SiteOne ($SITE): Mastering the Landscape Supply Chain
Introduction
Since I started to deep dive on Pool Corporation’s (POOL) business model, my interest on wholesale 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 those companies generate. POOL, for instance, is the leader of the swimming pool industry thanks to is ability to make the selling process much more efficient for more than 2,200 product suppliers and 120,000 customers. Watsco (WSO) is another interesting example: WSO is the largest distributor in the HVAC/R distribution industry in North America and again is able to make the distribution process much more efficient for more than 1,200 manufacturers and 120,000 contractors and technicians. These powerful business models provide many incentives for all the players within an industry to work with them and these, in turn, create feedback loops that keep them growing and improving. SITE, as we will see, fits perfectly into this group.
SITE is the largest wholesale distributor of landscaping products in the United States and it aims to provide a one-stop-shop experience to its customers offering a complete portfolio of landscape products (i.e. irrigation, nursery, fertilizer, control products, landscape accessories, hardscapes and outdoor lighting). Its history starts in 2001 when Deere & Company (Deere) decides to enter the wholesale landscape distribution market with the acquisition of McGinnis Farms, a supplier of irrigation and nursery products. Since then, Deere grows its landscape segment (John Deere Landscapes) through subsequent acquisitions until they decide to sell 60% of its ownership to a private equity investment firm (Clayton, Dubilier & Rice, LLC or CD&R) in 2013. In 2015 John Deere Landscapes is rebranded to SiteOne Landscapes Supply, Inc. and in 2016 the Company completes its IPO where Deere and CD&R sold a part of its ownership. Finally, in 2017, through different secondary offerings, they completely sold the remainder part of their ownerships and SITE becomes a complete independent company (no proceeds were received by the Company in any of the offerings).
After this short introduction just to give a little bit of context, let’s deep dive into SITE’s business model.
Business Model
The landscape industry is a highly fragmented market with over 5,000 suppliers trying to reach approximately 500,000 residential and commercial landscaping contractors. The direct distribution makes sense (and indeed this represents approximately 6% of SITE’s total business) when it is feasible to move large quantities of landscape products between producers and customers. However, most of the time the dynamics of this industry require connecting “large landscape product producers with smaller volume landscape contractors whose consumption patterns tend to make them uneconomical to be served directly by producers”. The beauty of SITE’s business model lays in its capacity of solving this problem: SITE, as POOL and WSO, has been able to position itself as a hub within the supply chain making the distribution process much more efficient and creating a valuable connections between customers and suppliers, where the former usually need small quantities of products from different vendors and the latter prefer bulk shipments.
This business model thrives because it is able to provide multiple advantages for both its suppliers and customers:
With regard to manufacturers/suppliers:
SITE is able to provide immediate access to a nationwide network of over 630 branches and more than 280,000 customers. The landscape industry is very local and mainly composed of small independent distributors that usually operate with few locations and within limited geographic areas, and cannot provide SITE’s capillarity of branches and final customer reach.
SITE helps OEMs/suppliers to save the costs and complexity of maintaining and managing a distribution business.
SITE is capable of carrying out large purchases, making for manufactures easier to manage their supply chain and reduce transportation costs thanks to freight consolidation.
In order to reduce cost, to take advantage of volume-based financial incentives and to shorten lead times, a large distributor like SITE can warehouse significant volumes of products throughout the year and this reduces inventory management risk and costs for manufactures.
SITE helps manufacturers to deal with final customers (technical and product support, training, queries, etc.), avoiding them many burdensome tasks and saving costs.
With regard to customers (residential and commercial landscape professionals):
SITE creates a one-stop-shopping experience providing with a full range of products and services and avoiding customers, that look for small quantities of many different products, the burdensome task of dealing with multiple suppliers.
The capillarity of SITE’s location network provides convenience and delivery possibilities that are hard to match for other for landscape distributors: “our network of branches allows us to service most customers from multiple locations and also enables us to move products efficiently and economically throughout our branch system to service customers on a timely basis”.
SITE offers its customers project services, product knowledge and technical expertise.
SITE provides technology resources for its customers to make their businesses much more efficient and increase their productivity (e.g. project estimation tools, marketing toolkit, mobile apps, e-commerce platform).
SITE is able to access vendors’ volume-based incentive programs and offer better conditions thanks to its scale.
SITE can extend credit and favorable payment terms for its customers to purchase goods now and pay them later.
Besides, the Company completes its virtuous cycle with all the advantages that can provide to other independent distributors and that have contributed to build SITE’s reputation as the buyer of choice in the industry:
SITE provides capital and resources for business leaders to accelerate growth and develop scale in their businesses.
SITE guarantees access to strong vendor relationships and better conditions. Due to its scale, SITE is able to get specific conditions and purchasing synergies that are no available for independent distributors.
SITE also provides access to cross-selling synergies and full product-line offering. Most regional and local distributors present a limited product offering that cannot match SITE’s variety of product categories.
SITE provides independent distributors with technology and digital capabilities that will be rather difficult for them to get outside the network. SITE scale allows the company to deploy many resources on technology innovations and that situation increases the pressure over smaller players.
SITE allows acquired businesses to keep running as separate businesses, with a completely decentralized approach: keeping intact the management team, the employee base and the day-to-day decision making process. SITE acquisition strategy is based on acquiring well-run companies and let their own teams to keep building the company.
All these advantages create some sort of feedback loop where all the stakeholders win when interact with SITE and as SITE gets bigger those advantages also increase.
Strategy and Value Creation
Once we have clear how well-oiled SITE’s business model is and the multiples advantages that this model provides to all the stakeholders, the next question to answer is how this supposedly superior model is performing in the real world. In other words, is the implementation of this strategy really creating value? Let’s have a look at the Company’s evolution during the last years:
As it can be observed, SITE has been able to more than triple its business since 2014 and multiple its EBIT and FCF by 8x. This impressive evolution is the result of SITE’s value creation strategy, which lays on three complementary levers: acquisition growth, organic growth and margin expansion. Let’s analyze this triad by diving into each one of its components.
Acquisition growth
One of the main drivers of SITE’s growth is its acquisition strategy. The Company has been able to add 78 companies since 2014 with approximately $1.4 billion in annualized sales, which means an average of approximately 10% acquisition growth per year:
SITE strategy aims to grow through the acquisition of well-run local and regional companies in order to fill in their product lines and expand its geographic reach. Although the company expects to keep improving its market position in all its product categories, its main focus is on hardscape and nursery (and less on irrigation and agronomics). SITE only have a full product line offering in approximately 50 of its targeted 240 markets and this is basically a consequence of the lack of nursery and/or hardscape branches, and its plan is to gradually add the majority of these branches through acquisitions:
In order to achieve this objective, SITE has been steadily improving its M&A team, firstly focused on the acquisition side but recently reinforcing also the integration part of the team. The Company had the feeling that its inability to more-efficiently digest past deals has held them back from making more acquisitions and needed to improve the integration part of the process. The Company is now ready to ramp-up its ambitions and achieve its objective of carrying out 20 to 25 deals per year, which is well above last years numbers.
Organic Growth
The second lever for value creation is organic growth. SITE’s organic growth strategies can be subsequently structured around three pillars:
Growing customer base
As commented at the beginning of this article, SITE’s powerful business model provides multiple advantages to its customers and this generates strong relationships with current customers but also serves as a magnet for new ones. Additionally, the Company is constantly making investments in order to improve its product portfolio, customer service, salesforce performance and brand awareness, and to attract new customers.
SITE is currently focused on acquiring smaller customers. The Company has realized that despite having approximately 15% market share of its addressable market, it is underweight with smaller customers, with a market share lower than 10%, while with regard to larger customers it is in the range of 20% to 25%. This, as we will discuss in the following paragraph, will also help to improve its gross margins.
Increasing wallet share
SITE’s expansion strategy also generates a powerful effect in terms of wallet share. As the Company deploys its full-line product strategy, SITE becomes much more important for its customers and as a result the amount of their spending with the Company increases. Let’s think for instance that in one specific geographic area the Company is able to provide just irrigation and agronomics products and services. Once the Company broadens its product range and adds nursery and hardscapes it will probably make contractors to centralize all their operations with the Company, because for them it is much more convenient to work just with one distributor and for the smaller distributors is rather difficult to match SITE’s convenience.
Cross-selling synergies
This is another powerful effect coming from SITE’s expansion strategy. When SITE acquires new companies there are some synergies that emerge almost immediately, as is the case of purchasing synergies or branch consolidation. However, there are others that require some time and this is the reason to include them as part of the organic growth. After the acquisition, SITE will start the expansion of the product categories that are not in the portfolio of the acquired company in order to complete the full product line offering. However, these cross-selling synergies will require about a year or two before really taking effect, but, once they appear, those synergies represent a relevant part of SITE’s organic growth.
All in all, these levers have allowed the Company to generate meaningful organic growth during the last several years and it is expected them to keep driving this growth:
Margin Expansion
Despite the relevance of the previous two points, maybe the secret sauce of SITE’s value-creation strategy resides on the margin expansion. In order to better understand how the Company is being able to expand its margins, let’s divide this category into two different subsections:
“Internal” margin expansion
SITE implements many internal initiatives to improve both gross and SG&A margins of its base business. On the gross margin front the Company has been mainly focused on the development of its private label brands, the movement of as much volume as possible to its preferred suppliers, the expansion of its market share with smaller customers and the reinforcement of the supply chain initiatives. On the SG&A side the focus has been on operational excellence in order to make the organization much more efficient. All these initiatives have allowed the Company to increase its gross margin and leverage its cost structure.
“Acquired” margin expansion
Apart from the “internal” margin expansion, the acquisition strategy has a relevant impact in terms of margins. In that sense, it is important to make clear what are the dynamics that these acquisitions create. In terms of EBITDA margin, initially, acquisitions tend to be rather neutral. This means basically that acquired businesses present a similar EBITDA margin as SITE and don’t contribute to the expansion of the Company’s EBITDA margin. It takes two to three years for SITE to fully integrate new companies and take SG&A excesses out, and it is then when the operating leverage emerges and the EBITDA margin starts to improve.
However, the acquisition strategy creates a temporary distortion on gross and SG&A margins depending on the type of acquisition. The irrigation and agronomics businesses tend to run at lower gross and SG&A margins compared to SITE’s base business, while nursery and hardscape are businesses with higher gross margin but higher operating costs. As the acquisition strategy is mainly focused on nursery and hardscape categories, this creates a perverse effect in terms of SG&A margin: the SG&A leverage on the base business arising from the “internal” margin expansion is sometimes difficult to observe because it is mitigated by the higher SG&A acquired.
Additionally the acquisition strategy creates another effect in terms of margin expansion: in those markets where the Company is capable of deploying full-line product offerings, economies of scale appear and, with them, higher EBITDA margins. The Company perfectly explains this effect in one of its conference calls: “because you have economies of scale that are local in the market, so your salesforce, your general manager, your area infrastructure, if you will spread out now over a lot more sales and it gives you those local economies that give you that higher EBITDA percentage”.
In summary, despite some potential short-term distortions arising from the acquisition strategy and from the many operational investments that the Company has carried out in the last years, the acquisition strategy is significantly contributing to expand SITE’s EBITDA margins:
Besides, many of these effects are expected to keep pushing margins up in the future and indeed the company has recently increased its EBITDA margin objectives to the range between 13% and 15%, once it has surpassed the 10% margin milestone set in 2016 at the time of the IPO.
Additional Positive Points
Apart from the wonderful business model presented in the previous paragraphs, SITE presents many other additional characteristics that make them a really interesting company:
SITE is the consolidator of a fragmented market with a large pipeline.
A company like SITE needs a fishing ground of potential acquisitions to deploy their strategy over time. Fortunately the landscape distribution market is highly fragmented, with few large operators and more than 1,000 small-to-medium independent players. Besides, being SITE the clear leader in the industry and 5x larger than its next competitor, it only represents approximately 15% market share of a $23 billion industry. This provides a lot of room for the Company to keep executing its acquisition strategy in the future.
Besides, although there are always competitors for M&A deals, SITE is one of the few big players competing for the consolidation process and the majority of the deals (over 90%) are exclusively negotiated with them.
SITE generates real synergies and will keep its margins expansion.
The companies that tend to thrive with its acquisition strategies are those that are able to add value to the acquired company. In the case of SITE, the peculiarities of the company and its sector allow them to provide mainly two kinds of advantages. On the one hand, as a large national company, they can leverage economies of scale, resources and operating capabilities that are difficult for regional or local competitors to replicate. On the other hand, its local-market growth strategy makes possible to exploit economies of scale on a local basis. SITE’s full-line product offering strategy pursues growth across product lines while optimizing salesforce and infrastructure at local level, and this allows branches to spread out their costs over more sales.
Those advantages ultimately help the Company expand their operating margins and it is reasonable to think that this expansion will continue in the future, as long as its strategy keeps its execution.
SITE enjoys purchasing and pricing power.
In those cases where there is a relevant fragmentation among the customer and supplier bases, or when the position that a distributor holds within the supply chain is very important, this distributor is often able to exert some power over its suppliers and/or customers. In the case of SITE, the Company meets both criteria.
SITE’s customer base is highly fragmented, with the Company serving more than 280,000 landscape professionals and none of them representing more than 2% of its revenues. Besides, for landscaping projects, material costs represents between 10% and 20% of that overall budget, being the remainder part mainly labor costs. These two circumstances allow SITE to enjoy a relevant pricing power and make for the Company rather easy to pass any cost increase coming from the OEMs to its customers.
The supplier base is also rather fragmented. The Company works with more than 5,000 manufacturers and its top 10 suppliers account for just 34% of its purchases. SITE represents the most relevant customer for many of its supplier and therefore is able to exert purchasing power over them.
SITE presents a strong financial position to keep deploying its acquisition strategy.
SITE keeps its leverage ratio well under control. Historically its target leverage ratio was in the range between 2x and 3x, and the Company fluctuated around those levels. However in August 2020 the Company completed an equity offering in order to enhance its cash position during the COVID crisis and strongly reduced its debt levels and leverage ratio:
Since then SITE target leverage ratio has been reduced to the range between 1x and 2x and the Company has significantly increased its financial flexibility.
Besides, SITE has been able to avoid dilutive acquisitions, using the right mix of cash and debt for its deals while always maintaining its leverage under sustainable levels.
SITE deploys a disciplined acquisition strategy and its reaccelerating its pace.
SITE has a clearly-defined and time-tested acquisition strategy with two broad objectives: firstly, expand the company and consolidate the market, adding new regions and products; and, secondly, complete its full-line product strategy by adding product lines to its target markets and reinforcing its local market leadership positions.
Additionally, the Company has a dedicated team focused exclusively on M&A activities with more than 70 people in the field looking for opportunities. As previously commented, this team has been recently reinforced in order to improve the integration activity, which was slowing down a little bit the acquisition activity in the past, and now the Company is ready and looking forward to ramp up its deals pace.
SITE follows a decentralized approach that is really attractive for “acquired” management teams.
SITE is not an opportunistic buyer and its acquisition strategy lays on the idea of acquiring well-run companies and integrating their teams within the Company. This policy is in line with SITE’s decentralized management approach. The Company has no intention of disrupting acquired companies or changing their leadership. Its approach is to let the teams operate their business locally, providing just functional support when needed and leveraging those resources that could be fully exploited more efficiently on a centralized level.
This generates high levels of management and employees retention rates (SITE praises itself of accommodating “over 70 former owners”) and helps building its reputation as the buyer of choice in the industry.
SITE is managed by a seasoned team with strong alignment.
SITE is a company led by executives who have run this playbook before and show a proven track record of acquisitions. As previously mentioned, this management team has acquired and integrated 78 landscape distributors since 2014 and its CEO, Doug Black, had already implemented a similar strategy in its former company, Oldcastle (part of CRH plc), “where he helped grow net sales by over ten times and oversaw more than 100 acquisitions”.
In terms of ownership, there is also a strong alignment, as the CEO owns almost 1.2% of the Company (~$61m) and all the Directors and Executive Officers combined almost 1.4% (without including shares which the executives have currently the right to acquire and that could increase this percentage above 2.4%).
SITE is well diversified across end markets.
Although exposed to the housing market evolution as we will see in the following paragraph, SITE is a well-balanced business:
Maintenance represents 37% and this part of the business is rather essential and non-discretionary. Maintenance budgets tend to remain steady regardless of the economic situation.
Repair and remodel, which represents 27%, could be considered as partially discretionary (in a typical downturn tend to decline approximately half of new construction). This part of the business is not so dependent on new housing market, but more on employment levels, consumer confidence or home equity. Nowadays consumer confidence is deteriorating rapidly, but job market is still rather resilient and home values remain high (at least for now).
Finally there is another 36% that depends on new construction and so it would be highly affected in case of a real estate slowdown. However, right now the slowdown seems to be concentrated on the residential market, which represents just 21% of the Company. The other 15% is commercial new construction, which seems to be in a healthier situation.
All in all, as new residential demand softens, the Company will be inevitably affected, but the impact should be buffered (at least partially) for the less-discretionary parts of the business.
Potential Headwinds
Housing market
As commented in the previous paragraph there is a part of the business that is closely tied to the housing market and there is no doubt that this market is deteriorating:
It is still rather unclear how deep could be the slowdown in the US housing market, but in case of a sharp deterioration, the impact for SITE might be relevant. Besides there is a lag of about six months between housing starts and landscaping, so the impact is probably not yet fully reflected on SITE business.
However, in any case, this should be a short-term impact that would not affect the company’s overall business in the long-run. During the last years there has been a deficit production of homes and well below the estimated household formation. There are no excesses to purge like in during the Great Financial Crisis (GFC) and so the base scenario it is not a deep and prolonged real estate downturn.
Home equity
In close relation with the previous point, the impact coming from the housing market is not only about transactions but also about prices. The repair and remodel part of the business is closely tied to home equity, that could also affect consumer confidence and consumer willingness to carry out renovation projects.
However, it is important to recall that real-estate price declines are rather uncommon and currently there are opposing forces in the real estate sector that make difficult to predict how prices will evolve in the near future:
Again, it is still uncertain how deep could be the slowdown in the US housing market, although probably not like the one on the GFC as this deceleration could be cushioned by a relative lack of available homes in the U.S. and the still strong job market and household finances. However, this is something to closely monitor.
Labor constraints
Although recently intensified, this a structural headwind for the landscaping sector and has been affecting the Company at least for the last five years. New generations just don’t want to work on the landscape business. This is one of the most relevant issues for the Company as it affects them through two different ways. There is a direct impact that comes from the difficulties that the company encounters to hire employees and the correlative wage inflation. But there is also an indirect impact that arises from the impact of this labor shortage over its customers: a labor-constrained market means lower number of construction days available and so lower projects and lower business for SITE.
Landscape professionals are working on this issue trying to find ways of getting more productive, but this is problem is expected to continue and the job situation to remain tight.
Price realization and FIFO accounting
This is a short-term risk that could temporarily affect the Company. During the last quarters (especially in the last half of 2021 and beginning of 2022) SITE has been positively affected by inflation and price realization. Under inflationary environments, FIFO (First-in, First Out) results in higher profit margins: the cost of older goods is lower than the cost of newer goods, so selling first older goods results in a higher profit margin. The problem arises when these inflationary dynamics change, which is expected to happen sometime in the future, and this may produce the opposite effect, negatively impacting its margins and results.
The Company was expecting this price realization effect to start to normalize in 2022 with a “modest gross margin reduction“, but finally this year is also being rather strong in terms of pricing and so the reversion will probably take place in the near future.
Valuation and Final Thoughts
As commented in previous articles, there are companies like SITE, POOL or WSO, which are persistently trading at “expensive” multiples or above the ones that could be considered as “reasonable” for an average company. However, this is a common characteristic of those exceptional companies that, due to the quality of their business models and their trajectories, 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:
SITE has a short trading history because it is a public company just since 2016 but it can be observed that it is currently trading well below the last years multiples. However, current multiples don’t take into account potential earnings normalization that could take place in the short-term. SITE has clearly benefited during the post-COVID recovery of stay-at-home trends and price realization, and its multiples might be “artificially” low.
Anyway, in order to have a more comprehensive view, let’s compare also with other specialty distributors:
The Company is rather in line with its peers and with the average. This is a slightly heterogenic list of companies, but in any case it doesn’t seem SITE to be extremely under or overvalued compared with them.
As commented throughout this article, there are some uncertainties in the short-term that could affect the company and its sector. There is a non-negligible part of SITE’s business that is tied to the evolution of the housing market, apart from the secular situation of the job market and the potential impact of the price-realization reversion. All these aspects could affect the Company valuation in the near future. However, from a longer term perspective, this is a company with many tailwinds and with much room to keep deploying its strategy. Its acquisition strategy has demonstrated its success during the last years and the positive impact that it has in terms of margin expansion. The management team has also demonstrated its capacity to deploy this strategy and is ready to accelerate its pace. In my opinion, there are no specific circumstances that could make think that this company will not keep thriving in the future and, in that sense, it is for sure a company to keep in the watchlist.