Bullish View Expects Data Center And Waterworks Expansion Will Reshape Long Term Prospects

Catalysts

About Ferguson Enterprises

Ferguson Enterprises is a distributor of plumbing, HVAC, Waterworks and industrial products serving residential and nonresidential construction and repair professionals across North America.

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

• Rising demand for large capital projects such as data centers, pharma and manufacturing facilities is feeding a growing project pipeline. Management highlights this through strong growth in Commercial/Mechanical and Waterworks, and this can support higher revenue and earnings as Ferguson captures more multi-year work.
• The company is leaning into the build out of data centers, where it already sees data center work at a bit over half of its large capital project revenue. Its ability to support modular construction and complex logistics can help it win a greater share of project content over time, supporting revenue density and operating margin.
• Expansion of HVAC counters, dual trade locations and OEM relationships is aimed at capturing more repair and replace activity and the dual trade contractor trend. This can lift HVAC revenue and, over time, help support gross margin through better mix and scale benefits.
• Ferguson is steadily consolidating highly fragmented markets through bolt on acquisitions and investing in fabrication, valve actuation, automation and virtual design services. This can widen its service offering per project and support operating margin and earnings growth as more value is captured from each job.
• A focus on Waterworks diversification into public works, general municipal, meters and metering technology positions the business to benefit from long term investment in aging water and sewer infrastructure. This can underpin recurring project flow and support more stable revenue and operating profit.

Assumptions

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

• The bullish analysts are assuming Ferguson Enterprises's revenue will grow by 7.4% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 6.3% today to 6.7% in 3 years time.
• The bullish analysts expect earnings to reach $2.6 billion (and earnings per share of $12.81) by about January 2029, up from $2.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bullish analyst cohort, the company would need to trade at a PE ratio of 27.4x on those 2029 earnings, up from 22.8x today. This future PE is greater than the current PE for the GB Trade Distributors industry at 21.4x.
• The bullish analysts expect the number of shares outstanding to decline by 1.59% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.24%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Ferguson is leaning heavily on large capital projects such as data centers, pharma and manufacturing facilities, which currently represent only mid to high single digits of total company revenue and have longer gestation periods and potential lumpiness. Any slowdown, delay or cancellation in this project cycle could reduce nonresidential growth and put pressure on revenue and earnings.
• Residential end markets account for roughly half of U.S. revenue and are described as challenged, with weak new housing starts, permits and softer repair, maintenance and improvement activity. A prolonged weak housing cycle would make it harder for residential revenue to recover and could limit overall earnings growth.
• The HVAC business declined 6% in the quarter against a prior 9% comparable and management highlights continued pressure from efficiency standard changes, higher equipment prices and a consumer leaning toward repair rather than replace. If this repair bias and weak demand persist longer than expected, HVAC revenue and net margins could remain under pressure.
• Canada is described as subdued, particularly in residential, with operating profit of US$16 million that is US$7 million below last year. If those conditions become more entrenched and acquisitions fail to offset them, segment profitability and consolidated earnings could be weaker than hoped.
• Ferguson is investing heavily in working capital, CapEx, acquisitions and trainee and counter expansion while also returning large amounts of capital through dividends and buybacks. If growth slows at the same time as pricing normalizes and gross margin benefits fade, the company could see tighter free cash flow, reduced operating leverage and pressure on net margins.

Valuation

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

• The assumed bullish price target for Ferguson Enterprises is $300.0, which represents up to two standard deviations above the consensus price target of $259.77. 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 bullish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $300.0, and the most bearish reporting a price target of just $201.0.
  
• In order for you to agree with the more bullish analyst cohort, you'd need to believe that by 2029, revenues will be $38.6 billion, earnings will come to $2.6 billion, and it would be trading on a PE ratio of 27.4x, assuming you use a discount rate of 8.2%.
  
• Given the current share price of $227.6, the analyst price target of $300.0 is 24.1% higher.
  
• 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.