8 reasons to buy consumer goods stock Hardwoods

Key stock Hardwoods Distribution is acquiring Rugby Architectural Building Products, which operates across the U.S. Hardwoods expects the acquisition to add to its earnings per share and cash flow. It will raise its dividend again. Hardwoods remains a buy for long-term share price gains as well as modest, growing dividends.

B.C.-based Hardwoods Distribution (TSX─HWD), one of our Key consumer stocks, continues to build its business. It will pay US$107 million for the ‘friendly’ acquisition of U.S.-based Rugby Architectural Building Products. Depending upon how well Rugby does, the acquisition price could rise by another US$13 million. Hardwoods is smart to make an acquisition in its own industry. It remains a buy for further long-term share price gains and modest, growing dividends.

Rugby is “a leading US wholesale distributor of non-structural architectural grade building products.” Its customers supply products to the commercial, industrial, retail, residential and institutional construction markets. The company’s 31 facilities serve more than 22,000 national, regional and local customers in 48 states.

The acquisition should pay off

Hardwoods’ president and chief executive officer Rob Brown said: “This is a highly strategic business combination that brings together two successful, growth-oriented companies to create the number one distributor in our industry.”

The acquisition should assist Hardwoods in a number of ways.

First, it makes Hardwoods the largest distributor of hardwood lumber, panel and interior architectural building materials. Add Hardwoods’ existing regional 25 locations to Rugby’s 31 and the combined company has 56 locations.

Second, Hardwoods expects the acquisition to immediately increase its earnings per share and its cash flow. The company expects these benefits to grow after the acquisition closes. It writes: “Hardwoods has also identified significant synergies, including operational, structural and revenue efficiencies that are expected to provide further upside to the immediate accretion.” In the year to March 31, Hardwoods’ adjusted EBITDA would’ve advanced by nearly 31 per cent, to C$53 million. (EBITDA, or Earnings Before Interest, Taxes, Depreciation and Amortization, measures a company’s underlying earnings.)

Third, thanks to the higher expected earnings, Hardwoods plans to raise its dividend again. It will climb by 13.6 per cent, to 25 Canadian cents a share. Based on the share price, the dividend will yield a modest 0.75 per cent. Then again, Hardwoods is a ‘dividend aristocrat’. It has raised its dividend every year since it first began paying them in 2011. This means that you can expect to earn growing dividends. In addition, Hardwoods expects its higher earnings will improve its payout ratio to 17.8 per cent. (A payout ratio is the dividend per share divided by the earnings per share). This ratio means the dividends are safe and have room to rise further.

Fourth, the acquisition significantly increases Hardwoods’ scale. Hardwoods and Rugby generated combined sales of C$1 billion in the 12 months to March 31. This was 68 per cent higher than Hardwoods’ sales of C$595 million in the dozen months. We may raise Hardwoods’ quality rating. With the acquisition expected to close this month, we’ll look at Hardwood’s total assets for September 30.

Fifth, it greatly diversifies Hardwoods’ revenue by end-market. One of Hardwoods’ principal strategic objectives was to raise its presence in the commercial market. Following the acquisition, Hardwoods’ commercial sales are expected to jump to 35 per cent of total sales, from 20 per cent today. This reduces its exposure to any one market.

The acquisition will benefit this consumer goods stock

Sixth, the acquisition diversifies Hardwoods’ revenue geographically. Indeed, it will significantly increase Hardwoods’ presence in the Eastern U.S. That’s because Rugby derives 40 per cent of its sales in Northeast and Southeast states, from 15 facilities. This reduces Hardwoods’ exposure to economic conditions in any one region.

Seventh, the acquisition diversifies Hardwoods’ revenue by customer. With more than 22,000 new customers, its exposure to any one customer is limited. Even better, Hardwoods’ consumer goods product offering has expanded. Rugby carries 36,000 products from 800 suppliers. This means that customers can likely buy everything they need from Hardwoods.

Eighth, Rugby gives Hardwoods a platform for further growth in the U.S. Rugby itself completed and integrated 17 acquisitions since 2009. Hardwoods writes: “Rugby management has identified a robust pipeline for future acquisitions in the U.S. which Hardwoods believes will enhance its ability to further execute on its acquisition strategy.” That is, it plans to keep on building its business.

Hardwoods will pay with cash and shares

Hardwoods says that the purchase price is made up of two parts: cash of US$100 million and 563,544 Hardwoods shares valued at US$7 million. The company will borrow about US$65 million to put towards the purchase price. It has set up a credit facility of US$135 million with an American bank. Hardwoods expects its debt to total C$120 million, when the acquisition closes.

Hardwoods can afford to take on some debt. On March 31, it’s net debt-to-cash-flow ratio was a safe 1.1 times. That’s within our standard comfort zone of two times or less. After closing the acquisition in July, Hardwoods plans to use its cash flow to reduce the debt.

Hardwoods has also raised about C$50 million through a ‘bought deal’. That is, a group of investment dealers wrote Hardwoods a cheque for 3,449,000 subscription receipts which will later turn into shares. If demand is strong, the underwriters can sell another 517,350 subscription receipts. This would give Hardwoods gross proceeds of nearly $5.2 million. Issuing shares should limit the increase in its debt-to-equity ratio.

One thing that we like is that Rugby’s president and its chief operating officer will remain in place. They know their industry well. This should minimize any disruption and increase the chances of achieving a smooth integration of Rugby. The potential additional payment of up to US$13 million gives Rugby’s top management a reason to do a good job.

 

The Investment Reporter, MPL Communications Inc.
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