POOL Corporation

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 4/5

POOL Corporation is the world’s largest wholesale distributor of swimming pool and related products. They serve a vast network of dealers, contractors, and retailers primarily in North America, Europe, and Australia.

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

POOL Corporation operates primarily as a wholesale distributor, meaning they acquire products from various manufacturers and then sell them to a network of over 120,000 customers including independent retail stores, pool builders, and service companies. They don’t directly sell to the end consumer.

  • Geographic Reach: The company is headquartered in Covington, Louisiana and operates across North America, Europe, and Australia. They have over 420 sales centers.
  • Product Range: They offer an extensive array of products, including pool equipment, maintenance supplies, and construction materials.
  • Business Model: As a wholesaler, POOL focuses on logistics, distribution, and customer relationship management, acting as an intermediary in the supply chain. The company sells roughly 175,000 different products.

Competitive Landscape

The swimming pool supplies market is fragmented, with numerous regional and local players.

  • Competitive Dynamics: While the industry is not dominated by a few massive players, POOL Corporation enjoys a unique position as the largest distributor, which provides some competitive advantages related to scale and a broad distribution network, helping it stay ahead of competitors.
  • Key Competitors: They compete with smaller, local, regional, and national distributors, some of which also have manufacturing operations. Competition is further complicated by the presence of a vast amount of direct distributors that are close to the customers, and manufacturers who may attempt to disintermediate.
  • Barriers to Entry: Significant barriers to entry are primarily logistical in nature: A large distribution network, the ability to manage large inventories, and the capacity to deliver products to a wide range of customers quickly, which are hard for new entrants to establish.

Financial Analysis

POOL Corporation’s financials present a mixed picture of strength and near-term challenges.

  • Recent Performance (Q3 2023 Results):
    • Net Sales: $1.62B, a decrease of 13.1% compared to the same quarter last year.
    • Gross Profit: $418 million, down from the same period last year.
    • Operating Income: $304 million, also showing year-over-year decline.
    • Net Income: $125.7 million.
    • EPS (Diluted): $3.24 per share, a decline from $7.62 per share in the same quarter of 2022.

The slowdown in sales is attributed to reduced consumer demand for new pool constructions and lower replacement and maintenance spending by existing pool owners. Macroeconomic factors, such as continued inflation, have also negatively affected consumers’ willingness to splurge on big ticket items, such as pools and their maintenance.

  • Key Metrics:
    • Return on Invested Capital (ROIC): ROIC is crucial for the business model since it measures how efficiently the company is generating profit from its investments. Though not explicitly mentioned in recent quarterly reports, ROIC typically tracks with operating margins, which are declining as the business is facing headwinds.

The company will need to focus on maintaining and growing ROIC levels for the business to be sustainable. * Revenue and Sales: Growth is critical for the business since it needs to maintain and improve its distribution network. They have recently experienced a decline of 13.1% in their sales, and should be concerning for shareholders. In particular, the reduction in spending in discretionary items (such as pools and related equipment) has affected the company. * Profit Margins: Gross profit margins have been decreasing, as operating expenses remain mostly stable, impacting the overall operating profitability of the company. This trend needs to be investigated further to understand the main culprit behind the margin compression. * Liquidity: Pool Corp has a strong current assets position at $1.74B and total liabilities at $1.18B as of September 30th, implying that it has enough assets to cover short term liabilities, but it needs to maintain its liquidity in the face of slowing revenues.

  • Capital Expenditure: Capex has remained fairly consistent, with around $30 million spent in the third quarter of both 2022 and 2023. This trend is in line with what you might expect from a well-established business in the distribution sector.
  • Recent Acquisition Activities: The company has acquired several companies over the past few years, indicating a potential strategy of growth by acquiring smaller distributors. Further info about this was found in the 10-Q. However, they mention their M&A strategies could dilute their profits. This needs to be closely monitored by shareholders.
  • Concerns: Recent reports show signs of slowing demand, with revenue and profits declining. This, combined with the rising competition and the risk of failing to effectively integrate acquisitions, represents major risk factors for the company.

Economic Moat: 3/5

While Pool Corporation enjoys some competitive advantages, they aren’t wide enough to rate its moat any higher than a 3.

  • Network Effects: POOL has a vast and well-established distribution network, which is quite difficult to reproduce. This creates a barrier of entry for newcomers. Also, its wide network means that it can fulfill customer needs more easily than competitors.
  • Switching Costs: Pool and pool maintenance are very complicated and expensive for a customer. They don’t change suppliers too often. When you go to a pool store, you usually go to the same supplier each time, which creates a level of customer loyalty and helps POOL retain its customers. This increases customers’ willingness to pay.
  • Intangible assets: Brands are important in pool chemicals. This gives some companies a competitive advantage and allows for differentiation. However, Pool does not make the products themselves, they instead distribute them. This could potentially be a risk for their moat.
  • Scale Advantages: Pool has the most distribution centers and revenue among its competitors and also has multiple warehouses in the US. All of this implies that their per-unit cost is relatively lower, allowing for better profitability.

Risks to Moat and Business Resilience

  • Industry Cyclicality: The business is tied to the overall housing and leisure markets, making them cyclical. This makes their revenue highly dependent on these market conditions and the company would be negatively impacted by a global recession.
  • Competition: While they are the leader in their industry, they compete with both small players and large players, some with their own production facilities and are very aggressive. In particular, direct sales by manufacturers directly to consumers may disintermediate POOL, which could negatively impact margins.
  • Technological Changes: Any major shift in the product or technology landscape for pool construction and maintenance, could weaken POOL’s market dominance if they fail to adapt.
  • Integration Risk: The large amount of acquisitions pose a threat, as POOL may struggle to achieve the expected synergies of each merger and integration process. These failures could hurt their ROIC, if they are not careful.
  • Inflation and Interest Rates: Higher interest rates and inflation tend to affect discretionary spending which impacts their sales growth.
  • Weather: Their revenue and profitability is extremely dependent on the weather. A longer winter season, or increased rains and flooding may cause their sales to drop substantially, especially in their construction related businesses.

Understandability: 2 / 5

Pool Corp operates in a specialized market and requires a working knowledge of the pool industry.

  • The business model, though not overly complex, isn’t as easily grasped as a retail operation. As a wholesale distributor, the company has its own complexities in the supply chain. This is in contrast to something like a restaurant that is easier to understand and where most investors have experience as customers.
  • A thorough analysis of Pool requires some understanding of the financial aspects of a distribution business, as well as analysis of regional market conditions, weather, regulations, etc. Also, since the company has a focus on B2B sales, it is harder to understand the business directly from personal experience.

Balance Sheet Health: 4/5

POOL Corporation has a reasonably healthy balance sheet, but there are points that need to be closely monitored.

  • Debt Levels: POOL has a significant amount of debt on their balance sheet. However, their high ROIC generally allows them to service this debt effectively.
  • Liquidity: They have enough current assets to cover short term liabilities, meaning they have enough resources to keep their business going. However, it is imperative for them to maintain strong liquidity in the face of declining revenues.
  • Inventory Levels: Pool is facing the same issue that many other businesses are in- inventory levels are high. Inventory value increased substantially in 2022. As long as prices stay high, this won’t affect profitability. But once prices decline, they will need to liquidate the inventory while taking a hit to their profits.
  • Goodwill and Intangibles: They have high levels of goodwill in their books, representing a large portion of their assets. These have been a source of profit manipulation by many companies, and need to be closely monitored.
  • Assets: They have a large amount of receivables. Since their business is primarily B2B, they mostly receive revenues on credit. If the companies have trouble paying back their debt, or if their main debtors become more concentrated in a single buyer, they may face a liquidity crunch.

Recent Concerns and Management Response

In the Q3 2023 earnings call, management acknowledged the current challenges, such as lower-than-expected demand and higher interest rates, affecting consumer spending. They are attempting to offset this by focusing on operational efficiency and cost reduction, which is needed in this environment. The company has stated that they have seen an uptick in certain product lines such as chemicals, and they believe that the long-term market outlook is still solid, because of the necessary upkeep of existing pools in the US. * Their CFO stated that ““Given the current economic environment we are planning for flat to slightly down volumes over the next few quarters”” * They intend to maintain their aggressive share buyback program, and have a remaining 1.2 billion authorization available.

Conclusion

Pool Corporation has a moderately strong business model with a narrow economic moat based on their established distribution network and customer lock-in. They are operating in a fragmented industry with high levels of cyclicality, and the business has recently been hit hard by macro economic conditions and reduced consumer spending. Although the company can be easily understood at a high level, a more in-depth analysis is required to grasp the mechanics of its operations, making it a complex business to evaluate. They have a strong history of consistent profitability and returns on capital, a quality that needs to be maintained and improved if they are to maintain a high level of intrinsic value. Their balance sheet appears to be in good shape, but their debt levels need to be watched closely.