Howden Joinery Group (HWDN) is a specialist joinery business that manufactures kitchens for the small builder trade (it does not sell to the public or housebuilders and does not install), manufacturing core cabinets or carcassing in the UK from its own factories. It also sells third-party white goods, brassware and accessories to complete the kitchen package. While clearly tied exclusively to the construction trade, it is listed (along with all other remaining builders’ merchants) in the support services sector, but is followed primarily by building sector analysts.
Sitting towards the upper end of the FTSE 250 index (its market cap is £3.5bn – it was very briefly in the FTSE 100 last year) Howdens generates around £2.3bn of revenues returning earnings before interest, tax, depreciation and amortisation (Ebitda) of around £485mn and pre-tax profits of around £350mn (all figures are consensus forecasts). Double-digit margins are high for a building materials distribution business reflecting its specialist nature, vertical integration and very strong market position.
Total returns have been pretty decent at 6.5 per cent per year over the past five years but, as the chart shows, this has been a bit of a rollercoaster, more than halving in 2022 and after a partial rebound is falling again through 2023. This is a home improvement and buy-to-let-driven stock, so concerns about the outlook are understandable and despite hopes that the interest rate cycle has peaked, there are still acute pressures in the housing market.
The home market
The addressable market for Howdens is estimated at around £11bn, meaning that the group has just under 20 per cent market share. The market overall is flat to down in 2023 thanks to the housing market so strong in 2021, flagging in 2022 and worsening into this year. The main competition comes from both the retail trade in the form of specialist high street ‘studios’, the larger DIY chains, IKEA, builders’ merchants and from the fast growing, high profile chain Wren Kitchens (private and UK family-owned). Howdens is the only pure trade-oriented business; its closest (but not that close) competitor would be Travis Perkins (TPK).
End customers are predominantly home owners buying via trade professionals with some exposure to the buy-to-let market and no footprint in new housing (private or social). The product offering is ‘mid-market’ (where a typical kitchen might cost £5,000-£7,000) with a slow drift towards more expensive ranges.
Operations and divisions
Howdens UK has essentially one substantial reporting line, the UK which is an integrated manufacturing, third-party sourcing, warehousing and distribution network with (last reported) 808 customer facing depots, a national distribution ‘campus’ in Northamptonshire and two manufacturing plants in Cheshire and Yorkshire.
The branch network has been expanding steadily at around 25-30 new openings per annum for the last decade and the group is in the middle of a substantial upgrade and overhaul programme. The focus of this has been to improve stock availability and to deliver less common components on a next day basis using expedited distribution centres. This has given Howdens a growing commercial edge and has allowed it to make steady market share gains.
In addition to branch upgrades, there has been heavy investment in the digital channel for both trade ordering and specification tools to allow customers to envision their kitchen. This may sound like old news in the era of artificial intellignence (AI) and machine learning (ML) but the building industry is many years behind others in developing digital channels. The rapid improvement has been helped by the experience of CEO Andrew Livingston at previous company Screwfix, which is streets ahead of the pack in this area.
Gross margins are strong at 61 per cent and Ebit (earnings before interest and tax) margins are 18 per cent. However, both figures showed a small decline last year (and in the recently announced H1 reporting) although this decline is largely normalisation after bumper trading in 2021.
Howdens’ margins are high compared with general building merchants (Travis Perkins makes 5 per cent Ebit and SIG makes 2.5 per cent) and DIY (B&Q/Screwfix at Kingfisher achieve around 10 per cent Ebit) reflecting not only the in-house manufacturing but also Howden’s strong market footprint and very good supply chain management. It is notable that during the supply chain issues in 2021 and 2022, Howdens seems to have suffered very little disruption.
Howdens Europe
There are also 60 depots in France, which has doubled since 2020 and is forecast to grow around 50 per cent by the end of 2025. The northernmost depots sell into Belgium. There are also five depots surrounding Dublin in the Republic of Ireland, a figure that is scheduled to have doubled by the end of 2023. Revenues remain small at €74mn (£63.93mn) or just 3 per cent of the UK operations and the revenue per depot is only a little over €1mn compared with almost £3mn per outlet in the UK. Profit figures for European operations are not separated out.
Interesting dynamics
The macro picture
The outlook for the new/refurbished kitchens market is somewhat uncertain given various pressures on consumers and their potential sources of finance (many buyers re-mortgage) and in the aftermath of a super-heated trading climate during and after the Covid-19 pandemic. This is likely to have brought forward a material amount of demand.
The housing market squeeze
Spending on kitchens is part of the sub-set of the construction industry known as housing RM&I (repair maintenance and improvement) which traditionally has been driven by the health and momentum of the UK housing market. The availability of mortgage finance is crucial as stay-put homeowners also extend their mortgage to fund home improvements, but rates have risen steeply. Data from HMRC and the Bank of England point to headwinds for this market.
But not all households are feeling the squeeze. Howdens’ end customers are home owners rather than private or social landlords, which means they have around 61 per cent of UK households as an end market. Of these (27.5 homes million in total) some 32 per cent are owned outright and unaffected by rising mortgage rates. Many of these households are likely to have more savings.
UK RM&I trends and outlook: Spending on home improvements has been exceptionally strong since the middle of 2020 following the spikes in the housing market. Even if the UK was not facing the spending squeeze and housing market weakness it is today, it would be reasonable to expect the market to return to trend or ‘mean revert’ with quarterly spending potentially dropping to around £6.5bn against today’s still elevated figure of £7.5bn.
Howden specifics
Refurbishments and digital: While Howden’s digital channel roll-out is unlikely to be expanded much further in its scope, it could still boost revenue, lower costs and improve stock and working capital management. There is also more to be extracted from the physical improvements to depots. By the end of FY2022, only 185 depots had been addressed leaving more than 600 yet to be improved, with 90 due in 2023.
The maturity flywheel: The almost pure organic growth that Howdens offers through expanding its depot network delivers a useful ‘flywheel’ effect. The flywheel means that even if there is a slower macro climate, there is an internal power source for growth that should make at least some offset to negative market momentum. The typical depot takes seven years to reach optimum revenue which means that there is a material part of the business yet to contribute its full measure.
European business to mature: European operations are still small, but growing fast. Branch numbers are rising rapidly, sales per outlet are likely to increase as the depots mature (assuming the same seven-year cycle as in the UK), the gross-to-net margin gap should narrow and in time there could be manufacturing capacity in France. Overall, a larger scale of perhaps 10-15 per cent the size of the UK should lend good support to the margins.
Exceptional cash flow: Howdens is a highly cash-generative business making around £500mn of Ebitda and needing only to spend around £150mn to £180mn on its organic opening programme and upgrades each year. This leaves ample cash for distribution from an already strong balance sheet ( over £300mn held at the end of FY2022 after being over £500mn in 2021). Reflecting this heavy cash build-up, a £250mn buy-back was undertaken last year and there is scope for an additional £50mn (as in this year) annually going forwards. The buy-backs essentially add around half again to the value of direct distribution via the dividend.
There is ample room for bolt-on acquisitions, although the board has no interest (at present) in looking at potentially disruptive step changes. There have been a few small additions made to the group mainly to buy in supply chain security and this would likely continue.
Valuation and conclusion
Howdens is a very well run business that holds a strong and improving market position in a tough market environment. There are a lot of questions about what will happen to larger ticket consumer items, but history does suggest other items such as entertainment services, new cars, expensive holidays and gadgets see the chop more than spending on housing assets.
People still see spending money on extensions, new bathrooms and new kitchens as an investment capable of making a positive impact on their house value. This drives up the argument that spending on kitchens et al might prove to be more robust.
This is, of course, illusory as new buyers are likely to rip out a kitchen and the investment made is really a maintenance rather than a capital expense, but people do fall for the illusion: this is a central plank of retail kitchen rival Wren’s marketing campaigns, for example.
Howdens is taking market share and smaller independents are likely to struggle with passing through higher costs and funding stocks/working capital meaning that larger players should ride out the current economic squeeze better. One potential danger might appear to be that people look towards DIY rather than DIFM (Do It For Me), but kitchens are complex – plus any gas and electrical work cannot be carried out DIY.
Are the current forecasts realistic or too bullish?
Forecasts have come under pressure with the consensus indicating that profit before tax (PBT) in 2023 will be £55mn or 13.5 per cent below last year; a year ago consensus suggested profits would be flat.
That was always too bullish as 2022 contained both a rebound from projects delayed by the pandemic and post-move spending from the 2021 spike in housing transactions. Analysts only expect PBT to edge above 2022 levels even by 2025 which is more reasonable but there is scope for estimates to be lowered and this is what the PE ratio (share price divided by earnings per share) looks to be telling investors. The mean reversion of RM&I spending could be fairly nasty.
Against its own long-run average in more ‘normal’ times Howdens has traded on a Year 1 PE of around 15x, but in early July this was nearer 13x which indicates (and this squares with the macro) that profit estimates for 2024 could still be too high by around 10-12 per cent. While Howdens is technically a builders’ merchant there are some marked differences between it and these much more volatile businesses:
- Howdens is a manufacturer as well a distributor, and while general merchants do sell ‘own brand’ they buy in rather than make products.
- Operational gearing – the sensitivity of profits to changes in revenues. Merchants have high operational gearing – they have high gross margins, high fixed costs and low net margins. Howdens does have sensitivity to revenue swings with a large gross to net margin gap but a far higher proportion of its costs are variable rather than fixed.
The forecasts could be vulnerable, but not to anything like the extent of the general merchants, plus there is the ‘flywheel effect’ on maturing branches, rapid European growth (that also has a maturity benefit), market share gains, a strong balance sheet capable of funding expansion and share buy-backs that can boost earnings per share (EPS).
My colleague Mitchell Labiak has a different view here, but my own thoughts are that, after what amounts to a re-rating (the shares are up 21 per cent in two weeks), the shares look fully valued at best, overbought at worst.
One can understand the surge in the housebuilders after a very weak performance over 12 months (typically down more than 30 per cent), but Howdens Joinery shares had been essentially flat over the last year, meaning that there is no similar discount to be unwound. While the outlook for housing and related markets might not now be as bleak as feared, there is unlikely to be a miraculous turnaround any time soon.
