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HD Supply (HDS) has seen its shares pull back along with the rest of the market recently. However, it has been proving it is able to grow its business both organically and through acquisitions. The company continues to trade at an attractive valuation and offers investors an opportunity in a market with limited competition. As deleveraging continues, the company will be in a better position to face any downturn as well as take advantage of competitive weakness. While the company operates in a cyclical industry, it can certainly come out of the next recession ahead. This should stop any investor fears from buying shares while in the longest bull run in history.

Company Profile

Originally founded as Maintenance Warehouse in 1997 before changing its name in 2004 to what it is now known as, HD Supply operates a distribution network through approximately 270 branches and 44 distribution centers, in the U.S. and Canada. The company serves more than 500,000 customers, selling to customers which include contractors, maintenance professionals, industrial businesses, and government operations.

Source: HD SUPPLY

The company primarily operates in two segments, “Facilities Maintenance” and “Construction & Industrial.” Facilities Maintenance offers products that serve the maintenance, repair and operations, while Construction & Industrial offers products used broadly across both the residential and non-residential construction market segments.

Since coming public in 2013, the stock price has performed quite well versus the broader market. However, investors have recently been offered the chance to buy shares on a pullback.

Source: Seeking Alpha

In the past, purchasing shares after a dip proved to be quite a good investment as shares would resume their path higher. The shares generally resume their march higher due to management’s outstanding job in turning the company around to a highly profitable and growth-oriented organization.

Source: HDS Investor Presentation

As we can see, the company paints a picture of the changes it has made since becoming public. What investors should be excited about now is the strong capital position and the ability of the company to pursue its capital allocation alternatives.

Operating Performance

HD Supply has grown its revenue from existing divisions, while overall revenue has decreased since its IPO due to divestitures and asset sales. As the company has tried to operate more simply, it has held on to its best-performing divisions.

As we can see below, the company on an adjusted basis has grown sales quite nicely.

Source: 10-K

The company has grown sales 42% from 2015. In the most recent first quarter, the company continued this trend, with sales growing to $1.6 billion, an increase of only $24 million or 1.5 percent over Q2 2018. This is the slowest pace in revenue acceleration we have seen in a while. Growth may have slowed this quarter, but in the end, only so much maintenance can be deferred while companies try to save money. As investors should always take joy in, the company is not just increasing revenues at the cost of profitability and is so far withstanding any tariff issues. While this could change and we would expect to hear more in the next earnings report, the company has not updated or changed guidance from its last revision.

In the most recent quarter, HDS missed estimated on both the top and bottom lines.

Source: Seeking Alpha

For the third quarter of 2018, earnings grew from $.99 to $1.08 per share for growth of 9%. For the rest of 2019, the company reduced guidance and now expects sales to be in the range of $6.1-6.2B and adjusted net income per share of $3.45-3.60. While this is growth is slower than expected, the shares reflect this in their valuation.

Valuation

As we can see below, the company currently trades at an attractive multiple compared to peers operating in the same segment.

ChartData by YCharts

With the lowest forward P/E and P/S compared to peers, investors get a chance to purchase a quality player at an attractive price.

Source: Guru Focus

Compared to its own history, the company is actually trading at many fundamentally attractive levels as well. As the company continues to repurchase shares, grow market share, expand operations, and acquire players in its space, it will outgrow these current values.

Source: Morningstar

Valuation compared to its 5-year history looks below average; however, only slightly. The shares trade above their average P/S ratio but below on most other metrics. Investing in HDS now would prove to be a fair entry point based on these valuation methods. However, it is important to note this can change should the economy take a downturn.

What is more interesting is that while the company is in a very cyclical industry, it has put itself into a financially strong foothold allowing it future flexibility.

Source: HDS Investor Presentation

The company has no significant debt due until 2021 and, with a growing stream of free cash flow, should have no problem refinancing or repaying this debt when the time comes. The only debt we would like to see refinanced sooner is the unsecured 2024 debt. The rate is set to increase to 7% in April 2019. The company further reduced debt in the most recent quarter to $2.06 billion. This should put it around 2.4 debt/EBITDA.

The company should continue to improve its credit ratings and see further improvement in financing options along with this. Currently, the company only has $147 million in cash on its balance sheet. This is not a lot to have compared to debt, but it will improve with its $400 million plus in cash flow expected this year. The company also still has $675 million in Net Operating Loss carry-forwards it can use to lower tax obligations in the coming years.

Using a DCF calculator, we find the following.

Source: Moneychimp

In the last 12 months, the company earned $3.53 per share. This year, earnings are slated to grow less at the midpoint of guidance. For this reason, I selected a more than fair growth rate of 8% annually for the next 4 years. This should be attainable based on historical trends from the company. We then selected a growth rate of 5% per share in earnings; this would not account for acquisitions but pure organic growth. This gave us a fair value of over $82 a share, offering investors an attractive discount at current prices.

Going Forward

We believe the demand for HDS products should continue to be strong. The company has identified several avenues in which it is able to grow.

Source: HDS Investor Presentation

Below, the company even highlighted some industry facts which investors may not know.

Source: HDS Investor Presentation

Its Facilities Maintenance category is showing strong market fundamentals due to demand and building age.

The company also continues to focus on its construction category. Focusing on both residential and non-residential customers enables it to have a broader reach. It also allows it to be less tied to the performance of one or the other at any given time.

Source: HDS Investor Presentation

Identifying $30 billion in annual sales in the market it currently operates in, the company will continue to capture this share through a few of its outlined methods. This is a positive as the company has not reached full market potential in North America. This allows us to be more confident in growth in the coming years.

Conclusion

HD Supply and its management seem to have a clear understanding of the business they are in, with management proving it is focused on reducing debt, improving operating performance, and growing the business. Shares pulling back have offered a chance for shareholders to start a position in the company. Recently, long-term investors have begun to be rewarded as the company started returning capital with share repurchases. Presumably, as the company continues to see a larger cash flow stream, stable earnings growth, and market opportunities, shareholders should continue to be rewarded. Right now, investors are able to buy shares at a discount to fair value and should use any weakness in the share price as a buying opportunity. Investors should keep an eye on the construction market. If it were to weaken, it may offer a better opportunity in share price due to the company being tied to the sector. Any move to pick up shares in this quality-run company should pay off for a growth investor in the long run.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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2019-09-12