Data Center And Housing Tailwinds Will Shape A Balanced Long Term Outlook

Catalysts

About Ferguson Enterprises

Ferguson Enterprises is a leading distributor of plumbing, HVAC, waterworks and industrial products, providing end to end solutions for residential and nonresidential construction professionals.

What are the underlying business or industry changes driving this perspective?

• Although data center and other large capital projects are currently generating double digit growth in Commercial and Mechanical and Waterworks, the extended gestation periods and potential project lumpiness could slow order conversion. This may temper the pace of revenue growth and limit further operating margin expansion.
• While underbuilt and aging U.S. housing stock should eventually support a rebound in residential demand, the continued weakness in new housing starts, permits and repair, maintenance and improvement activity may prolong volume pressure in Residential Trade Plumbing and Ferguson Home. This could constrain top line growth and mix driven gross margin gains.
• Although HVAC demand should benefit over time from higher efficiency standards, a pressured consumer, the shift toward repair versus replace and tough industry conditions may delay a return to growth. This may weigh on HVAC revenues and dampen overall earnings growth despite recent cost leverage.
• Despite a healthy pipeline for bolt on acquisitions in fragmented end markets, integration risk, execution complexity and the need to preserve balance sheet flexibility at around 1 to 2 times net debt to EBITDA could limit the pace of deal making. This may moderate the contribution of acquired revenue and any associated net margin upside.
• While investments in trainees, counter conversions, fabrication and digital tools are designed to sustain share gains and improve construction productivity, elevated ongoing SG&A and CapEx requirements, including roughly $350 million of annual capital expenditure, may cap further operating margin improvement and keep earnings growth closely tied to modest mid single digit revenue increases.

Assumptions

This narrative explores a more pessimistic perspective on Ferguson Enterprises compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Ferguson Enterprises's revenue will grow by 4.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.3% today to 6.8% in 3 years time.
• The bearish analysts expect earnings to reach $2.4 billion (and earnings per share of $12.03) by about December 2028, up from $2.0 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $2.7 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 20.0x on those 2028 earnings, down from 22.5x today. This future PE is greater than the current PE for the GB Trade Distributors industry at 19.9x.
• The bearish analysts expect the number of shares outstanding to decline by 2.2% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.2%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Large capital projects such as data centers are becoming a structurally bigger part of Ferguson’s mix, with mid to high single digit exposure to these projects and a growing pipeline. If this trend is sustained, it could drive faster than expected revenue growth and operating margin expansion through higher value added services and project density. This could lift earnings above a flat share price scenario and support a higher valuation multiple via stronger operating margins and EPS.
• Multiyear structural tailwinds in U.S. nonresidential construction and the underbuilt and aging housing stock provide a long runway for both residential and nonresidential demand. Any normalization from today’s weak residential environment and continued double digit nonresidential growth could accelerate top line growth beyond mid single digits and enhance scale driven margin leverage, which could push net margins and earnings progressively higher.
• Ferguson’s healthy balance sheet at 1.1 times net debt to EBITDA and strong free cash flow, combined with a robust bolt on M&A pipeline in highly fragmented markets, creates scope for accretive acquisitions. These acquisitions could raise the company’s long term growth rate and profitability profile, potentially leading to higher revenue, improved operating margins and faster compounding of earnings than implied by a flat share price outlook.
• Ongoing investments in trainees, counter conversions, fabrication, technology and digital tools, including 650 dual trade counter conversions and expanded HVAC and Ferguson Home capabilities, are designed to fuel share gains and above market organic growth. If these initiatives continue to outperform subdued end markets, they may structurally lift gross margin and SG&A leverage, supporting higher sustainable operating margins and earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Ferguson Enterprises is $207.12, which represents up to two standard deviations below the consensus price target of $259.91. This valuation is based on what can be assumed as the expectations of Ferguson Enterprises's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $310.0, and the most bearish reporting a price target of just $194.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $35.3 billion, earnings will come to $2.4 billion, and it would be trading on a PE ratio of 20.0x, assuming you use a discount rate of 8.2%.
  
• Given the current share price of $224.66, the analyst price target of $207.12 is 8.5% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.