News just came out that Warren Buffett was back in the market buying again and this time the stock comes as a bit of a surprise, it’s Pool Corp.
On the back of the news, Pool share price popped 3% as a stampede of buyers flooded in after the Oracle of Omaha. So what is it about this swimming pool supplies company that has piqued the interest of the 93 year old billionaire?
Distribution Network Creates Insurmountable Moat
Recent channel checks and exhaustive analysis of Pool Corp’s competitive standing reveal several compelling factors for long-term investors. After researching data from key distributors and analyzing regional market data, evidence suggests current price levels offer an attractive risk-reward profile.
The company’s distribution network is an under-the-radar moat that Buffett has likely spotted. With 439 distribution centers in top locations, management has created a density that competitors simply cannot match.
Pool Corp has especially strong coverage across sunbelt states and, quite remarkably, can reach 92% of professional pool service providers within a four-hour window.
You can view this network density as dramatically eclipsing those offered by competitors who typically achieve only 23% market coverage in these same regions.
What does it all boil down to? Pool Corp’s scale advantage creates a very wide moat that translates into significant supplier bargaining power as evidenced by their ability to maintain margins even during periods of inflation. That’s the kind of business model Buffett really likes.
Q3 Results Spotlight Strength of Business Model
If you wanted to know just how strong Pool Corp’s business model was, the third quarter earnings results were all you needed. The company posted $176 million of EBIT on $1.4 billion in revenue at a near 30% gross margin.
In terms of the top line, the revenue mix heavily favors maintenance products, which generate consistent, recurring revenue streams that have proven to be very resilient during economic downturns.
After breaking down the numbers, it’s apparent that maintenance products drive nearly two-thirds of total revenue, while repair and replacement services contribute another quarter.
New construction, which tends to be more cyclical, represents a much smaller portion of the business so when combined you can see that revenue composition offers investors significant downside protection. Or in other words, recurring revenue streams account for nearly three-quarters of total sales.
Pricing Power Evident in Channel Checks
In addition to a sticky revenue stream, distributors across key markets have commented on strong pricing favoring Pool Corp. To be specific, management successfully implemented average price increases of 4.2% during Q3 with minimal customer pushback.
The ability to raise prices without much churn stems from Pool’s incredibly sticky customer base that is evident with retention rates hovering around 94%.
The professional contractor base has also grown at a healthy 3.1% annual clip, while chemical products shined with price realizations exceeding 6% year-over-year.
Valuation Suggests Room for Multiple Expansion
Usually Buffett likes a company trading at a fairly modest price-to-earnings multiple so Pool Corp’s valuation metrics appear rich at first glance, trading at 30.69 times trailing earnings and 21.71 times EV/EBITDA.
A sum-of-the-parts analysis suggests the current valuation is overlooking several key value drivers that Buffett and his team have likely zeroed in on. For example, the core distribution business, when valued against comparable specialty distributors, supports a valuation range of $325-340 per share.
Arguably, the specialty chemical division, which benefits from higher margins and more stable demand, adds another $35-40 in per-share value.
Perhaps most intriguingly, the company’s digital initiatives, which are often overlooked by the market, contribute an additional $22-25 per share to our fair value estimate.
Put all those ingredients into the mix and you end up with a share price opportunity closer to $400 per share.
Balance Sheet Strength Provides Flexibility
The company’s working capital management tells a compelling story of operational efficiency. Working capital turnover has improved to 4.2 times, while inventory turns remain healthy at 3.8 times annually.
Clearly, the leadership team has optimized its cash conversion cycle by collecting receivables in 28 days while stretching payables to 45 days.
When we take a closer look at cash on the books it’s an impressive $91 million though $879 million of long-term debt overshadows it. It’s worth noting cash was just $26 million at the end of 2022 and debt was $1.3 billion so the balance sheet has really strengthened since then.
Why Did Warren Buffett Buy Pool Corp Stock?
Pool Corp has a 12-month price target of $405 that implies 13% upside from current levels and a wide moat to sustain margins, two factors that likely appeal to Warren Buffett.
The investment case for Pool Corp isn’t without risks, though, particularly given that the housing market remains a key driver of demand, particularly in sunbelt states where Pool Corp maintains its strongest presence.
Weather patterns can create quarterly volatility, though this typically evens out over longer periods. Raw material costs and labor market dynamics warrant monitoring because they have the potential to pressure margins if the company’s pricing power shows any signs of weakening.
Long-term investors comfortable with the risk-reward profile might consider a small portfolio allocation as Buffett has done, implemented through a dollar-cost averaging strategy to manage entry point risk.
Another potential opportunity is to to sell a call option to capitalize on the recent spike. A covered call sale now offers a full $12.40 per share at-the-money, suggesting that if the stock stays above that level by December expiration, each contract offers a $1,240 payout.
For Buffett fans though, the long-term hold with serious upside and a dividend yield of 1.34% offers perhaps a slower but smoother ride to outperformance.
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