Finding Growth in Unexpected Places: Cyclical Industries
Published on September 5, 2018
Jim Callinan explores three firms from traditionally slow-growing cyclical industries that he believes are building businesses well-positioned to outperform the market.
Classic growth firms generally have two key ingredients: they operate in expanding markets with rising demand and their products are difficult to replicate, giving them pricing power.
Companies from cyclical industries do not usually fit this mold. They tend to be highly sensitive to changes in the business cycle and, even in good times, generally deliver returns that lag high flyers from sectors such as healthcare and technology.
In this piece we’ll take a closer look at three construction-related firms that exhibit classic growth behavior, despite hailing from one of the most traditionally cyclical industries.
Trex (TREX), a manufacturer of wood-alternative decking and railing materials, has a compelling and simple value proposition – they allow homeowners to build long-lasting outdoor living spaces that provide favorable lifetime economics. Despite the fact that Trex costs more than wood initially, the company estimates their decks provide twice the lifespan for half the cost because they require negligible maintenance. The economics are also favorable for Trex because they get paid the combined cost of the materials and maintenance up front, capturing the revenue formerly paid by the consumer for ongoing upkeep.
Perhaps most importantly, Trex has developed a synthetic material that is not only superior to the other faux-wood options available on the market, but also capable of competing with the natural look of wood. And as an added benefit for the customer, Trex products are made from 95% recycled materials, so consumers can feel good about reducing their environmental footprint.
The composite market has been taking share from wood – at a clip greater than 1% annually since 2014 – and Trex is the undisputed leader. The company focuses on wealthier markets across the globe where outdoor living spaces are in demand. And they leverage a combination of an extensive distributor network, including major U.S. retailers such as Home Depot and Lowe’s, as well as a robust TV and digital advertising program to drive brand awareness and produce sustainable growth.
Their current share of the composite market is 50%, up from 36% in 2012. And they expect to raise their share above 60% by 2023.
SiteOne Landscape Supply (SITE) distributes a wide range of landscaping products in the U.S. and Canada, including irrigation equipment, outdoor lighting, nursery supplies, fertilizers, and golf course accessories.
Like Trex, the company is well-positioned for growth, but not because they have built the proverbial “better mousetrap.” In fact, they mostly resell other manufacturer’s goods. SiteOne thrives by being the nation’s only wholesale distributor of landscaping equipment, creating economies of scale unavailable to would-be rivals. In particular, they are able to bundle products and services that smaller firms cannot offer, expanding their market share while saving money for customers.
SiteOne is by far the biggest company in their space – four times the size of their next largest competitor and bigger than their top seven competitors combined – yet they command only 10% of a $16 billion market. The company has grown substantially over the past few years – from 2014 to 2017, sales increased 17% annually and adjusted EBITDA increased 29% annually. But the company has much bigger ambitions, aiming for 50% share by continuing its successful combination of organic growth and strategic acquisitions.
Cavco (CVCO) designs and builds manufactured homes, modular homes, commercial building, and vacation homes.
The company is well-positioned for growth primarily because it operates within the very low-end housing market (its average home sale is priced at $55,000), which is currently growing faster than any other segment. Cavco has grown substantially over the past several years, jumping from 2.3% market share in 2009 to 13% in 2018 and 700 employees to 4,500. They’ve added factories around the country to increase their geographic reach, and they’ve also acquired a property and casualty insurance business and a financing division to offer mortgages and commercial loans directly to customers.
The company’s financial performance has also been impressive. From 2014 – 2018 the company has increased net revenue 13.1% annually and diluted EPS 36.2% annually. And because the company is one of just two publicly traded firms in the space (they were the first to go public) demand for their shares has been strong.
CONCLUSION
Growth investing is about more than finding flashy companies in high-profile sectors. In fact, sometimes the best opportunities come from overlooked industries. As Trex, SiteOne, and Cavco demonstrate, even cyclical, construction-related firms can still perform like traditional growth companies.
James Callinan
Chief Investment Officer – Emerging Growth
Featuring
James Callinan
Chief Investment Officer – Emerging Growth
Jim Callinan was the Co-Founder & Chief Investment Officer at RS Investments. He also co-founded the RS Growth Group LLC in 1996 and managed the RS Emerging Growth Fund from 1996 until 2010. In 1999 Mr. Callinan was named Morningstar’s Domestic Stock Manager of the Year.*
He served as portfolio manager for the Putnam OTC Emerging Growth Fund from 1994 to 1996 and began his career at Putnam Investments as an equity research analyst in 1987. He joined Osterweis Capital Management in 2016 and brought with him the Emerging Growth Partners, LP, a concentrated small cap growth strategy he founded at RS in 2006.
Mr. Callinan is a member of the Weatherbie Capital Advisory Board.
He is an equity owner in the firm and the Lead Portfolio Manager for the emerging growth strategy. He is also a Portfolio Manager for the growth & income and flexible balanced strategies.
Mr. Callinan graduated from Harvard College (B.A. in Economics), New York University (M.S. in Accounting) and Harvard Business School (M.B.A.). Mr. Callinan holds the CFA designation.
*Morningstar Managers of the Year are determined by a combination of qualitative research by Morningstar’s manager research analysts; risk-adjusted medium- to long-term performance track records; and performance in the calendar year.
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