Billionaire Bets Big on Plumbing Stock

Nelson Peltz’s Trian Fund is a well-known hedge fund that holds concentrated investments in “undervalued” companies.

 

Today, over 30 percent of Peltz’s portfolio is invested in Ferguson Enterprises (NASDAQ:FERG), a company specializing in plumbing supplies.

 

This massive position may seem unusual and risky, but it appears that there is a strong value argument in favor of Peltz’s bet. 

 

Ferguson Enterprise is a wholesale distributor of plumbing equipment. In addition to ordinary residential and commercial plumbing, the company also provides fire protection systems and industrial plumbing hardware.

 

Even for an investor who is clearly comfortable with a concentrated portfolio, Nelson Peltz took an aggressively bullish stance on Ferguson. The most likely explanation for Peltz’s large stake in Ferguson is that the company appeared significantly undervalued when he bought it.

 

In part, this undervaluation may have been the result of the company’s location. While the overwhelming majority of its business is conducted in the US, Ferguson is based in the UK. As such, investors may have been unclear on Ferguson’s strong position in the American market, leading to an undervaluation.

 

Some evidence for this is the fact that Peltz sold part of his stake in Ferguson in Q3, potentially indicating that he was taking profits from the investment as the stock drifted closer to a fair value. The sale represented about 12 percent of Peltz’s Ferguson holdings. The remaining stake has continued to appreciate in the following months.

 

Peltz is also a well-known activist investor, suggesting that he may have believed in his team’s ability to improve Ferguson. Certainly, the company has performed well since Peltz’s fund first reported its position in August of 2022. Given the short time frame since the initial purchase, however, it’s likely that Ferguson’s performance and increased share prices are organic.

 

Q3 saw double-digit growth in both revenue and earnings over the previous year for Ferguson. Sales rose 16.6 percent, including 12.7 percent organic growth. The remainder of the revenue growth was driven by three acquisitions made by Ferguson during the reporting period.

 

Earnings were similarly positive, with diluted EPS increasing 18.3 percent compared to the previous year. This earnings jump was largely made possible by cost control measures that resulted in a 10.5 percent operating margin.

 

Despite an obviously successful year, there are strong indications that Ferguson’s growth will slow in 2023. Management’s forward guidance calls for low single-digit sales growth and a slight reduction in operating margins.

 

Earnings for the fiscal year are expected to drop by about 2.25 percent. Earnings are also expected to remain largely flat for the next 3-5 years, suggesting that the stock price could stagnate for some time without further earnings surprises.

 

With the stock already up over 13 percent YTD, analysts do not foresee a great deal of additional room for Ferguson to run in 2023. The upside price for Ferguson stock is $150, just 3.9 percent higher than the most recent price of $144.39. The consensus rating for the stock is a buy, and only one of the 19 analysts covering Ferguson has offered a sell rating.

 

Ferguson appears to be fairly valued at today’s prices. The stock trades at 15.7 times expected earnings and about 13.5 times its cash flows. The company does carry a relatively high debt load of 0.91 times equity, but it appears to be in a good position to manage its obligations.

 

It should be noted that Ferguson was significantly more attractive in terms of value when Nelson Peltz acquired his enormous stake in the company.

 

Peltz’s stake was acquired at an average price of just under $103, and the noted investor has seen his shares rise by about 40 percent in recent months. This adds further evidence to the idea that Peltz may have bought Ferguson as a value play.

 

A final point to note on Ferguson’s value is the company’s dividend. Each share of Ferguson currently pays $3.00 annually for a yield of 2.08 percent. Given that the company’s payout ratio is under 30 percent, it’s quite likely that Ferguson will be able to increase this payout regularly going forward.

 

The most obvious risk factor investors should be concerned about with regards to Ferguson is its low projected future growth rates.

 

While the company could always deliver surprises, the expectation of lower growth calls the stock’s viability as an investment into question. With Ferguson having risen from being undervalued to being fairly valued, there may not be much room left for returns in the near to medium term.

 

The company may also see headwinds from slowing housing growth as the real estate market cools. Residential end markets account for over 50 percent of Ferguson’s US revenue. With less new housing being built as demand slows, Ferguson could see slower growth in this key business segment in the future.

 

The investment case for Ferguson is a mixed one. The company has been incredibly successful in raising both its revenues and earnings over the past year. Solid execution and cost management have benefitted the company, even as the macroeconomic picture has become less positive. Thanks to its large scale and dominant position in the market, Ferguson also likely has a moat around it as a plumbing wholesaler.

 

On the downside, however, both Ferguson’s management and independent analysts agree that the company’s growth will slow significantly in the near future. This will likely cause stagnation in share prices. Given the potential for a market recovery later in 2023 and the number of heavily sold-off companies in today’s market, buying Ferguson could represent an unacceptable opportunity cost for investors.

 

While Nelson Peltz seems to have made an extremely successful value investment in Ferguson, the stock appears to be a better hold than a buy at its current price. With limited growth prospects ahead, Ferguson stock has likely found its natural level for the time being.

#1 Stock For The Next 7 Days

When Financhill publishes its #1 stock, listen up. After all, the #1 stock is the cream of the crop, even when markets crash.

Financhill just revealed its top stock for investors right now... so there's no better time to claim your slice of the pie.

See The #1 Stock Now >>