POOL Corp Valuation
Business: The largest retail pool supply distributor in the world.
Financial History: It is a highly profitable firm with a long track record, albeit cyclical in accordance with the summer season and demand for pools or pool supplies.
Market Share: They have a 38% market share in an industry now expected to grow about in line with the overall economy, which is approximately 4-6% annually.
Competition: It is the dominant supplier in a fragmented industry where most competitors are comparatively much smaller or regional, though I have doubts that this advantage should last forever.
Macroeconomy: Considering that the industry itself is cyclical, I think that growth will be low in the short-term (next 5 years), but that it should increase in future periods as new bull markets appear (ultimately averaging out in the long term as previously specified). Due to the cyclicality of the business, I will use normalized earnings. Also, its current return on equity is high compared to competitors, but I believe it will converge on the industry average as competition increases over time. Failure risk is negligible for valuation purposes, due to its size and market position.
Business Story, 'The Bully and Low-Cost Supplier': It is a large company with many resources, ruthless in its ability to deploy capital and out-price regional competition (due to fixed operating charges). This moat is best described as a scale-based cost advantage, or economies of scale.
Valuation Data:
- Normalized EPS: $15.43
- ROE: 44.34% (down to 18.33% after 5 years)
- Augmented Dividends: $13.72
- These are expected dividends determined by the necessary payout ratio from the fundamental growth rate to maintain a growth of 4.91%:
- (1-.0491/.4434) * 15.43 = $13.72
- These are expected dividends determined by the necessary payout ratio from the fundamental growth rate to maintain a growth of 4.91%:
- Fundamental Growth Rate: 4.91%
- The current long-term government bond rate is an approximation of long-term nominal GDP growth.
- COE: 9.805%
- I'll spare the math, but I derived a bottom-up beta of 1.157 based on its market leverage and cash reserves. This is close to 1, which is appropriate for such a large, stable firm (which should act very much like an economy).
No-Growth Value: $157.4
-15.43/.09805 = 157.4
-This assumes no growth and all earnings are paid out at the current cost of equity. The implication is that the current market price of $202.93 has a growth component of $45.53.
My Estimated Value: $252.8
-High ROE stage: (1-1.0491^5/1.09805^5)/(.09805-.0491) * (13.72*1.0491) = $59.95
-Competitive advantages shrink, and buybacks are assumed to reduce as ROE converges on the industry average.
-New Payout Ratio: (1-.0491/.1833) = 73.21%.
-Earnings at year 5 = $19.61
-Augmented Dividends: $14.36
-Cost of equity does not change; the firm remains in a stable state with weaker competitive advantages.
-(14.36*1.0491)/(.09805-.0491)/1.09805^5 = $192.8.
-Total = 59.95 + 192.8 = $252.8
With a market price of $202.93 per share and an implied growth of about 3%, evidence could point to it being currently undervalued by roughly 20% (due to cyclicality). I did not account for stock options or warrants, which could alter the value.