Our view: Doman Building Materials Group Ltd. ("Doman") reported Q221 results that were below our expectations but largely in line with consensus as the rapid decline in lumber and panel pricing left Doman holding onto high-priced inventory. Although we expect results will be choppy over the next few quarters, we still like the Doman story as the company generates significant cash flow and integrates recent acquisitions. Therefore, we are reiterating our Outperform rating.
Key points:
We are reducing our price target -$1 to $11.00 and reiterating our Outperform rating – Our price target reflects a ~8.0x EV/EBITDA multiple (from 7.0x previously) on our 2022E EBITDA of ~$231MM. Our revised price target reflects our lower 2022E EBITDA estimate, partially offset by an increased multiple due to the company’s increased scale and reduced execution risk going forward.
Margins should be lower in Q3, but we expect a normalization into 2022 – Management noted on the call that declining construction material prices are likely to result in below average margins during Q3 before normalizing in Q4. In 2022, we expect that the full year contribution from Hixson Lumber will have a positive impact on margins. We expect that Doman will work higher priced inventory out of its system during the quarter, which should position the company to get back to business as usual going forward.
Order files have started to rebound following the price correction – After writing down inventories by ~$19MM, management expects the majority of the damage has been done and no further inventory write downs in Q3 are expected. Management does see light at the end of the tunnel as orders trickle in from clients they haven't seen in weeks with volumes levels expected to recover to pre-pandemic levels going forward. We expect to see some support from the demand side of the equation as contractors look to wrap up projects before the seasons change and the home improvement market recovers as summer leisure activity slows.
Acquisitions remain a key part of Doman's growth trajectory – Management reiterated on the call that acquisitions remain a large part of Doman's growth story. With Hixson Lumber closing in Q2 Doman was able to add 19 lumber treating plants, five specialty sawmills, and a captive trucking fleet to its operations. The guidance of the transaction being more than 55% accretive on both an earnings per share and free cash flow per share basis holds even with the decrease in prices in Q2.
Doman underperformed peers during Q2 – After a record quarter for construction materials pricing, we took a look at how Doman's EBITDA increased q/q relative to peers. We think the +57% q/q increase in EBITDA was underwhelming considering how it compared to its peers (Taiga +88% & Boise Cascade's BMD segment +68%) and the benefit of ~1 month of Hixson Lumber results. Management noted the underperformance was a result of carrying large inventories as prices began to roll over in May and throughout the end of the quarter.