Ferguson facing dark clouds on the US residential market

The trade in building materials constitutes a fair slice of US gross domestic product, but the status of the plumbing and heating products subset as a leading indicator is open to question. Yet interim figures for Ferguson (FERG), a Berkshire-based distributor with sizeable interests across the Atlantic, certainly point to a deteriorating outlook on the US residential market. So, its shares were duly marked down on results day as investors responded to a slowdown in revenue growth through the second quarter and an accompanying squeeze on margins.

We will probably need to wait for full-year figures to gauge the extent to which investor anxieties were justified. The residential market generates around half of Ferguson’s US revenue, so weakening new-start volumes have undermined immediate prospects, although this was mitigated to a degree by resilient demand linked to repairs, maintenance, and home improvements. In all, residential revenue grew by a single percentage point in the second quarter, against an 11 per cent gain from the group’s non-residential end markets.

Net set sales came in at $6.8bn (£5.67bn) for the second quarter, up 4.9 per cent on the 2022 equivalent, but the rate of quarterly growth slowed sequentially. Management said that the related 40-basis point decrease in the gross margin to 30.2 per cent was set against a strong comparator in the prior year. It’s a valid point and you would normally expect that that margin compression would have been more in evidence given the trajectory of input costs in the building trade.

The company cheque book was in evidence through the second quarter as four acquisitions were completed with aggregate annualised revenues of c. $300mn. Ferguson is also in the habit of returning cash to shareholders, as illustrated by another $198mn in share buybacks through the quarter, leaving around $400mn remaining under the current share repurchase program. The ability to fund the cash returns relies on sound working capital management. Inventory was down by 4 per cent on the 2022 half-year, so there has been no attempt to run down stocks. And despite the various outlays, Ferguson closed out the period with net debt equivalent to a manageable 1.1 times Ebitda.

Ferguson said it expects low-single-digit sales net sales growth for FY 2023, with an adjusted operating margin between 9.3 and 9.9 per cent. A solid, if unspectacular out-turn, with creditable capital management set against the problems in the US residential space. On balance, a middling forward rating of 15 times forecast consensus earnings adequately reflects the balance of risks. Hold.  

Last IC view: Hold, 9,776p, 28 Sep 2022