The Bull Case For Pool Corporation

With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in Pool Corporation POOL. Firms such as Balyasny Asset Management, Point72 Asset Management, and JP Morgan Chase have all added to their POOL positions recently. Most notably, Balyasny increased shares held by 233.93% (as filed on 9/30), bringing their total POOL holdings to 384,496 shares worth $136.5 million dollars at current market prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Pool Corporation.

In October, Pool Corporation reported Q3 earnings for fiscal year 2023. The earnings were very positive, with the business recording net sales of $1.5 billion dollars, the second highest net sales in the third quarter in the business’ history. This was down 9% from the third quarter of FY22, which was the highest recorded net sales in the third quarter in the business’ history. Despite post-Covid demand headwinds due to declining new pool construction (lowest level since 2016), which makes up 17% of the business’ revenue profile, Pool Corporation has seen little impact on their top line net sales and revenue. With 61% of their revenue profile coming from maintenance (those with pools must constantly maintain them, or they risk home price degradation, leading to very sticky spend), and 22% coming from renovation and remodel, it is evident that Pool Corporation’s revenue profile is allowing them to remain relatively unscathed from new pool construction declines and general post-Covid demand headwinds. Additionally, during the quarter, Pool Corporation expanded their sales center network through two greenfields, leading to a total of 14 new sales center locations during the year, including four acquired locations. With this positive earnings result in mind, we took a deeper look at some of the reasons why many investors may be bullish on Pool Corporation.

Pool Corporation is the world’s largest wholesale distributor of swimming pool supplies, equipment and related leisure products, and is one the leading distributors of irrigation and landscape products in the United States. As of December 31st, 2022, Pool Corporation operated 420 sales centers (plus an additional 14 new locations added YTD) in North America, Europe, and Australia through five distribution networks (SCP Distributors, Superior Pool Products, Horizon Distributors, National Pool Tile, and Sun Wholesale Supply Inc.)

Pool Corporation operates within the swimming pool industry, an industry that is expected to continue to grow perpetually at LSD with the increased penetration of new pools into households with the discretionary income and physical capacity to install a swimming pool. As the installed base of pools grows at LSD in the United States, significant growth opportunities also reside with pool remodel and pool equipment replacement activities due to the aging of the installed base of swimming pools. Management recognizes multiple favorable demographic and socioeconomic trends that have positively affected Pool Corporation’s industry, with management further believing that these trends will continue to play out in the long term. These factors include, and are not limited to, long-term growth in housing units in warmer markets due to population migration towards the southern United States, increased homeowner spending on outdoor living spaces, stay-at-home and remote work trends as homeowners seek to create attractive areas in their backyards as an extension of their home space, and consumers using more automation and control products, higher quality materials, and other pool features that add to Pool Corporation’s sales opportunities over time. The consistent growth of the installed base of in-ground swimming pools and the recurring nature of pool maintenance and repair gives Pool Corporation’s industry favorable characteristics that help cushion the negative impacts on revenues during unfavorable economic conditions and softness in the housing market, which often hurt consumer discretionary spending.

Pool Corporation serves roughly 125,000 customers, most of which are small, family-owned businesses. No single customer accounted for more than 10% of sales during FY 2022. Pool Corporation largely sells to contractors, and not the end-users of their products. This means that the pricing of their products are obfuscated by the contractors, who also charge end-users for time and labor. This gives Pool Corporation an interesting investment proposition, as this business model of selling to contractors gives Pool Corporation pricing power to annually increase the price of their products, as contractors pass on those prices to the end-users of Pool Corporation’s products. While these contractors also buy from mass merchants, home stores, distributors, and other specialty retailers (Pool Corporation’s competition), Pool Corporation has massive leverage due to this size. Pool Corporation is 4x larger than the next biggest player in the space, and the business uses this size to offer the most products at the lowest prices.

Management is solid, and their capital allocation priorities do a good job of aligning management and shareholder interests. Management likes to plow back a portion of the cash provided by operations into share repurchases. In FY22, Pool Corporation generated cash provided by operations of $471.2 million dollars for the year, with management repurchasing shares to the dollar amount of $484.9 million dollars. In addition to these share repurchases, management also issued quarterly cash dividends over the fiscal year that totaled to $150.6 million dollars. Therefore, in total, Pool Corporation returned around $635 million dollars to shareholders during FY22, nearly 5% of the current equity value of the business. As we can see, Pool Corporation handsomely rewards shareholders through share repurchases and quarterly cash dividends, returning excess cash. As a shareholder, it is important to invest into businesses where the management team treats shareholders like partners in the business, and it seems in this case, management does treat shareholders like partners in the business, returning excess cash and increasing shareholder value consistently.

In terms of management incentives, management is incentivized well with a compensation structure that incentivizes management to meet strategic long-term financial goals and build equity in the business via equity rewards, which help align management and shareholder interests. The NEO compensation structure includes a base salary, an annual cash incentive / bonus, strategic plan incentive program (SPIP), and long-term equity awards. In FY21 and FY22, the annual cash incentive included ROIC as a threshold performance metric. In order for the bonus pool to be paid out, ROIC has to be above 10%. ROIC came in at nearly 30% over FY22, meaning bonuses were paid out to NEOs for meeting the threshold requirement. In addition to this general NEO bonus, each NEO was granted potential bonus opportunities based upon thresholds relevant to their line of work, giving management further incentive to meet their specific thresholds, in addition to thresholds important to the business in general (ROIC for example). SPIP, or the medium-term cash reward, is based on three year diluted EPS CAGR. Thresholds for the SPIP go up to 20%, meaning that management is aggressively incentivized to grow EPS at a CAGR of up to 20%.  Management believes that EPS growth correlates strongly with the business’ stock price growth over the long term, meaning that this incentive is strongly related to the business’ stock performance. With EPS growing at a CAGR of nearly 19% within the last decade (which we will cover later), management has a history of meeting the upper thresholds of the EPS benchmark. Lastly, with long-term equity rewards being vested over 3-5 years, management is able to build long term equity in the business, further aligning shareholder and management interests. As we can see, NEO compensation structure incentivizes management to meet important and strategic financial thresholds within the business while building up long-term equity in the business, doing an excellent job of aligning shareholder and management interests.

Pool Corporation is an efficient business. The business currently operates at a LTM ROE of 41.7% and a LTM ROIC of 27.6%. With a WACC of 9.7%, Pool Corporation currently operates at a ROIC to WACC ratio of 2.84x, showcasing the business’ ability to generate returns on cash reinvested back into the business at rates of return far higher than the business’ weighted average cost of capital. Businesses that are able to efficiently reinvest cash back into the business at favorable rates of return are considered to be compounders, businesses that are able to rapidly compound intrinsic value over the long-term, handsomely rewarding shareholders. From FY20 to FY22, Pool Corporation increased retained earnings at a whopping CAGR of 69.6%, retaining excess earnings from pandemic demand tailwinds. With $811 million dollars worth of retained earnings on the balance sheet (LTM), Pool Corporation has plenty of dry powder to reinvest back into the business at favorable rates of return (including acquisitions), repurchase shares, and/or offer / increase a dividend. Analyzing Pool Corporation’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2014, Pool Corporation has grown revenue at a CAGR of 9.6%, with gross profit growing at a CAGR of 10.1% in that same time period. Gross margins have stayed relatively flat within the last decade, hovering around 29% - 31%. In terms of earnings, Pool Corporation has grown EBITDA at a CAGR of 14.8% since 2014, with EPS growing at a CAGR of 18.7% in that same time frame. This growth in EPS can largely be attributed to share repurchases. Since 2014, shares outstanding have decreased by 11.3%.

Looking at Pool Corporation’s balance sheet, we can see that the business is operating in sound financial health. The business currently holds around $85 million dollars worth of cash and equivalents on the balance sheet, with no short term borrowings and $996 million dollars worth of long-term debt. While this low cash to long-term debt ratio may be a red flag for some investors, we believe that this isn’t something to be too worried about. In terms of short term liquidity, the business currently operates at a current ratio of 2.58x, signifying that the business has 2.58 times the amount of assets compared to liabilities. In terms of long-term solvency, the business currently operates at an interest coverage ratio of 12.57x, meaning that the business generates $12.57 in EBIT (earnings before interest and taxes, also known as operating income) for every dollar of interest expense that the business incurs. Furthermore, with over $800 million dollars in retained earnings (which can be used to pay down the debt if needed) and around $1.1 billion dollars in net working capital (as of the business’ most recent 10-Q), the business has plenty of runway to cover its debt obligations and continue to operate efficiently. So, while the business has high long-term debt obligations in relation to its cash holdings, the business has plenty of runway from retained earnings and net working capital to continue to operate efficiently, all while having additional runway to cover debt obligations.

Analyzing Pool Corporation’s cash flow statement, we can see some stellar sustained growth in net income and free cash flow, showcasing the business’ increased operational efficiency. Since 2014, net income has grown at a CAGR of 17.3%, while free cash flow has grown at a CAGR of 23.6% in that same time frame. This growth in free cash flow can largely be attributed to expanding free cash flow margins. In 2014, Pool Corporation operated at a free cash flow margin of 4.7% of revenue, compared to today where the business operates at a LTM free cash flow margin of 15.4% of revenue. This handsome expansion in free cash flow margins allows the business to generate more free cash flow from revenue (which is exacerbated by strong YoY revenue growth), which the business can use to further reinvest back into the business, repurchase shares, and / or increase / offer a dividend, as mentioned before.

After conducting a reverse discounted cash flow analysis, we found that Pool Corporation is trading at share prices that imply a 3.87% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 9.7% (Pool Corporation’s WACC). Pool Corporation is a high quality business, and we believe that this growth rate of free cash flows implied by current share prices is low. While past performance is not indicative of future results, Pool Corporation was able to handsomely expand free cash flow margins, and in turn, expand free cash flow (at a CAGR of 23.6% since 2014). If revenue continues to expand at a mid to high-single digit CAGR, and free cash flow margins continue to incrementally expand, we conservatively believe that Pool Corporation will be able to grow free cash flow in a range of 5-7% (CAGR) within the next ten years. This implies a share price range of $381.70 - $435, implying a 7.6% - 22.63% upside from current share prices (remember, this is a conservative estimate based on historical revenue and free cash flow growth rates). While our models have led us to this valuation, we encourage all investors to do their own due diligence and arrive at their own valuation. This valuation was purely based on our proprietary models.

Keep an eye out for POOL stock’s latest news, data, and more with Quiver Quantitative.