Written by Benjamin Peters (email ryan@investingcity.org) if interested in contacting Ben)
Thesis
PoolCorp (PC) is a great business with impressive financials, good leadership, and a long history of consistent, organic growth. PC has an impressive sales mix which protects the company from economic downturns, as 60% of the products they sell are non-discretionary pool items involving maintenance and repair. Their non-discretionary sales will help sustain growth in the industry. However, several factors, including migration patterns, home building, and Covid-19 will help PC build their business beyond expectations as the demand for new pool installation and outdoor living improvement rises.
Background
PC is the world’s largest distributor of swimming pool supplies, equipment, and related pool products and is one of the leading distributors of irrigation and landscape products in the U.S. Since the pool industry is highly fragmented, the company claims to add value by purchasing products from over 2,220 manufacturers to redistribute to its customer base on more favorable conditions than customers could obtain on their own. PC makes money by selling its products through 378 sales centers named under four different distribution networks; SCP Distributors, Superior Pool Products, Horizon Distributors, and National Pool Tile.
SCP Distributors: PC’s largest sales center network with the largest array of pool products, serving independent wholesale customers in need of products and services.
SCP International: Operates in Australia, Belgium, Canada, Croatia, France, Germany, Italy, Mexico, Portugal, Spain and the United Kingdom. This arm works to serve pool professionals and promote the growth of the industry in international markets.
Superior Pool Products: Offers wide array of pool items including the most recognizable brands in the industry, mostly caters to pool builders, which are essential to industry growth.
Horizon Distributors: Offers extensive array of lawn and irrigation products for irrigation professionals.
PC sells over 200,000 products branded with the company name. 75% of the products PC sells are from branded manufacturers, while 25% of the products sold are private label brands. Most of the company’s products have to do with pools, pool installation, pool maintenance, irrigation, and other products related to the outdoor living space for a single-family home. Basically, when Americans want to make their backyard pool area better, PoolCorp gets paid.
PC is the only U.S. wholesale distributor that is geared towards pool supplies. There are over 120,000 PC customers, but no customer accounted for more than 10% of sales in 2019. The company sales are entirely business to business, or B2B. The majority of customers are small businesses, like specialty retailers and independent contractors. Generally, PC sales centers offer about 3,500 products for the pool professional at one time.
The financial growth of the company has been promising. They have continued to maintain steady margins, as outlined below. PC expects they will grow revenue 6-8% each year for the next five years, while keeping gross profit margins around 26-29%. They also expect to maintain EPS in the mid-teens %.
Moat
PC’s moat is multi-dimensional, with several competitive advantages in the pool industry that are hard to replicate. These competitive advantages are described below.
1. Discretionary vs. Non-Discretionary Items
The future growth of PC does not depend solely on the growth rate of new pool installation in the U.S. and abroad. In fact, the non-discretionary items that the company sells are essential to the business. For every pool that exists, the water must be moved, filtered, and treated, unless the owner wants a green, stinky, mosquito heaven in their backyard. Therefore, even during a downturn in construction or refurbishment of pools, PC is protected by its sale of non-discretionary pool items. Furthermore, during the pandemic, while new pool construction might be down, PC is finding that customers are spending more on discretionary items for their pools because these customers are more likely to spend their leisure time at home. The company also finds that cosmetic considerations such as a pool’s appearance and the overall look of backyard environments create an ongoing demand for other maintenance-related goods and certain discretionary products. Overall, the recurring nature of the maintenance and repair market has historically helped maintain a relatively consistent level of industry growth, especially for PC itself, which offers a wider variety of these products than any other distributor.
2. Protection From Online Sales
It’s also interesting to consider PC’s protection from online sales outlets like Amazon. Currently, 70% of transactions for PC still take place at the counter, rather than through online distribution channels. This phenomenon can be attributed to the company’s maintenance and repair product mix. These products are needed as soon as pool owners want to use their pools, and the businesses that serve pool owners must serve their clients ASAP, not in a few days or a week. This instant demand unique to the pool industry plays well into PC’s sales center model, where the majority of retail still takes place in person.
Additionally, many pool owners have no idea how to use or install common pool products for maintenance, repair, and refurbishment. For example, it would be hard for a pool owner to buy a new pump on Amazon and properly install it in their own pool. So, these pool owners would rather rely on professionals, who buy from PC as needed when demand for a product has presented itself. As noted by Peter Arvan, PC’s current CEO, (pool professionals) “come today, buy today, and use today.”
3. Footprint
One of the most important parts of PC’s moat is the location of the company’s sales centers. The company puts their sales centers in areas that are most convenient to PC customers, including other distributors and independent contractors. PC has about 378 sales centers worldwide, with the highest concentration in the southern half of the U.S. the company does an excellent job providing knowledgeable customer service, and has established strong relationships with its ~120,000 customers as a result. PC has established relationships with so many manufacturers and customers, and has so many branded products and sales centers in all the right areas, that it would be extremely hard for another competitor in the pool space to cast a net as wide as PC.
Growth Opportunity
Peter Arvan has claimed that he believes the company will continue to experience 6-8% sales growth over the next five years, while margins will remain fairly stable. The company’s growth strategy relies on five components.
1. Promote the growth of the industry
The company uses various marketing and advertising outlets and websites like swimmingpool.com and hottubs.com in order to help drive demand for swimming pools and promote the overall growth of the industry.
2. Promote the growth of the businesses of their customers
PC offers promotional tools and marketing support to help customers generate increased sales.
3. Continuously striving to operate more efficiently
PC strives to make continuous improvements to its warehouses, sales centers, and online platforms in order to generate increased sales.
4. The company wants to expand internationally
PC has about 6% of sales outside of the U.S., (Western Europe, Canada, Australia), but management believes this number should be higher. Organic growth opportunities are better in the international markets PC occupies because there are a relatively low number of pools compared to the U.S. The company will look to continually grow share in these markets.
5. Grow market share in the commercial pool space
The company estimates they have about 10% market share in the commercial pool industry, which they will look to improve to 20% in the next ten years. PC likely won’t capture more than 20% of commercial market share, since it does not offer bulk chemicals, which are a large part of the commercial industry.
Externally, the company is set up to benefit from population growth in the Sun Belt of the United States, which includes the southern half of California and states like Texas, Florida, and others in the South East and South West with warm and sunny climates.
If you take a look at the map of PC sales centers in the Americas, you will notice that the majority of these sales centers are located in the Sun Belt, with an especially high concentration in California, Texas, and Florida.
According to the U.S. Census Bureau, projections in 2005 indicated that 88% of population growth in the U.S. would occur in the Sun Belt between 2000 and 2030. Although the 2008 housing crisis slowed migration, patterns of migration and population growth to the Sun Belt have resumed. PC is well positioned to open new sales centers in areas where the company already has a strong foothold to meet increasing demand. Their cautious, organic growth model will serve them well as they capitalize on serving new urban developments by opening new stores. However, since single family homes in the Sunbelt tend to be more spread out, it’s likely that PC will be able to open new sales centers to provide convenience for pool professionals without too much cannibalization of existing stores.
The Future
According to CNBC, because of Covid-19, home searches in suburban zip codes have jumped 13%. That’s double what the growth rate is for urban areas. It’s not too surprising that these trends are taking place. The desire for more space and the possibility to work from home for more professionals caused increased growth in more than half of the nation’s largest 100 suburbs. Obviously, PC will benefit from more population movement toward suburban areas, because it means more pools will be built, refurbished, treated, and maintained.
Covid-19 may also be a catalyst in growing the total addressable pool market in the U.S. Estimates are that there are somewhere between 10-11 million swimming pools in the U.S. That doesn’t necessarily mean that the total addressable market makes up all the remaining single family homes without a pool. The addressable market is constrained to single family homes with room for a pool, that want a pool, and can afford a pool. Most importantly, people moving from urban areas to suburbs given reasons involving Covid-19 are more likely to have the disposable income for a pool. In an urban area, a pool may not have been possible, but with new migration patterns, the total addressable pool market is growing.
Sales Breakdown
As you can see below, the “North America Pool” segment makes up the majority of PC’s revenue, with irrigation and landscape + international sales making up just 15% of revenue.
Since the company offers such a high number of products, it’s hard for them to report an exact sales breakdown. Regardless, here are some sales stats that may help you better understand the business.
Acquisitions accounted for 2% of sales growth in 2019. Historically, the company has grown mostly organically.
The company’s maintenance and repair segment represents the largest amount of sales (about 60%), followed by remodel and replace (25%), and lastly new pool construction items (15%).
Chemicals are the largest single product group within PC sales, making up 12% of total sales.
Horizon, a brand under the PC umbrella, is included in these sales categories but is largely irrigation and landscaping. Horizon makes up the 9% “irrigation and landscaping” segment of sales.
PC’s sales are mostly residential, but commercial sales to hotels, apartment complexes, schools, etc. make up about 5% of total sales. The commercial pool business is inherently different from the residential business. For example, if a competition pool pump breaks, and that pool needs a certain model in order to host a swim meet coming up, the only thing that matters is if a pool distributor has that pump in stock. There is less concern over price, customer service, and the convenience of the location overall. As a result, some of PC’s value proposition is lost when dealing with pool professionals that mainly specialize in commercial pools. However, that doesn’t necessarily mean that the company can’t grow its professional business by tailoring more locations to commercial pool specialists.
Using Technology to Boost Sales
PC has introduced different technology to help boost sales. First, they have recently introduced the NPT backyard pool app. This app allows potential pool owners to use artificial intelligence to visualize a custom pool in their own backyard. The user is able to pick the pool finish, tiles, and other accessories, so they know exactly what they’re getting before they get serious about upgrading their outdoor living space.
Additionally, the company recently launched its Pool360 customer service tool. Pool360 is a B2B platform that allows customers to place their orders to pick up at sales centers. Not only has this kept sales steady during Covid-19, but has also helped service customers far better when considering changes in the nature of transactions given the pandemic. Pool360 allows users to browse catalogs and find exactly what they want for pickup that day, rather than visiting a sales center and failing to get the proper products or finding that certain products are out of stock. The customer service based Pool360 platform allows PC to boast better customer service and more closely align themselves with competitors like Home Depot and Lowes that carry customer service centered strategies. The Pool360 platform is now responsible for 12% of overall sales and accounts for 10% of orders placed with PC.
Post-2008 Change in Product Mix
In 2007, pre-recession, PC sales looked considerably different. Maintenance alone represented 43% of revenue. Now, maintenance represents over 50% of revenue. New pool construction represented 22% of overall revenue in 2007 but has since fallen to 15% because of the growth of both maintenance, as well as repair and remodel segments. PC’s Horizon business, focused on irrigation and landscape items and significantly tied to new home construction, represented 13% of revenue in 2007 but only 9% of revenue today. Overall, PC’s sales mix has greatly improved to make the company less tied to new home and new pool construction. However, the company still grew about 7% a year in the 2010’s.
Pre-recession, new pool construction in the U.S. was running at about 200,000 - 210,000 units per year. During the bottom of the recession, new pool construction slowed to about 40,000 units a year. In 2019, the new pool construction number was estimated to be about 78,000 units. It’s clear that the company has shown that it can grow significantly without rapid growth in new pool construction. However, the number of new pools being built per year in the U.S. is still less than half of what it was at its peak. The potential for higher growth in new pool construction is only positive for PC, and will promote growth in both the discretionary and non-discretionary markets.
As of the end of 2019, the company had favorable leverage. For large retailers and wholesalers, 1.5x leverage is fairly low, and a 63% debt to capital ratio is also favorable.
Competitive Dynamics
PC is 20x larger than the second-largest player in the industry as far as wholesale distribution. However, the pool industry is highly fragmented. For example, PC competes with Leslie Pool Systems. However, Leslie Pool Systems caters to both pool professionals and pool owners and also has a serviced based segment of their business offering pool maintenance. Consequentially, it’s difficult to make a direct comparison between the two companies, since PC is entirely B2B whereas Leslie Pool Systems is B2B, B2C, and offers pool services.
PC also competes with retailers like Home Depot and Lowes, which offer a wide variety of outdoor living space products. Finally, the company competes with more local pool retailers and stores. The barriers to entry for the industry are relatively low. PC claims to differentiate from competitors in the following categories.
1. The breadth and availability of products offered
2. The quality and level of customer service, including ease of ordering and product delivery;
3. The breadth and depth of sales and marketing programs
4. Consistency and stability of business relationships with customers and suppliers
5. Competitive product pricing
6. Geographic proximity to the customer
Of these categories, PC strongly believes that customer relationships give them the greatest advantage.
PC management has stated multiple times that they are in a better cash position with lower leverage than most of their competitors to withstand any diverse effects during a downturn caused by the pandemic. Management is open about using the opportunity to buy some of these competitors. Although the company’s growth strategy is largely organic-based, its well-timed acquisition of several small competitors worked well for them during the 2008 recession. The acquisition of smaller pool and outdoor living retailers plays well into PC’s sales center strategy where convenient locations are a key part of its competitive advantage.
Key Risks
The company acknowledges several risks to the future health of their business. These risks and how they affect PC are outlined below.
1. Unfavorable economic conditions
Although the majority of the company’s business is non-discretionary, the pool and outdoor living space is still very much tied to economic prosperity. During an economic downturn, PC may be adversely affected in several areas, mainly in their discretionary product sales. Interest rates can also be a risk to PC as they are instrumental in driving the demand for single family homes.
2. Weather
The nature of PC’s business extremely seasonal. In 2019, the company generated 63% of net sales and 81% of operating income in the second and third quarters. In the past, the company has fallen short of earnings expectations because of the effects of mild climate trends in a certain year. Other times, the company has far surpassed earnings during abnormally hot time periods. The effects of global warming, which produce higher variability in weather, also make the business itself more subject to changes in earnings.
3. Favorable relationships with suppliers
The company believes that relationships with suppliers are critical to its value proposition because it can obtain products and redistribute them to customers better than PC customers could do on their own. A decision by some of their largest suppliers, like Pentair PLC, Hayward Pool Products, and Zodiac Systems (20%, 9%, and 8% respectively), to bypass distributors like PC and sell directly to consumers, would have a negative impact on the business.
4. Competition
The pool industry is highly fragmented with relatively low barriers to entry. The company faces competition from other distributors, B2C pool companies, home improvement companies, online retail outlets, and more local pool supply chains. Outside of the industry, the company indirectly competes with discretionary industries like the boating and RV industries, and other industries where consumers can choose to spend on leisure activities outside of their own homes.
5. Lack of Product Differentiation
More intense competition in the future could mean that another company would attempt to compete directly with PC in wholesale distribution of pool products. There would be limited barriers for the company to offer similar products to PC.
6. Labor Constraint Issues
The remodel, repair, and new pool construction markets rely heavily on the availability of professionals to complete these jobs. Without enough labor in these industries, the number of remodels, repair and construction jobs will falter, which will in turn adversely affect the company.
Management
PC management has been successful because so many of its past and present C-Level managers have an immense amount of knowledge in the pool industry. Most C-Level employees and board directors come from other areas of the pool or outdoor living space industry. During 2019, Peter Arvan became the PC CEO, taking over for Manuel Perez de la Mesa, who had been the company’s CEO since 1995. De la Mesa was a sales focused CEO who invested heavily in his employees, most notably by offering extensive training to employees to further their careers and climb the ladder at PC. Peter Arvan, who is still new to the pool industry, came by way of the Roofing Supply Group, serving as their CEO from 2013-2015. Previously, he worked as the president of SABIC Polymershapes from 2004-2013. Before becoming president at SABIC Polymer Shapes, he served as the manager of the global supply chain and used his Six Sigma black belt to implement efficiency improvement at the company. Arvan’s Six Sigma experience, which teaches operational and business improvement through a multi-step process, has carried over to his management of PC and their sales center model.
Management runs a fairly lean operation and expects a lot from its employees at sales centers during peak season. Judging from feedback on multiple job websites, employees confirm that warehousing and sales center jobs at PC can be very demanding. The company is performance-driven, but is generally reported to have a positive, yet traditional corporate culture.
Valuation
PC’s steady growth and moat in the pool industry is no secret to investors, but regardless, the stock has compounded 21% over the last 20 years. I am optimistic about the company’s cash generation abilities, and I expect the company to grow free cash flow at 10% a year for the next few years. PC’s EPS was 3.87 vs the 3.19 forecasted, and their sales were $1.28B vs the forecasted $1.16B. Given its relatively low leverage position and its market cap, I have the company’s EV just above $13B dollars. This means the company’s current FCF yield is around 2%. They should be able to grow sales by at least 6% each year for the next five years with a little bit of operating leverage flowing down to the ultimate bottom line.
Based on an expectation of 10% free cash flow growth and a meager 2% free cash yield, PC could deliver some market-beating returns from here on out.
As more evidence, the company just released its Q2 2020 earnings and completely outperformed expectations and raised its guidance for the back half of the year. PC’s Q2 results are just another example of the strong demand trends that the company benefits from as a result of their competitive advantage and consumer trends related to Covid-19.
Conclusion
At its core, PoolCorp is a stable business poised for further growth. The company has a solid balance sheet with a history of strong cash generation. They have a multi-faceted, sustainable competitive advantage in their industry. Finally, they have new, stay-at-home trends that promote further growth of the business. PoolCorp has performed consistently as an investment since its IPO in the 90’s, and it seems they will continue to perform as an investment in the 2020’s.
Once again, reach out to ryan@investingcity.org if interested in contacting Ben.