Flyover Stock: Core & Main (CNM)
Flyover Stock: Core & Main (CNM)
A water-focused distributor led by industry veterans that's poised to capitalize on much-needed water infrastructure spending in the coming decades
Executive summary
Core & Main was once a part of HD Supply. In 2017, Clayton, Dubilier & Rice (CD&R) acquired HD Waterworks, which became Core & Main, and the company went public in July 2021. CD&R remains a majority shareholder.
Core & Main’s CEO, CFO, and company presidents have worked together since HD Supply and made dozens of acquisitions.
Demand for water, wastewater, storm drainage, and fire protection infrastructure should remain steady in the next decade and beyond due to chronic under-investments in infrastructure and housing.
One of only two national distributors in its key end markets.
Introduction
In a recent post called 5 Signs of a Flyover Stock, I highlighted a few attributes that pique my interest: a funny or non-obvious name, headquartered outside of major cities, unglamorous work, slow but steady growth, and low/limited analyst coverage.
Core & Main checks off at least three of those attributes.
Its name is non-obvious. If you glanced at the name, you might think it was a fashion retailer rather than a national water, wastewater, storm drainage, and fire protection infrastructure distributor.
Water pipes, fittings, and drainage systems are decidedly unglamorous – yet mission-critical to our economy and lifestyles.
The end markets are growing low-to-mid single digits, though C&M is growing faster than the industry, for reasons we’ll discuss in a moment.
Over the past year or so, I’ve heard good pitches for Ferguson, C&M’s major U.S. competitor, but not C&M. While C&M has decent analyst coverage, it has a decidedly smaller following than Ferguson. As a data point, 3,080 people are following Ferguson on Seeking Alpha, and just 1,300 are following Core & Main. Both companies’ followings pale compared to other industrial distributors like Fastenal (24,300) and Grainger (20,500).
One reason it flies under the radar is because the St. Louis-based company has only been an independent company since 2017 and publicly traded for over two years. The company’s leadership, however, has been together for over a decade. As we’ll discuss in a moment, CD&R returned to buy HD Waterworks (now Core & Main) after it sold out of its HD Supply investment in 2014. There must’ve been something they liked about that business.
Business overview
Market cap: $6.5 billion
Revenue TTM: $6.63 billion
Net debt: $1.6 billion (1.7x Adjusted EBITDA)
P/E Ratio (forward): 12.8x
Number of analysts covering: 14
All market data as of September 29, 2023
The amount of innovation occurring in various parts of the economy is head-spinning. Technology like AI, autonomous vehicles, and robotics will impact many industries and companies. To illustrate, these innovations will affect the retail and restaurant industries – it’s just a matter of how much and which companies survive. This makes for less certain terminal value assumptions, which accounts for most of your fair value estimate in a DCF model.
In contrast, there are better odds that water infrastructure will be roughly the same a decade from now. If anything, it’s a beneficiary of technology, as has been the case with the introduction of smart meters, which allowed utilities to read meters wirelessly rather than having someone walk door to door every month or quarter.
While technology can help utilities and municipalities monitor system efficiency, ultimately, there’s no code-writing or robotic substitute for old, corroding pipes. That’s going to require good old-fashioned digging in the mud.
And a lot of digging will be needed in the coming decades. According to studies by Bluefield Research, the average age of wastewater pipes in the US is 45 years, up from 20 years in 1970.
Moreover, over 600 municipalities still use 200-year-old cast iron pipe systems. A recent example of the underinvestment in municipal storm drainage systems can be seen in New York City this past week, where streets and subways flooded after a significant rainstorm.
Even in my tiny Cincinnati suburb, I receive at least 2-3 alerts per month from the city alerting me to road closures due to water main breaks or leaks.
According to a 2021 McKinsey study:
“The need for investment in the US water system is at an unprecedented level. On average, 14 to 18 percent of total daily treated potable water in the United States is lost through leaks, with some water systems reporting water-loss rates exceeding 60 percent. Much of the nation’s water and wastewater infrastructure was built in the 1970s and 1980s. Since then, the share of federal capital investment has declined, putting the majority of capital-funding responsibility on state and local governments, which are increasingly juggling funding priorities.” (my emphasis)
In 2020, the American Society of Civil Engineers and the Value of Water Campaign released a study that estimated that, on top of the roughly $1 trillion already expected to be spent on US water infrastructure through 2039, the US needs to spend an additional $2.2 trillion to modernize its water infrastructure.
We should be skeptical of a projection from two groups who stand to benefit from more water infrastructure spending, but they're directionally correct. It's time to address the problem. They're also right that investing in water infrastructure has massive economic benefits, such as reduced water service disruptions to businesses and faster weather disaster recoveries.
Enter Core & Main, which is one of only two national coast-to-coast distributors of water, wastewater, storm drainage, and fire protection products. The other national competitor is the Ferguson, which we’ll compare with C&M.