Pool Corporation ($POOL): The Magic of Conquering a Fragmented Supply Chain
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Introduction: POOL’s Business Model
PoolCorp (POOL or the Company) is the world’s largest wholesale distributor in the swimming pool industry. It funnels products used in the construction, renovation and maintenance of residential and commercial swimming pools, placing itself at the center of the supply chain.
In order to better understand POOL’s importance within this sector it is relevant to make clear the industry’s structure and the middleman role that the Company plays within it. The swimming pool industry is very fragmented with a large number of both manufactures/suppliers and customers. According to POOL’s last presentation, the Company works with more than 2,200 product suppliers and it serves more than 120,000 customers (most of them “small, family-owned businesses with relatively limited capital resources”).
The beauty of POOL’s business model is that, taking into account this market fragmentation, the Company is able to make the selling process much more efficient for manufacturers and retailers, creating a win-win-win situation, where all of them (manufactures, retailers and the Company itself) benefit.
The reason for this model to thrive is the multiple advantages that POOL provides to its suppliers and customers:
With regard to manufactures/suppliers:
POOL is able to provide immediate access to a nationwide distribution network of sales centers. The pool industry is rather local (POOL ships 90% of its orders to dealers 125 miles away or less) and smaller distributors cannot provide this capillarity of branches and final customer reach.
POOL saves manufactures the costs and complexity of maintaining and managing a distribution business.
POOL is capable of carrying out large purchases, making for manufactures easier to manage their supply chain and reduce transportation costs thanks to freight consolidation.
POOL helps manufactures manage their inventory with year-round purchases and participation in early buy programs, reducing the impact of seasonality.
POOL can warehouse significant volumes of products throughout the year, reducing manufactures costs.
POOL helps manufacturers to deal with final customers (warranties, rebates, training, queries, etc.), avoiding them many burdensome tasks and saving costs.
Within an industry with low brand awareness, POOL helps manufacturers create and maintain brand recognition.
With regard to customers:
POOL is able to provide a one-stop shopping experience thanks to its extensive product assortment (more than 200,000 products).
POOL is able to offer better conditions thanks to its scale (dealers can obtain better conditions than going directly to the manufacturer).
POOL can extend credit and favorable payment terms for its customers to purchase goods and pay them later.
POOL is able to provide quick and cheap delivery thanks to its dense sales centers network that reduces time and distance.
POOL helps to promote the growth of its customers’ businesses and assists them with many aspects of their operations (e.g. promotional and marketing tools, product merchandising, assortment selection or inventory management).
All in all, the importance of POOL resides in that, within a fragmented supply chain, it is able to make the distribution process much more efficient and helps manufacturers and dealers to sell their products, providing all the players in the sector with many incentives to work with them.
Competitive Advantages
What makes POOL really special is the business model commented in the previous paragraph and all the advantages that it is able to provide to the other stakeholders within the swimming pool industry. However, there are many other characteristics that make this company rather unique:
Buying power and purchasing capacity
POOL’s huge scale enables the Company to develop strategic relationships with its vendors and exert a relevant buying power. No one in the industry has the capacity to place orders as large as POOL and this helps the Company to get favorable conditions like competitive pricing, access to purchasing incentive programs, special return policies or rebates, and helps maintaining its margins.
Distribution network and market coverage
The Company is absolutely conscious about the local nature of the business and the importance of convenience and proximity, due to the high cost of transportation and the general need of a rapid delivery. In that sense, POOL has been steadily expanding its distribution network through strategic acquisitions and opening new sales centers, further penetrating existing markets and expanding into new geographic areas.
Nowadays, POOL is able to provide rapid, quick and cheap delivery thanks to its dense national distribution network and its capacity to move products from one location to another when necessary, giving their customers the convenience they look for and few incentives to work with other distributors.
Pricing power
POOL’s unique and prominent position within the supply chain gives the Company the capacity of passing cost increases along its channels with no impact on demand. This is an extraordinary feature under any environment, but it is even more appreciated in the current situation where above-average inflationary product cost increases need to be passed through.
Operating leverage
The Company’s structure and scale confer the capacity to leverage its existing distribution infrastructure and personnel base, resulting in a steadily improvement of its efficiency metrics (see next paragraph).
Financial Results
Despite the slowdown during the 2007-09 recession, the financial evolution of the Company during the last two decades can only be considered as impressive, being able to 10x its sales and 20x its operating income:
The evolution of its sales is basically the result of two factors. On the one hand, organic revenue growth: the Company has been steadily spreading its sales center network and gaining market share. On the other hand, POOL has been expanding its market presence acquiring other companies and taking advantage of its fragmented market: since 2006 the Company has acquired more than 100 sales centers in more than 40 different acquisitions.
However the secret sauce of POOL’s business model lies on its operating leverage:
During the last years there have been some headwinds for gross margins:
The new pool construction activity, which usually carries higher margins than maintenance activities, is well below pre-recession levels (though it is gradually recovering).
The importance of the remodeling and replacement activity has increased, with typically bigger ticket items but smaller margin percent.
There has been an ongoing migration to higher-efficiency products, which also come with a lower margin percent.
The Company has put in place many initiatives to mitigate those impacts (e.g. improving sales execution, purchasing and sourcing discipline, pricing management, increasing the use of exclusive and private-label products) and thanks to these efforts it has been able to keep its gross margin rather flat over the years (though with gross profit dollars steadily growing).
Additionally, the Company has centered its efforts on the operating margin and, specifically, established a target of growing its operating expenses at approximately half of the rate of gross profit growth, which implies a steadily operating margin improvement:
In order to achieve this target, POOL carries out a continuous process of sales centers assessment and improvement. The Company analyzes one by one each one of the centers and clusters them by its operating margin. The idea is to rapidly analyze and enhance the operating margin of all the new, acquired or underperforming locations through improvements of their processes and sales execution, and the review of their expenses and assets (labor, facilities, freight, delivery, etc.). Looking at the following two slides (provided in 2019 and 2022 Investor Days) it is easily observable how successful this process is being:
By the end of 2018 POOL reported 96 sales centers with an operating margin above 16%, while three years later the Company has 315 centers with an operating margin above 15% (in the US only). The comprehensive process that POOL carries out in each sales center brings a steadily improvement of many efficiency metrics:
The final result is a company that is continuously improving its operating margins and profitability and that is capable of increasing is capital returns every year:
Long-term Tailwinds
Though there are many uncertainties that could negatively affect the Company in the short-term (and that will be analyzed in the next paragraph), there are many other secular trends that invite to be optimistic with POOL’s future evolution. Let’s have a look to some of them:
Robust housing market
The pool industry is highly dependent on real estate activity and, regardless of some dark clouds in the near future, it is expected this sector to keep thriving in the long-run. New home sales remained below the long-term average during the last decade and also well below the estimated household formation, creating a production deficit that is expected to support real estate markets in the future
According to Harvard University, “the number of households in the US will grow by 12.2 million between 2018 and 2028 and then 9.6 million between 2028 and 2038”, meaning that estimated household formation will remain stable and real estate demand should follow.
Millennials generation
In close relation with the previous point, the pressure coming from household formation is increasing due to Millennials entering adulthood and buying their first homes.
Besides this is a generation much more prone to a flexible-work lifestyle, favoring Sunbelt states and suburban relocations, which are the main POOL markets (see next point).
Migration toward southern United States
Migration patterns are causing economy and population to grow in many Sunbelt states.
Though this year there has been some slowdown in state-to-state moves compared with the early months of the pandemic, there are no yet signs this trend to start reversing and is expected to continue in the following years.
As previously commented, Sunbelt states are the main POOL markets and this should provide a relevant tailwind for the Company.
Aging pool installed base
There is a large and growing installed pool base within the US:
This situation, combined with the aging of this installed base (average age over 20 years), creates an additional tailwind for POOL that benefits from both the growing number of pools and the incremental need of renovation and remodeling services.
Remote/hybrid work and de-urbanization trends
During the pandemic there was a migration from large urban areas to suburban counties and to small- and medium-sized metros, thanks to households being able to work remotely and reversing the long-term trend away from rural areas.
Those flexible working options, despite some reversion in 2022, seem to be here to stay. Living in close proximity to work is neither longer a priority nor a need for many employees, and the current work-from-home opportunities are allowing those employees appreciating outdoor living spaces to move to suburban areas. These suburban relocations are a clear tailwind for a company like POOL.
Besides, these out-of-town homebuyers usually have significantly higher budgets because they come from big-city centers with high salaries and cash on hand from selling a high-value home, and this will probably mean a tailwind for larger homes in the relocation town (with space for backyard and pool).
Consumer spending on home and outdoor livings spaces
The home remodeling market has been steadily growing during the last decade thanks to a combination of gains in home equity and the aging of the housing stock:
During the pandemic period homeowner improvement and repair spending soared and it seems to remain strong, with post-COVID consumer inclined to keep spending on home improvement and realtors “reporting that homeowners seek(ing) properties with a backyard retreat, including a pool, are in very high demand”.
ESG regulation and environmental concerns
Pool industry’s customers are increasingly worried about environmental issues and this is pushing regulators and industry stakeholders to take specific actions to respond to these concerns.
This circumstance creates an additional tailwind for the industry as, in general terms, this kind of initiatives bring the development of new environmentally sustainable and energy-efficient products, that in the end are accretive to the pool industry.
A recent example is the regulation passed by the U.S. Department of Energy, which became effective in July 2021, requiring pool pumps sold in the United States to be variable-speed pumps and entailing a relevant stimulus for manufactures and distributors.
Short-term Headwinds
As commented in the previous paragraph, despite the positive long-term view, there are some uncertainties that could negatively affect the Company in the short-term:
COVID “hangover”
The pandemic period has clearly benefited the pool industry. New pool construction was gradually recovering from the Great Recession levels, but the dynamics created by the pandemic implied an additional stimulus:
Nowadays, when we start see the pandemic in the rear view, new pool demand and builder/remodeler backlogs remain strong. However it wouldn’t be strange to observe some return to more normalized growth levels. In any case, should this effect materialize, it would be a short-term impact as the gradual recovery of new pool construction seems to remain healthy.
Home equity
Home value appreciation highly correlates with demand for new pool construction. After two years with huge price increases it would be also expected some return to more normalized growth levels. Even it would be possible for home prices to decline in case of a severe recession.
However, it is important to recall that real estate prices move slowly in market declines and it is rather uncommon for them to decline:
There are currently opposing forces in the real estate sector that make difficult to predict how prices will evolve in the near future, with steeping interest rates and cooling homebuyers demand pushing in one direction, and inventory shortfall in the other. However, the most likely scenario, also taking into account many other real estate circumstances, seems to be the slowdown in the pace of price growth (or even a soft decline of home prices).
Home sales
Since the onset of the pandemic homebuyer demand has shown a remarkable strength. However, as commented in the previous point, there are specific factors that could negatively affect home sales. Declining consumer confidence or rising interest rates and home prices are all forces that could reverse this positive trend or at least reduce the euphoria in the real estate market. A slowdown in the real estate market will inevitably affect the pool industry.
Fortunately there are also some aspects that could help to (at least partially) offset those negative impacts, as is the case of new construction backlogs that could act as offsetting factor:
Consumer sentiment
Despite the recent increase in August, consumer sentiment has been deteriorating since the last months of 2021 and overall sentiment remains extremely low:
According to the last University of Michigan Survey of Consumers, “consumers continue to feel the negative impact of persistently high prices” and “there is a long way to go before consumers feel truly confident about the state of their personal finances and their outlook for the economy”. Consumer sentiment is usually considered as a leading indicator that predicts changes in the economic activity and, should these pessimistic readings materialize, the pool industry will probably feel the pain.
Consumer discretionary spending
The end of the support to consumer spending provided by pandemic-related stimuli and the inflation-induced reduction in real disposable income are clearly affecting households’ discretionary expenditures. There is a relevant part of POOL’s sales that significantly depends on consumer discretionary spending and, should this slowdown continue, it could be seriously affected.
However, there are two factors that could help to overcome this impact on discretionary spending. On the one hand, POOL has been steadily lowering the proportion of its most discretionary business and nowadays any recession is likely to be less severe than 2007-08. On the other hand, US consumers are in a much better situation than pre-pandemic levels:
In any case the evolution of consumer discretionary spending requires close monitoring since any additional deterioration would hurt the pool industry.
Interest rates and affordability
Since the beginning of 2022 interest rates have been rapidly increasing, with the correlative effect on affordability:
A sharp increase in interest rates means financing becoming more expensive and this could cause a slowdown in home buyer demand and/or pool construction or remodeling to be postponed.
Labor constraints
Labor shortages are affecting the whole pool industry (as is the case of many other sectors) and remains “one of the biggest limiting factors on pool construction and remodeling growth”.
Companies are having hard times finding workers and this is making them experiencing project delays and not being able to keep up with demand.
Valuation
POOL is that kind of company that, at first glance, always seems expensive, with multiples well above the ones that could be considered as reasonable for an average company. However, this is a rather common characteristic of those exceptional companies that, due to their quality and trajectory, are usually trading with a premium over the market. In that sense, it is sometimes much more useful to compare the company with the historical levels of the company itself in order to have an idea of its current valuation:
As it can be observed, the Company is currently trading well below the last years multiples and the average of the period 2007-2019 (which includes the Great Recession and excludes the potential distortion of the period 2020-2022). Besides, if we take FY22 guidance (recently reaffirmed in July 21 earnings release) the Fwd P/E ratio would be 18x, which is still rather reasonable for a company like POOL.
As commented throughout this article, there are many uncertainties in the short-term that could affect the company and its sector, making even necessary for POOL to revise its short-term projections. Besides a relevant part of the pool industry is rather discretionary and it is not expected the market to look kindly on this kind of companies in the near future.
However, this is a company with many tailwinds under a longer-term perspective and that is expected to keep thriving in the future. In that sense, as its multiples are starting to be attractive, POOL deserves a place of honor in the watchlist.