, I do not own any of the below-mentioned securities as of this writing.
Finally, we get each investment letter from r/SecurityAnalysis, which you can find here.
Let’s get after it.
Right Tail Capital: Ferguson PLC (FERG)
Jeremy Kokemor runs Right Tail Capital and in his latest letter pitches FERG, which you can read here. Let’s run FERG through our four main questions (emphasis added).
What does FERG do?
“Ferguson is a leading, primarily US-based distributor ($23B mkt cap) of plumbing and HVAC supplies that is split roughly evenly between non-residential (44%) and residential (56%) as well as repair/remodel (60%) and new construction (40%).”
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Why is it a good bet?
“Ferguson benefits from a prime spot in its value chain – fragmented suppliers (over 30,000), many customers (~1 million), and small competitors (75% of revenue comes from #1 or 2 market positions where the primary competitors are mom and pops). By providing great service and parts availability, Ferguson can help guide its customers to the parts they want and supply them in a timely fashion.
The contractors who buy from Ferguson certainly care about price, but price is likely not as big of a concern for most of them as getting the correct part on time and on budget. While prices going up too high too fast may lead to demand destruction, Ferguson and contractors can often pass-through increases in prices due to the company’s great service, parts availability, and that in many cases the parts are needed.
Ferguson trades at a significant discount to other high quality industrial distributors (for example, FAST, POOL, and WSO trade at 17x P/E or higher) despite having economics that look more similar than different. ”
Why does the mispricing exist?
“Investors are questioning Ferguson’s near term fundamentals partially due to increases in interest rates and the impact that may have on construction. I do not know what will happen to business fundamentals though I recognize that this business has historically done a good job of holding onto price after prices have risen. The 60% of revenues that comes from repair/remodel should provide some protection against any potential cyclical headwinds in new housing starts and commercial construction.
There has likely [also] been some forced selling from European passive investors now that the business is no longer primarily listed in London. Management estimates that as Ferguson gets added to US indices (possibly the S&P 500) over the next year or so, there could be demand for twice as many shares.
What is the prize if you’re right?
If the economy holds up and FERG’s earnings are flat to growing over the next several years (Ferguson usually grows earnings at a mid-teens rate), then the stock could potentially double in the next 3-5 years. If there’s a more severe pullback in business fundamentals, then Ferguson’s earnings could decline further (perhaps 25%) and our potential returns as shareholders may take longer to realize – even in this case, Ferguson’s earnings multiple would still be trading at a discount to the broader stock market despite being an above average business.”
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