An Update on Our Investments in Building Products Companies

This article is authored by MOI Global instructor Phil Ordway, Managing Principal at Anabatic Investment Partners, based in Chicago, Illinois.

Armstrong (AWI) shares fell 3.6% in 2018 but the company is performing in line with our expectations and its prospects have improved in a few important ways since we first invested three years ago.

After spinning off its low-margin, underperforming flooring segment in April 2016, Armstrong completed its restructuring in 2018 by closing the sale of its international operations to Knauf for $250 million in net cash. I think it was a good decision for the company. The price was attractive, and it removed a complicated, low-margin segment while allowing management to focus on the better markets in the company’s portfolio. It also reinforced the balance sheet, which is now as strong as it has been in many cycles. The company’s competitive position and market share remain dominant, and its lead has widened in several key categories.

Capital allocation remains crucial and it is at the top of my list of concerns. By the end of next year Armstrong will have allocated between a half billion and $1 billion of capital over the preceding 24-36 months.^[1] The board recently approved the initiation of a small dividend to go with its previous (and small) accelerated share repurchase program and its ongoing open-market share repurchases. Now more than ever the company’s capital allocation decisions will determine our fate as investors.

Builders FirstSource (BLDR) share price tanked as the market turmoil spread in the fourth quarter of 2018. The year presented numerous challenges for the company. Commodity prices whipsawed the homebuilding industry, and the volatility in the price of lumber – a key product for BLDR – was exceptional. After hitting $639 per 1,000 board-feet on May 17, 2018 – an all-time record that was far higher than previous cyclical highs – lumber collapsed by almost 50% and finished the year down 26%. A weaker housing market, tariffs, wildfires, and delivery bottlenecks all hindered the company.

Despite everything that went wrong in 2018 there is a better story to tell looking forward. BLDR continues to entrench its business as the low-cost distributor and supplier of choice in its markets. Regardless of the exact number of housing starts in any given year, the country needs more housing over time and BLDR will be a prime beneficiary.

Even a “bad” year like 2018 wasn’t so tough – the company was very profitable, generating copious free cash flow that further deleveraged the balance sheet. The shares could remain volatile, but it is worth remembering the business outlook and the odds implied by the current market price.

^[1] Including the cash received from Knauf.

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