Core & Main: A Core Business, Still Commands A Premium Valuation (NYSE:CNM)

When Core & Main, Inc. (CMN) went public in the summer of 2021, I concluded that a “main business” was not the same as a “main position.” The distributor of (waste) water goods has seen a solid operating performance, and enjoyed decent long-term growth prospects, yet it were the demanding valuations, which made me a bit cautious.

Fast forwarding nearly three years in time, shares have more than doubled even after a big pullback following the first quarter results. The company seems high quality and still trades at a premium valuation, although I am keen on initiating a position on further dips here.

The Business

Core & Main is a distributor of products in specialized markets, including water, waste water, drainage and fire protection, among others. These products are typically distributed to municipalities, water companies and professional contractors. The company claims to hold a leading position in these specialized markets, at the time of the offering measuring $27 billion, as the market has grown some 50% ever since.

Typical applications to think of include pipes, valves and fittings which are responsible for about two thirds of sales. This is complemented by storm drainage products, fire protection and meters, combined responsible for the remainder of sales.

Around that time, the company distributed products which it gathered from over 4,000 suppliers to some 60,000 customers across 285 branches, as these numbers have grown over time to over 350 branches, now supplied by more than 5,000 suppliers. The scale, technical knowledge, as well as broad product portfolio stood at the basis of its success. In terms of new construction and maintenance, the split was pretty evenly distributed.

Private equity firm Clayton, Dubilier & Rice cleverly bought the business back in 2017 at a $2.5 billion valuation, as the company has seen growth on the back of organic achievements and dealmaking ever since. In the summer of 2021, the company was brought public as 327 million shares outstanding, valued the business at $7.9 billion, including net debt.

This was applied to a business which posted 2020 sales at $3.6 billion, on which operating profits were reported of $185 million, for margins equal to 5%, although that it was somewhat depressed by amortization charges, which unfortunately were not broken out. A 20 times sales multiple and unknown realistic profits multiple looked a bit demanding, as I lost sight of the shares, although I really like the business from a positioning point of view.

Forwarding In Time

The cautious stance initially served me well, as one and a half years following the IPO, shares were trading flat at $20. Shares saw real momentum through 2023, though, when they double to $40 per share, and a momentum run pushed shares up to the $60s in May. Shares are now back to $48 as the latest earnings release clearly disappointed investors.

Nonetheless, shares have doubled since the public offering, translating into handsome returns. Investors have gotten used to the bolt-on acquisition strategy of the business, as the investor relations section is filled with press releases of bolt-on acquisitions.

In March, the company posted its fiscal 2023 results, a year in which revenues were up just a percent to $6.7 billion, yet that was up nearly three billion from the 2020 sales results, aided by growth, inflationary pressures and continued dealmaking. Contrary to the time of the IPO, the company has posted solid earnings, with operating profits of $740 million (GAAP accounting) resulting in low double-digit margins. Following a substantial interest to non-controlling interests, earnings came in at $2.15 per share.

The company operated with about $1.9 billion in net debt, with EBITDA posted just over $900 million, for a leverage ratio just over 2 times. Moreover, the company guided for growth in 2024, seeing sales at $7.5 billion (plus or minus one hundred million). Adjusted EBITDA was set to rise by forty million to a midpoint of $950 million.

With earnings power topping $2 per share after a somewhat more difficult year, it was easily understood why shares traded at $40 at the start of the year, as a secular growth play traded at a high-teens earnings multiple, in fact, at 18-19 times earnings. However, with earnings set to rise by $0.20-$0.25 per share in 2024, it was the move to the $60s which over extended the valuation a bit recently. After all, 50% year to date returns through May followed a strong year for the shares in 2023 already.

A Problematic Quarter

Early in June, Core & Main reported a 10% increase in first quarter sales to $1.74 billion, aided by five tuck-in deals which closed during, or after the quarter, with the cash flow statement revealing over half a billion spent on dealmaking. In fact, growth was largely aided by this, as the company witnessed some margin pressure, with first quarter earnings down a penny to $0.49 per share.

Problematic is that trailing EBITDA fell to $907 million now, pushing up leverage to 2.7 times, being a bit high, but still manageable. Nonetheless, the company actually hiked the midpoint of the full year sales guidance to $7.55 billion on the back of dealmaking, with EBITDA seen at a midpoint of $955 million. This should avoid leverage concerns, but the issue is that earnings power is likely stuck around $2 and change. Subsequently, some air has come out of the stock at as a $60 stock now trades at $48, levels seen as recent as March.

Working with a $2.25 per share earnings estimate, valuations have come down a bit to 21 times, but amidst lackluster organic growth and some leverage, this is still far from a very compelling entry multiple.

What Now?

The truth is that Core & Main is a great business, which is focusing on bolt-on M&A to grow its current 17% market share in a hugely growing $39 billion market segment. The reality is that continued M&A feels a bit rushed amidst a softer performance more recently, pushing up leverage a bit, although that lack of dividends means that deleveraging can be quick if capital allocation stops.

The reality is elementary: Core & Main, Inc. shares have gotten overextended recently, and the current 15% pullback seems fair in reaction to elevated expectations. Amidst all this, I am glad that Core & Main, Inc. shares have resurfaced on my radar again, and while I like the fundamental business, I am hoping for a better entry point. All of this makes me willing to start a position in the lower $40s.