In my years as a Wall Street analyst, I never found a better stock than Pool Corporation (NASDAQ:POOL). I used to jest that a framed picture of POOL's stock chart on my living-room wall would be more beautiful to me than the Mona Lisa. However, during my coverage of the stock, I often debated with CEO Manuel Perez de la Mesa about the potential impact of a housing downturn. Now that I've left Wall Street, I'm discovering the effects of such a slump on PoolCorp firsthand.
PoolCorp's management was always well-prepared for this question in the past, noting the company's steady revenue streams from pool maintenance. Unsurprisingly, people who own swimming pools tend to use them, and their maintenance requirements provided some 60% of PoolCorp's revenue. Another 20% came from repairs, while the final 20% from new pool construction.
Despite this reassurance, I remained concerned that the 20% of revenue coming from construction might still be enough to set PoolCorp's stock off course. Apparently, I was right. In the midst of the current housing recession, PoolCorp just reduced its full-year 2007 earnings forecast to a range of $1.75 to $1.85, from $2.00 to $2.10, based on weakness in -- you guessed it -- construction.
PoolCorp reported that net sales for the second quarter lagged analysts' consensus, growing 2.9% from prior-year levels. The company blamed a construction slowdown, especially in Florida, Arizona, and parts of California. Poor weather in Oklahoma and Texas also contributed. During the conference call, de la Mesa indicated that flaws in Florida had been somewhat camouflaged by the strength of the overall housing market. Like a wad of leaves expunged from a drain filter, those flaws have now been flushed out into the open.
PoolCorp's base business only grew about 1%, and sales otherwise benefited from new center openings and the company's acquisition of Wickham Supply. Offerings of complementary products were once a strong growth engine, increasing from $3 million in 1999 to some $180 million in 2006. However, PoolCorp may have extended too far into this segment; sales here increased just 9% in the quarter, down from 23% year over year.
During the conference call, management mentioned that it would become more selective about which complementary products it pushed. To this Fool, it sounds like PoolCorp might scale back its efforts to sell items like fencing and housing-related goods and services. While the company has indicated that some 80%-90% of new pool construction is not directly related to new home starts, I still believe that tighter lending restrictions and lighter home equity borrowing will hinder the pool industry's growth. Furthermore, the remaining 10% of construction that is related to new home starts is hardly insignificant.
Elsewhere, margins narrowed because of less efficient sales efforts. The operating margin declined 110 basis points, but management kept earnings per share stable through share repurchases. After buying back shares, EPS matched the prior-year level of $1.12.
Given a normal operating environment, PoolCorp contends that it should grow EPS at 15%-20% annually over the long term. However, investors still have to contend with short-term cyclical fluctuations. This Fool would like to see the company intensify its international expansion efforts in order to diversify the current economic risk in the U.S. Priced at 19 times the midpoint of its earnings guidance for the year ($1.80 a share), POOL shares trade at the high end of the company's long-term expectations (20%). With the current declining estimates and cyclical downturn we're seeing, I'd argue that PoolCorp's stock would be more fairly valued at the lower end of that range.
Compared to leisure-industry and sporting-goods peers, PoolCorp shares compare relatively well. For instance, Callaway Golf (NYSE:ELY) enjoys a P/E ratio of 37, while Oakley (NYSE:OO) trades at 40 times earnings. Neither of these firms has exposure to housing or lending-related weakness.
Given the difficulty of finding close peers, we must look to intrinsic value metrics like the PEG ratio. Earnings-estimate momentum has soured, following management's just-revised outlook. As a result, I'd recommend that Fools avoid this stock over the short term, although I'm confident that management will eventually adjust to its changing environment. For now, PoolCorp is a great company with a sadly overpriced stock.
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Fool contributor Markos Kaminis has no ownership interest in any of the companies discussed here. He did once follow POOL on Wall Street. The Fool's disclosure policy maintains an optimum pH balance.
