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Gypsum Management & Supply ($GMS): Another Wonderful Distribution Business
I had always thought about distribution as a boring business and I am surprised how wrong I was! Since I started to deep dive in Pool Corporation (POOL), my interest on specialty distributors have been steadily increasing. It is fascinating how those companies are able to create virtuous cycles where all the stakeholders surrounding them benefit with the dynamics they generate. After analyzing POOL, I did the same with Watsco (WSO) and SiteOne (SITE) and my suspicions were confirmed: all of them are wonderful and powerful business models.
Now I come back with a new specialty distributor: Gypsum Management & Supply (GMS). GMS is one of the largest distributors of wallboards, ceilings and steel framings in North America. The business started in 1971 with just one location and nowadays has more than 400 branches all over US and Canada, and its recent evolution is nothing but impressive:
GMS has been able to grow with a balanced combination of organic growth and acquisitions, and its execution and numbers are certainly impressive. However the secret sauce resides in its business model. As we will see, its capacity to improve the situation of all its stakeholders is what really makes the difference for this company and invites to think that it will continue thriving in the future.
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There are some industries that require connecting large product manufacturers with small-volume contractors whose consumption patterns tend to make uneconomical to be served directly by those manufacturers. The wallboard, ceilings and steel framing industry is one of them and GMS takes advantage of this logistical complexity:
GMS serves “as a critical link between (its) suppliers and (its) fragmented customer base”. The beauty of this model lays in GMS’s capacity, within a fragmented supply chain, of making the distribution process much more efficient for all the stakeholders, helping manufacturers and contractors to sell their products and providing all the players within the sector with many incentives to work with them:
With regard to manufacturers and suppliers, GMS provides immediate access to a nationwide distribution network and salesforce; saves the costs and complexity of maintaining and managing a complex distribution business; reduces transportation costs and inventory management risk and costs; helps to deal with final customers and improves brand awareness.
With regard to customers (contractors and home builders), GMS creates a one-stop-shopping experience and removes the burdensome task of dealing with multiple suppliers; provides convenience and tailored delivery possibilities; offers product knowledge and technical expertise; can access to better conditions thanks to its scale and can extend credit and favorable payment terms.
With regard to other independent distributors, GMS provides capital and resources for business leaders to accelerate growth and develop scale; guarantees access to strong vendor relationships and better conditions; access to cross-selling synergies and full product-line offering; provides with technology and digital capabilities that will be rather difficult for independent distributors to get outside the network; and allows acquired businesses to keep running as separate businesses, with a completely decentralized approach.
All in all, the different stakeholders have many incentives to keep working with GMS and, those that do not pertain to the network, to join in (feeding GMS’s inorganic growth). Besides, as if it were some sort of virtuous cycle, all those advantages get reinforced as the distribution network grows, increasing the convenience for manufacturers and contractors and making the community even more attractive for other independent distributors. In that sense we could expect GMS to keep thriving in the future, as long as the construction sector helps along.
Sectorial Overview: Short-Term Headwinds But Long-Term Tailwinds
The construction sector is rather difficult to predict as it is highly cyclical and exposed to many variables that are outside of the companies’ control. However, the objective when one analyzes a company with a long-term perspective is not to accurately predict what is going to happen in the next quarter or year, but to understand what are the economic forces that could directionally move a company in the long run.
In the case of GMS, the Company is involved in residential and commercial construction, both new and repair and remodeling (R&R), and we find potential tailwinds in all these segments. With regard to the residential part of the business there is a clear housing deficit as a consequence of the significant underbuilding over the last decade:
Home inventory has been steadily decreasing and this problem is accelerating during these days as there are many owners under the "lock-in" effect of high mortgage rates that are not willing to sell their homes (exacerbating even more the problem of home inventory). At some point the new construction will have to fill this gap.
Besides, in terms of residential R&R, favorable home equity levels and aging housing stock (average age of existing homes ~40 years old) are expected to keep pushing R&R projects. Many homes “have structural deficiencies or lacked basic features like plumbing, electricity, water, and heat” that require urgent repairs or investments and they also need to adapt to new environmental regulations. Additionally the previously mentioned housing shortage and "lock-in" effect could also have a positive effect in terms of R&R, as many potential homeowners will choose to remodel their homes instead of buying a new one, providing an additional boost to the sector.
With regard to commercial/institutional construction, there are also many favorable trends that are expected to provide relevant tailwinds to the sector: de-globalization or reshoring of critical supply chains; warehouse and distribution centers development; data centers construction; “green energy” projects and energy transition processes (e.g. EV and EV battery manufacturing facilities, renewable energy projects, etc.); or the need for infrastructure improvements and favorable legislative actions (e.g. Infrastructure Investment and Jobs Act, Inflation Reduction Act, CHIPS Act, etc.). These are just some examples of the many tailwinds that are expected to make the commercial/institutional construction keep playing a relevant role.
There is no doubt that there are some clouds in the horizon that may affect the flow of construction starts in the short run (e.g. tighter lending standards, higher interest rates, labor shortages, elevated material prices, etc.). However we can observe many tailwinds in the long run for both residential and commercial construction. There is no way to predict when all those tailwinds will take effect, but the relevant point is that they will probably make the construction sector to keep thriving in the future and GMS is ready to take advantage of this.
Valuation and Final Thoughts
As stated above, GMS presents a wonderful business model that is expected to keep attracting many participants within the construction sector, and construction itself is an economic area with many idiosyncratic issues and forces that will probably boost the sector in the long run. But this is not enough. What about the valuation? I am pretty sure that all of you have heard the mantra that a great company is not always a great investment, or, in different words, “a great company is a great investment only when you pay the right price for it”. Let’s have a look to GMS’s current valuation and its recent evolution.
GMS has a short trading history because it is a public company since just mid-2016 but we can observe that it is currently trading well below the last years multiples:
The market seems to be considering GMS as a beneficiary of the post-COVID recovery and betting for potential earnings normalization well below current levels. However, as it has been previously commented, there are many tailwinds that invite to be optimistic and to think that the construction sector, despite the obstacles that may encounter in the short-term, could keep outperforming in the future.
Should we compare with other specialty distributors, in order to have a more comprehensive view, again GMS trades well below its peers:
This is a slightly heterogenic list of companies but all of them with similar business models to GMS and the majority closely related with the construction sector.
In summary, GMS is a fascinating business trading with really interesting multiples. As commented throughout this article, there are some uncertainties in the short-term that could affect the Company and its sector. The macroeconomic environment is not the most favorable for the construction sector and there could be some activity slowdown due to the high level of material and financial costs that currently housing and construction projects bear. However, GMS has created a powerful business model that is expected to keep thriving in the future and within a sector that enjoys many long-term tailwinds, and all this with a rather cheap valuation, especially if we compare with its peers. Definitively I love distribution businesses! (especially at these prices)
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