AGB 2021.19 - Pool Corp (POOL)
Share Gainer in Scale Advantaged Industry
Subscribe to AGB - One analysis of a good business every two weeks.
Pool Corp is the largest wholesale distributor of pool supplies and related equipment. The company is a B2B value-add distributor that sources products from over 2.2k suppliers and provides them to over 120k customers, mainly through the company’s 400+ sales centers. Most of Pool Corp’s customers are local contractors that build and/or maintain pools for residential or commercial pool owners and retailers that sell supplies to these pool owners.
Pool Corp operates 4 different distribution networks, two of which are related to pool supplies (SCP and Superior) and these are referred to as the “Blue” business. This is the main business, contributing ~92% of revenues (86% in North America, 6% in Europe/Australia). The company also operates an irrigation and landscape distribution business (Horizon) and this is referred to as the “Green” business. Horizon is the #3 player in North America and contributes ~8% to total revenues. The company also operates a tile and building material distribution network called NPT, which is much smaller compared to the rest of the business.
The pool and related outdoor living industry is a $12B market (as of 2018 data, likely > $15B in FY20), 70% of which goes through wholesale distribution. The remaining 30% goes through mass merchant retailers and specialty retail chains. The industry structure is mainly wholesale (rather than retail) because owners of pools usually hire someone to build and maintain their pools vs. doing it themselves. And these service companies tend to purchase directly from a distributor for product availability, better selection, geographic proximity and sometimes even discount pricing.
Customers make most of their purchases at sales centers that typically have a front retail space, a sales desk, as well as back-office space and sometimes even a warehouse attached. Over 70% of transactions still happen at the counter even as online/mobile ordering is becoming more commonplace. The size of these sales centers can range anywhere from 2k to over 70k is sq ft, depending on the market.
While a distribution business isn’t usually that interesting, the favorable industry dynamics makes pool supply distribution a good business. There is a large installed base of 5.5M in-ground pools in North America (and an additional 3M above ground) and that number is increasing at a higher rate each year as the economy continues to recover from the housing crisis. And because these pools need maintenance, most of the industry spend is non-discretionary and recurring. Water in these pools need to be moved, filtered and chemically treated when in use. ~60% of industry spend is on maintenance and minor repairs.
The next 25% of spend is on renovations and remodels (R&R) of existing pools, usually part of the older stock that needs a upgrade. Timing of these R&R projects are impacted by economic factors such as home values, housing turnover and consumer confidence, but on average it usually occurs when the pool is 7-10 years of age. As these older pools get a makeover, new technology is usually installed (automatic covers, connected pools, energy efficient pumps, etc.).
Then the last 15% of spend is on new pool construction. This is largely dependent on the perceived benefit of pool ownership for homeowners and the most discretionary part of industry spend. This category of spend usually competes with other home remodels like kitchen and bathroom as well as other outdoor recreational equipment like motorcycles and RVs. Access to financing is also important as some of these new pool projects range between $50k-$100k, including the surrounding landscaping work.
New pool construction in the U.S. reached 100k in 2020, almost double the amount from FY11, but it’s still 53% below historical peak of 215k in 2006. Now, there was a housing bubble in 2006, so it’s unlikely that we’ll see numbers like that anytime soon, but it’s Pool Corp’s view that 100k is still 40% below normal levels.
Aside from growth in the residential side of the Blue business, there are two other business lines that add to the growth profile. The first is selling products to businesses that service commercial pool owners. Commercial customers include schools (11% of commercial revs for Pool Corp), municipalities (19%), waterparks (8%), hotels/motels (22%), apartments/condos (28%) and health clubs (12%). Pool Corp acquired Lincoln Aquatics in 2017 to gain a strong foothold in this space. The company was able to add 10k new products to the system and add many new customers. The commercial business has outgrown the residential business in recent years to represent 4% of revenues in FY20.
The second is growth in the Green business. Irrigation and landscape distribution is similar to the core pool business in that large purchases usually occur in conjunction with a home sale. There are also maintenance items like chemicals and fertilizers that provide recurring revenues to service providers. Pool Corp acquired Horizon in 2005 to get a jump start into the business. Most of the geographical coverage is in the southern and western states. With new management in 2018, sourcing and back office was integrated with the rest of Pool Corp for efficiency gains.
Pool Corp expects to grow the topline by 6%-8% over the next 5 years (from 2019 analyst day). The breakdown of the growth targets are 1%-2% of installed base growth (new pools), 1%-2% of price inflation, 2%-3% renovation and remodeling and 2%-3% of market share gains. Price inflation is usually passed down to the end consumer. This year, growth from inflation expected to be much higher than the typical 1%-2%. After F21Q1, the company stated that it expects inflation to reach 4%-5% this year. On costs, Pool Corp aims to grow opex by half the rate of gross profit growth to realize operating leverage.
Why is it a good business?
At the core, owning a pool (especially an under-ground pool) is a luxury and customers generally don’t want to do maintenance work related to that luxury themselves. This makes pool supply distribution a good business because 70% of the market goes through wholesale distributors like Pool Corp. Couple that with a growing installed base from the new pools constructed each year, and distributors should benefit from the increasing base of recurring, non-discretionary revenues (60% of industry spend).
There is also a renovation and remodel opportunity for many of the older pools as consumers benefit from increasing home prices and the shift from urban to suburban/rural living (accelerated by Covid). The average age of a pool is now 22 years old, up from 19 years old in 2012. On average, a pool owner will make minor upgrades in years 3-7. Starting in year 8, owners opt to replace certain equipment and add new features like automatic covers, connected pools, etc. Major remodels generally happen in later years and/or when there is a change in ownership of the home.
As the largest distributor of pool products in North America, Pool Corp has benefits from scale advantages. First, the company can source products with better pricing and availability from its vendor partners. Vendors have incentive programs that provide volume discounts on large orders.
Second, Pool Corp can leverage its scale to make early purchases for the next pool season to improve profit margins. Because certain vendors and manufacturers want to know how to budget the sales of their products ahead of the next pool season, they offer advanced buying of certain products. Pool Corp can order products at a discount in the fall/winter, take delivery during the off season months and then pay for the product when pool season comes around the following spring or summer. Price increases also usually happen at the start of the following year, and Pool Corp can choose to buy products early (if the company expects larger than usual price increases) to help with margins the following year. This happened in 2018, when the company purchased $100M more products ahead of the 2019 season.
Third, a larger network of sales center locations can help when winning customers vs. the competition because proximity to a job site can be a benefit to the customer. Furthermore, there is a higher chance that a specific item is available (or will be made available) with a larger distributor and a product that’s available in one location can easily be made available at another.
Fourth, the company can leverage its scale to push its private label and exclusive product lines (called PLEX) to its customers. PLEX products can provide Pool Corp’s customers a sense of branding/identify with their own customers within a local market. The gross margins on PLEX products are 8%-9% above a comparable branded product even with favorable pricing. And as Pool Corp has scaled its network larger over time, that margin differential has gotten wider. In 2012, PLEX products were just 2.5% better and in 2016 just 7.5% better than branded products. Currently, PLEX makes up ~25% of total revenues.
Operationally, Pool Corp is focused on improving the efficiency of its operations. The company has a list of “focus centers” which are comprised of new centers (including newly acquired centers) and underperforming centers. Focus centers generally have lower operating margins vs. the median sales center. In FY18, the number of focus centers was 75, with operating margins below 8% (closer to 4%) vs. the median sales center with OM of 13%. The goal is to improve these margins to the median level, either by increasing sales efficiency or by lowering costs (this is more likely with newly acquired locations).
Returns on incremental capital?
Over the past 10 years, Pool Corp has spent 57% of its capital on capex and 43% on acquisitions. Most of the capex is spent on new sales centers, purchases and maintenance of its fleet of delivery trucks and technology related investments. The company has opened on average 5 new sales centers per year domestically and 1 new sales center internationally. Of the different distribution networks, Pool Corp has focused most of its new sales center builds in the Blue business.
Acquisition spend is lumpy given that the company doesn’t acquire targets unless the owner wants to sell the business. Typically, these are smaller operations with 1-5 locations that have aging business owners without a succession plan. Ideally, a target has meaningful market share in their local market and can take advantage of Pool Corp’s supplier relationships and operational expertise after they’ve been acquired.
Pool Corp has acquired on average 6 new sales centers per year domestically, with an even split between the Blue and Green businesses. The disclosures aren’t great for this, but on average, the dollar amount paid for an acquired sales center is $1.6M over the past 10 years. This number varies year to year and that likely has to do with the different sizes of an acquired sales center (in square footage and in revenues).
We can take the revenue growth that is excluded from the base business to try to calculate the average revenues from newly built + acquired sales centers. There are flaws to this calculation because Pool Corp excludes these sales centers for a period of 15 months (instead of 12 months) and there is likely a wide disparity between acquired and newly built sales centers. But we can calculate the first year average revenue contribution from these newly built + acquired sales centers, which has averaged $780k over the past 10 years.
This doesn’t get us to a return calculation but it does show that the ramp up to a mature sales center takes a long time. The average revenues/sales center for the entire company was $10.2M in FY20 and that’s grown from $6.1M in FY11 (+6% CAGR).
For new sales centers, the company wants to see a 25% pretax return on capital by year 4, implying that the ramp to maturity takes at least that long. For acquired businesses, the company likes to pay 6x EBITDA, which would imply a pre-tax return on capital of 16.7%. And if we assume that the revenues of an acquired sales center increases 6%-8% per year (EBITDA growth should be higher), the return numbers for these acquired sales centers should be in a similar range by year 4.
We estimate that Pool Corp has generated returns on incremental capital between 40%-60% over the past 5 years prior to FY20. Including FY20, that number jumps materially. The tailwinds of the industry as well as appreciating home values, housing turnover and availability of financing have made pool ownership (and the recurring revenues associated with it) grow materially since Covid started.
The installed base of in-ground pools in North America is 5.5M and that number is growing by 2% per year. As the installed base of pools increases, the opportunity to service these customers for maintenance (and renovations and remodel activity years later) also grows.
If we assume that 100k new pools is still 40% below “normal” levels (as the company believes), normal annual new pool construction would be close to 165k. New pool construction has grown by an average of +6% in the 9 years prior to 2020 (when it grew +25% from 2019 levels). And Pool Corp has stated that 2021 new pool construction will be close to 110k units (or +10% growth). Growing off that number by +6% annually would imply reaching 165k new units by 2028 or in 7+ years. By that math, the total installed base of in-ground pools would be close to 6.6M by 2028 or 20% higher than the current installed base of 5.5M.
The R&R market should also increase as the average age of the installed base of pools increases over time. As pools get older, necessary equipment like heaters, pumps and safety products need to get replaced. And as pool owners want new technology that automates a lot of the heating, filtering, etc., these pools will get these upgrades.
The pool industry is highly fragmented on the distribution side as well as the customer side. Pool Corp has more sales centers than the next 60 distributors combined, most of which have just 1-10 sales centers. For Pool Corp, the company is always looking to expand its footprint. Over the past 10 years, Pool Corp has grown at 2x the rate of the industry, driven by its market share gains and its sales center acquisitions.
From the company’s analyst day in 2019, Pool Corp estimated that there are 33 markets in the U.S. with over $50M in revenue potential, 35 markets with $20M-$50M and 138 markets with less than $20M. Of these markets, Pool already commands better than average market share in 104 of these markets or roughly half.
Pool Corp also has the opportunity to expand in commercial pool markets and the Green business. The irrigation and landscape market is a $5B opportunity, which implies that Pool Corp has 6% market share. It’s currently the #3 player in this space after Site One and Heritage. The company operates the Green business in a similar fashion as the Blue business and has been taking market share.
With a reinvestment rate between 20%-25% and a return on incremental capital between 40%-60%, we estimate that Pool Corp has increased its intrinsic value between 10%-12% annually over the past 5 years prior to FY20.
Compared to the rest of the companies we’ve analyzed for AGB, this is an average return, but the stock has been one of the best performing among smid/mid companies in recent years. This is partly because of the growth of the business in FY20, which is likely explained by the strong housing market in the U.S., materially higher new pool construction since Covid (implies higher base of future recurring revenues), the anticipated revenue benefit from inflation and recent market share gains.
What else is important?
Pool Corp and the rest of the pool industry were large beneficiaries from the impact from Covid. As lockdown measures were put in place, people invested in their homes (and pools) and contractors saw demand for new pool builds and renovations increase materially. Some were seeing inbound reservations for new pools increase by 4x-5x the levels of 2019. That should be a nice tailwind for maintenance products, which benefit from increase in the number of pools in the installed base as well as higher usage rates of pools.
As we know, more usage means that the water has to be treated more often. The company saw increased demand for chemicals for pool treatment. Certain products like chlorine experienced shortages and prices went up 60+% y/y at the peak in the summer of 2021.
Pool Corp benefited directly from these trends, growing revenues by +23% y/y in FY20 and continuing on that path with +57% and +40% growth in 1Q and 2Q of FY21. The company was able to gain 3%-4% of market share from the competition as Pool Corp was able provide more inventory availability and fewer stock outs.
There have been questions in the past about impact of eCommerce to the pool industry. The company has addressed this issue many times in the past. The online channel is roughly 5% of industry revenues (2016 data) and the products that are sold online are a limited portion of the industry’s total products. This is because (similar to other home improvement products) the last mile delivery of some of the heavier/bulkier items are just not economically feasible. And couple that with the fact that most of the industry goes through wholesale distribution, online retail doesn’t really move the needle that much.
Amazon has been in the business of selling pool related products since 2006 but it hasn’t had an impact on Pool Corp’s ability to grow or pass on price increases related to inflation.
The one impact that eCommerce has had is price transparency, especially around the items related to recurring treatment of pool water. There used to be a meaningful price differential between products sold to seasonal vs. year round markets. Prior to eCommerce prevalence there were a few distributors that were taking advance of this price difference.
Geographical expansion is Pool Corp’s largest area of optionality. The company does have a presence in Europe and Australia but it’s small relative to the rest of the Pool Corp.
If you made it this far, I hope you received some value from reading our analysis. Please subscribe to the newsletter and share with anyone that would find it valuable. Thank you for your support!