Ferguson

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

Ferguson plc is the world’s largest distributor of plumbing and heating products, with a significant presence in the U.S., Canada, and the U.K. The company operates a complex, wide-reaching distribution network, moving plumbing, heating, and related products to a diverse set of customers.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Ferguson operates in a highly fragmented industry, primarily distributing plumbing and heating products, with a core focus in North America. Its main revenue streams are derived from residential and non-residential end markets across its different geographical areas.

The company has a large geographic footprint:

  • U.S.: 90% of revenues. The vast majority of the business’s revenue, with a nationwide network of distribution centers.
  • Canada: ~5-7% of revenues. Serving a similar market to the U.S., with some regional differences.
  • U.K. and Ireland: The remainder of revenues. A smaller, but established, segment focusing on more mature markets.

In terms of end-markets:

  • Residential: Includes single-family, multi-family housing, and repair/remodel segments.
  • Non-Residential: Encompasses commercial buildings, industrial facilities, healthcare, and infrastructure.

Ferguson’s business model involves sourcing a wide range of products from various manufacturers and then utilizing a vast distribution network to deliver these products to their customers.

  • The company employs a “buy-and-build” growth strategy, acquiring smaller players and integrating them into its existing operations. This has increased sales, distribution power, and scale of operations.

Trends in the Industry:

  • Fragmentation: The plumbing and heating distribution market is highly fragmented with a large number of small to medium-sized players. As such, consolidation through acquisitions is expected to be a driver for growth.
  • E-commerce: Increasingly, customers expect online buying and ordering options. Ferguson has invested in their digital capabilities and platforms, but there is room for further innovation.
  • Inflation and Volatility: Raw material, transportation, and labor costs can vary, making it challenging to maintain profitability if pricing and efficiency are not managed properly.
  • Focus on Sustainability: More customers are looking for more environmentally friendly options, adding to the burden of companies that need to source those.

Competitive Landscape:

  • Limited differentiation: The products are mostly commoditized. This puts a bigger focus on customer service, availability of the product, and delivery times.
  • Scale matters: Larger companies can offer a wider variety of products, have more extensive distribution networks, and offer lower costs as a result of economies of scale.
  • Relationships are key: Long-term relationships and contracts with contractors and local customers are important and can take time to establish.
  • Regional strength: Many customers prefer local suppliers, so national players have to understand local conditions.

Financial Deep Dive

The financial overview here is based on the company’s earnings releases up to October 31, 2024, and a proxy statement outlining details of the merger with Wolseley UK.

  • Q1 2024: For the first quarter of 2024, Ferguson reported net sales of $7.5 billion, which represented a 3.7 percent increase year-over-year (YOY). Adjusted operating profit decreased by 2.9 percent, to $659 million. Net income was $525 million. Earnings per share came in at $2.54.

Margins:

  • Gross Profit: The gross profit margin declined by 80 basis points in Q1 2024 to 30%.
  • Operating Income: Operating margins have also decreased from 11.6% in 2023 to 10.5% in 2024.
  • EBITDA: Q1 2024 EBITDA is $760 million, compared to $799 million in Q1 2023.

Other financial data and important points:

  • Cash and liquidity: Ferguson’s had a net cash balance of about $300 million, after funding an acquisition in the first quarter of 2024 with 570 million dollars.
  • Balance Sheet: It has about 14.9 Billion dollars in assets, and 10.4 billion dollars of liabilities, netting at around 4.5 Billion dollars in equity. In general the company has very decent, if not fantastic, credit metrics.
  • Buybacks: Management plans to continue repurchasing stock to offset dilution and is projected to complete $500 million of repurchases in this fiscal year.
  • Inventory: Management has taken steps to proactively manage inventory levels, which had increased in recent quarters, and has reduced that level.
  • Acquisitions: Ferguson’s growth is mainly fueled by acquisitions. A large merger with Wolseley is expected to close in January 2025.
  • The company has announced it is in the process of transferring its UK and Canadian listings to only list on the NYSE, which would happen following the Wolseley merger.

The financial statements show a company with large sales, generating a nice profit. However, margins have been under some pressure in recent periods. The company seems to be well-managed and is focused on its long-term financial goals. It is also important to note that there is a lot of “noise” in their financials, owing to acquisitions, so understanding the real organic growth of the company might be a bit challenging.

Moat Assessment

Rating: 3/5

  • Switching Costs (Moderate): While plumbing and heating products are often commoditized, the company tries to establish tight relationships with customers, leading to the possibility of customer stickiness. Some customers also prefer to stick with a single distributor for consistency and ease of sourcing, which translates to a moderate amount of switching costs.
  • Economies of Scale (Moderate): With a wide geographic footprint, and thousands of stores across North America, the company benefits from economies of scale. It is also one of the biggest companies in a very fragmented industry and has very wide reach. This is a definite advantage against some smaller competitors.
  • Distribution Network (Moderate): The company has a large and complex distribution network that is hard to fully duplicate. This network provides a value to customers through the availability of products and speed of delivery. Some smaller companies might lack the scale to replicate the large network of Ferguson.
  • Brand (Weak): Although Ferguson has a positive reputation within the industry, and they are one of the leading players in the industry, it lacks the name recognition of other consumer brands, as they are selling products to contractors and other companies, not consumers themselves.

Ferguson’s moat is mainly dependent on its scale and wide-reaching operations. The industry is very fragmented and small players in local communities are still thriving and can compete well with the company. The company has a great history of acquisitions, which provides it with the scale, but there is no guarantee that it will continue to be a winning strategy. In general, we have a positive view on the business but would not give it a very high moat rating.

Risks to the Moat and Business Resilience:

  • Economic Cycles: As the company is heavily involved in the construction and infrastructure industries, it is particularly sensitive to economic downturns. A slowdown in any of these industries could significantly lower revenues and profit.
  • Integration Risks: Integration of acquired businesses can be a challenging task. Problems with integration can lead to increased expenses and lower profits, and may affect the overall business, as well.
  • Competition: As the industry is very fragmented, and there are many players, the companies have to compete based on price. A smaller player might decide to lower the prices and force the bigger players to do the same.
  • Commoditized products: Since many of the product that are sold are commoditized and don’t have a differentiation, it is often very hard for the company to raise prices, as customers will find the same products somewhere else at lower prices.
  • Cost inflation: Raw materials, transportation, and labor prices are unpredictable and have been rising recently, making it more costly to run operations.
  • Technology shifts: Customer preferences are always evolving. Although the company is working to offer better technological solutions for its customers, it might be slow to keep up with changes.

The company has performed well in previous economic downturns and has a balance sheet which would help them stay strong. However, the risks that could potentially harm its moat are a bit more long term, such as technological changes or the fragmentation of the industry not changing.

Understandability

Rating: 2/5

  • Business complexity: The company is a distributor and it acts as a middle-man between manufacturers and customers. It has many different revenue streams through many different channels.
  • Geographic footprint: The company has a large geographic presence and some differences in each of those.
  • Financial analysis: While the basic aspects of the company are understandable, a deeper look into the company reveals that it has a complex capital structure, due to its numerous acquisitions and mergers and operations. This also means that the financial statements have a lot of different components and can be a challenge to decipher.
  • Industry Dynamics: The industry has a few complex dynamics that can be hard to understand by casual investors.

Based on these aspects, the understandability rating is 2/5, meaning that it is still relatively easy to understand, but might take a lot of work to understand the business fully.

Balance Sheet Health

Rating: 4/5

  • Debt levels: The company’s debt levels are relatively low and it is focused on paying down its debt in future periods.
  • Cash Position: The company has enough cash to weather some unexpected market events and even make strategic acquisitions.
  • Interest coverage: The interest coverage ratio is great, which means that they have the ability to easily pay their debt obligations.
  • Inventory Management: The company has been actively reducing inventories which reduces its balance sheet risks.
  • Acquisitions: Although acquisitions help growth, they do add complexity to the financial statements. As such, the quality of future acquisitions is of importance to the health of the balance sheet.

The balance sheet is mostly healthy, but there are some risks that need to be monitored to ensure the health is maintained over time.

Recent Concerns and Management Commentary

  • The company has announced they have agreed to a merger with Wolseley UK and that the company will shift its listings to only the NYSE. This has been a point of contention for the company, and they have addressed it thoroughly in earnings calls. The company expects that this merger would be accretive and has already seen a positive stock market reaction.
  • There have been some concerns about management’s ability to execute its growth-through-acquisition strategy, but management has expressed that they have a long history of acquisition experience that will enable them to successfully go through this process.
  • Inventory levels grew too large in 2023, but the management has reported they have lowered those and are working on better inventory management in the future.
  • The management has noted concerns about the volatile macro-economic conditions, but remains confident about the future profitability of the business. They have also stated their commitment to their return on invested capital (ROIC), and are taking actions in order to maintain and improve it in the future.