Diving Into Pool Corporation's Growth, Leadership, and Valuation

In this second of two segments on Pool Corporation (POOL 0.32%), our Industry Focus crew discusses the company's avenues to growth, its management team, and valuation. Tune in to learn more about the only true nationwide distributor of pool equipment and the impressive returns it has delivered to shareholders.

A full transcript follows the video.

This video was recorded on March 6, 2018.

Vincent Shen: It's really important what you mentioned, how the demand for the new pool installations is down 50% from historical levels, I believe something like 65% from their peak levels previously before the recession, so really significant there. That's why I think it's really important with this company, generating a lot of their revenue from that more non-discretionary routine repairs. But then, the side business in terms of their irrigation business, the landscaping that they do, is going to be a little more closely tied to new home construction. And there's that opportunity there as more people decide to, for example, move to warmer states, with retirees and things along those lines, if they choose to install new pools, that's definitely an area of potential growth for them.

I just want to note, too, on the management side, the CEO, Manuel Perez de la Mesa, he's held that position since 2001. Very stable leadership here at the company. Management has done a good job at consistently expanding their operating and net income margins. The online channel, another opportunity, represents just 5% of industry sales. With some of those improved margins, the inventory turnover for the company, I think the business is pretty well executed and run.

And going more into the growth initiatives, you've mentioned a few of those, Asit, something else that they talked about a lot in some recent presentations and investor calls is their private label. The company is relying on what they call private label and exclusive product offerings, or PLEX. These improve profitability, since PLEX products, these private label products, offer about 7.4 percentage point stronger margins than the OEM non-private label products. The company thinks, at some point, that they could hit, in terms of a long-term goal, think 10 to 15 years in the future, about 40% of their revenue, the products that they sell, could be in this category, so increasing their profitability and their margins over time.

Then, something else that they've mentioned in terms of another opportunity is the commercial market. Pool has a much smaller presence here and market share, less than 10%. An interesting number that they touted in an investor presentation is that there's 65 billion gallons of treatable water in this part of the industry, the commercial side. Keep in mind again that the largest product category for them is the pool and spa chemical treatments. For the U.S., the market amounts to about, I believe, $1.5 billion in new construction, renovation, and maintenance on the commercial side. There's been 18% five-year compound annual growth for this market, so another area that the company is focused on, moving in to seize an opportunity there.

Final topic before we roll onto our next company, of course, to talk a little bit about their stock performance and valuation. Can you take it from there, Asit?

Asit Sharma: Absolutely. This company has returned to investors 231%, that's total return, over the last five years. And those are great numbers. In doing so, it's pushed the forward P/E ratio up. And on the show, I often talk about two different measures for this industry, distributors, I think forward P/E or price to earnings ratio is a good gauge, and we can compare that to the broader market sector.

This company now trades at a forward P/E ratio of about 27x. It's 27x forward earnings versus the consumer discretionary sub-sector of the S&P 500, which is currently trading around an aggregate of 21x forward earnings. The little wrinkle in there is, as Vince mentioned, although this is a consumer discretionary stock, it has such a built-in revenue stream from that recurring maintenance need. Vince thinks of this sort of as a consumer staples stock, I think, and he's right to do so.

Shen: Yep.

Sharma: It trades at a premium to this market, but if you look at the revenue potential, it's probably justified. Pool has returned 9% revenue growth and 13% net profit growth between the 2015 and 2016 period. And in the last year, the company exhibited 8% revenue growth and 28% net profit growth. Those are great numbers. It has a net profit margin of around 7%, which for a distribution company, that's pretty solid. Typically, you see those a few percentage points lower. So you're paying for growth, and you're paying for the prospect of improved profitability in those areas that Vince mentioned, the ability to go to private label, to branch out into irrigation. So I don't think this is an overvalued stock. It's probably fairly valued. If you're looking to get into this, do your research, of course, don't just take our word for it. But maybe take a gradual entry point in 2018. I like this company a lot.

Shen: I'll just add to that, given that this stock has pretty handily outperformed the broad market, the S&P 500, over one, five, and 10-year timeframes, it's up 11% just year to date. This can be considered by some people as more of a mundane industry, not quite as flashy as some of the other companies we talk about, other sectors. But given the way they've been growing their earnings, as you mentioned, Asit, and the five-year forecast for their bottom line growth is about 17% per year, quite robust, I think that helps justify a little bit of that premium on the P/E valuation, as you mentioned.

The company cites a few long-term trends that they think will be a tailwind for their business. I want to talk about a few of those before we wrap up here. For example, one I mentioned a little earlier about the retirees, baby boomers are moving south to warmer climates for retirement. That often means more pools being built, and also more maintenance and upkeep. For example, 10,000 Americans are estimated to enter retirement every day at the moment. In 2016, which is the latest data I could find, 600,000 Americans moved from the Northeast and Midwest regions farther south. Some of those major retirement centers in South Carolina and Florida saw the most growth among all metro areas in the country. Pretty compelling story there. Also, in general, homeowners are spending more on their outdoor spaces, whether that's for leisure or for relaxation overall. Again, this can speak to that 50% deficit right now in terms of where installations are across the country.

The last thing, and management spoke to this a little bit, too, is the kind of products that are selling really well with consumers when they have their pools built, when they're maintaining them. It's different now, because consumers often want more automation, they want higher tech for their filters, their heating, their robotic vacuums and filters. And these things all often raise demand for other pool products and often command better prices, and that can benefit the small businesses that supply them, and then in this case, Pool, who supplies those businesses.

The company has repurchased about $650 million worth of shares in the past five years. They pay a consistent dividend, the payout ratio is very reasonable, like 30%. Given that yield, the stock buybacks, the stable portion of their revenue, which is a pretty significant part of the top line, and then also the very dominant market position in a very fragmented industry, if you believe in some of those long-term tailwinds I just mentioned and some of the opportunities that we've talked about so far, I think this is a pretty compelling story. I agree with you, Asit.