Distributors in a cyclical industry are usually seen as unattractive investment candidates with volatile revenue streams and an absence of pricing power. Pool Corporation (POOL -1.96%), the largest wholesale distributor of swimming pool supplies in the U.S., proves its detractors wrong on both counts.
High proportion of non-discretionary products
Pool's business is typically perceived as cyclical and highly dependent on new housing construction. The financial numbers tell a different story. While Pool's revenues decreased by 7.5% and 13.7% in 2008 and 2009, respectively, during the Global Financial Crisis, the magnitude of the decline was much smaller than what you would expect from a distributor of consumer discretionary products.
This is because Pool derives a large proportion of its sales (60% of its fiscal 2012 revenues) from maintenance and repair products that are non-discretionary in nature. These products, such as chemicals, supplies, filters and pumps for existing swimming pools, represented about 70% of its sales in 2008 and 2009. Products relating to the refurbishment, replacement and construction of new swimming pools provided the rest of Pool's revenues.
While the construction of new swimming pools has slowed down in recent years due to the weak housing market, the large installed base of more than nine million swimming pools in the U.S. helped Pool generate a stable revenue stream from maintenance and repair products. For example, certain chemicals are needed to maintain the proper water chemistry to keep the pools safe for swimmers.
Gross margin stability
Pool has historically exhibited strong margin stability, with gross margins staying in a narrow range of 27%-29% for the past decade. There are two key factors contributing to its pricing power and cost efficiencies.
Firstly, Pool derives significant economies of scale by virtue of its relative market share superiority. In the U.S., it currently boasts 221 sales centers, a number only matched by the total amount of sales centers of its top 53 competitors.
Secondly, Pool has significant bargaining power over its fragmented customer base, a base that includes approximately 80,000 customers. Also, its customers are typically small, privately-owned businesses that rely on Pool's assistance and support in various activities such as marketing, staff training and store operations. This allows Pool to justify the price premium on its products.
Future outlook
Pool delivered record quarterly revenues and earnings for the second quarter of fiscal 2013. Both quarterly net sales and earnings-per-share per diluted share grew by about 4% to $790.4 million and $1.39, respectively.
The key contributor to this good set of results was the increased business activity for pool refurbishment and replacement. With more than half of U.S. in-ground pools aged 15 years and above and pent-up demand from deferred refurbishment and replacement expenditures from 2007 to 2010, this product segment is likely to contribute significantly increased revenues over the next few years.
Furthermore, the number of new pools constructed in 2012 is still down by more than 70% compared with 2005 peak construction levels. Also, according to housing data in August, permits for U.S. single-family homes are now at a five year high, pointing to signs of a housing market recovery, which would lead to more swimming pools being constructed in the near future.
Peer comparison
Pool's peers include MWI Veterinary Supply (NASDAQ: MWIV) and Watsco (WSO 0.77%).
MWI is a distributor of animal health products to veterinarians in the U.S. and U.K. MWI's key strength lies in its network of distribution centers located across the country, which enables 98% of orders to be delivered on the same day. Also, a majority of MWI's customers are small, independent veterinary practices that value distributors' role in inventory management and warehousing.
MWI increased its quarterly revenues and net income by 9.3% and 15.7%, respectively, in the third quarter of fiscal 2013. The highlight of the quarter was the strong 25.8% growth in U.S. internet sales. MWI's product sales from e-commerce currently makes up about 42% of its total U.S. revenues, compared with 21% in 2005. Based on the lower end of its forecasts, MWI has guided for a 12.3% and 15.6% increase in revenues and diluted earnings per share, respectively, for full year fiscal 2013.
Watsco is a distributor of heating, ventilation, air conditioning and refrigeration (HVAC/R) products. Similar to Pool, it is not significantly exposed to the cyclicality of the housing market, given that three quarters of its revenue is generated from replacement demand. Watsco estimates that there is an installed base of about 120 million units, of which 90 million units are more than 10 years old, which should continue to drive replacement demand going forward.
In the second quarter of fiscal 2013, Watsco achieved record quarterly revenues and earnings of $1.1 billion and $51.3 million, respectively, representing year-over-year growth rates of 11% and 31%, respectively. It has guided for 20%-25% growth in full year 2013 diluted earnings-per-share. With more than 2,000 independent distributors, Watsco's size puts it in a good position to grow through industry consolidation via acquisitions.
Conclusion
I like Pool for its strong pricing power and significant economies of scale. In addition, it combines characteristics of both stability and growth. While it generates stable revenues from maintenance and repair, it is well-positioned to benefit from the growth in new swimming pool construction driven by the housing market recovery.
