Doman Building Materials Group Ltd (TSX: DBM), formerly CanWel Building Materials Group Ltd, is a wholesale distributor of building materials and home renovation products. It primarily serves new home construction, home renovation, and industrial markets, as well as provides its building products to dealer/lumberyard and home improvement centers. The portfolio of the firm consists of engineered wood products, fasteners, insulation, outdoor living products, and others. Its operating segments are Building Materials Distribution and Forestry. The majority of the revenue is generated from the building materials distribution segment. Geographically, it operates in the region of Canada and the Western United States, of which Canada regions account for a larger revenue share.

Investment Rationale

• An Income Play: Amid a lower interest rate environment where interest rates on fixed income securities are not able to protect the purchasing power, DBM stock is a lucrative bet to generate a decent income in the form of dividends as the company is yielding 7.36%, which is quite decent amid lower interest rate environment. Further, the company has a consistent track record of dividend payment over the past decade. A high yield together with consistency in dividend payment would keep the DBM shares in the investor’s limelight.  

Dividend History (as on September 13, 2021). Source: Analysis by Kalkine Group

• Solid Topline Performance in Q2FY21: Sales for the second quarter of FY21 were CAD 756.8 million against CAD 412.9 million in the comparative period in 2020, representing an increase of CAD 343.9 million or 83.3%. The solid topline growth was mainly driven by strong sales for the Building Materials segment as sales increased by CAD 342.0 million or 84.6%, partially due to the results from the Acquisitions (increase in sales of approximately 17.4%), with the balance of the increase attributable to the Company’s legacy operations, demonstrating continued resilience and strong overall end-market demand. The Company’s sales in the quarter were made up of 76% of construction materials, compared to 67% during the same quarter last year, with the remaining balance of sales resulting from specialty and allied products of 21%. The increase in sales in the Company’s legacy operations is attributable to improvements in pricing. Construction materials pricing continued to increase during the second quarter of 2021, before beginning to decline in May 2021 and continuing to decline through the second quarter and subsequent to June 30, 2021.

Source: Company Filing

• Generating Higher Return on Shareholders’ Money: The company is generating a significantly higher return on equity (ROE) against its peers. TTM Return on Equity of the company stood at 32.7%, whereas the industry average stood at 13.9%, which implies a strong competitive edge DBM shareholders are having over the competition.
  

• Consistent Improvement in Margin Profile: The company has reported consistency in margin profile, with a gross margin above 15% over the last four quarters, EBITDA margin expansion and improvement in the net margin over the past two quarters.

• Strategically Hedging Commodity Prices: DBM management implementing mitigation strategies to cool of the potential impacts of future construction materials price volatility. These strategies comprise the use of vendor-managed inventories, direct shipments from the manufacturer to the customer, use of lumber futures contracts and the Company’s internal policy of optimizing inventory levels to maintain its high standard of customer service levels and minimizing excess inventory otherwise exposed to market fluctuations.
  

• Solid Jump in Asset Base: Total assets of the Company were CAD 1.71 billion as of June 30, 2021, versus CAD 867.2 million as of December 31, 2020, an increase of CAD 844.5 million. Current assets increased by CAD 421.6 million. Trade and other receivables increased by CAD 219.3 million due to a combination of the results from the Acquisitions, increased sales activity, higher construction materials pricing and regular seasonal factors. Long-term assets within the Building Materials segment were CAD 797.7 million as of June 30, 2021, compared to CAD 371.3 million as of December 31, 2020, an increase of CAD 426.4 million, primarily as a result of the assets acquired from the Hixson Acquisition and the L.A. Lumber Acquisition.
  

• Competitive Strength: The group prices its products in the competitive construction materials market so that the Company’s profitability is based on cost plus value-added services such as wood pressure-treating, distribution, short-term financing and other services provided., which gives a key competitive advantage to DBM against the peers.
  

• Risk Associated with Investment: The Company is subject to normal business risks associated with similar firms operating within the building materials industry in Canada and the US. The recent plunge in the lumber prices would have some impact on the group’s financials in the upcoming quarter. Further, a general slowdown in the economic recovery could also weigh on the group’s financials.

Financial Highlights: Q2FY21

Source: Company Filing

• Sales for second quarter of FY21 were CAD 756.8 million against CAD 412.9 million in the comparative period in 2020, representing an increase of CAD 343.9 million or 83.3%.
• The solid topline growth was mainly driven by strong sales for the Building Materials segment as sales increased by CAD 342.0 million or 84.6%, partially due to the results from the Acquisitions (increase in sales of approximately 17.4%), with the balance of the increase attributable to the Company’s legacy operations, demonstrating continued resilience and strong overall end-market demand.
• The Company’s topline in the second quarter were made up of 76% of construction materials, compared to 67% during the same quarter last year, with the remaining balance of sales resulting from specialty and allied products of 21% (2020 - 28%) and other of 3% (2020 - 5%).
• Gross margin increased to CAD 131.2 million in the quarter compared to CAD 58.9 million in the same period of 2020, an increase of CAD 72.3 million, including the impact of an inventory valuation reserve.
• Expenses for the quarter ended June 30, 2021 were CAD 47.9 million as compared to CAD 37.2 million for the same quarter in 2020, an increase of CAD 10.7 million or 28.8%.
• Distribution, selling and administration expenses increased by CAD 9.8 million, or 37.6%, to CAD 36.0 million in the second quarter of 2021 from CAD 26.1 million in the same period of 2020.
• Depreciation and amortization expenses increased by CAD 907,000 or 8.2%, from CAD 11.0 million to CAD 11.9 million, largely as a result of the acquisitions.
• For the second quarter, operating earnings were CAD 83.3 million compared to CAD 21.7 million in the comparative period of 2020, an increase of CAD 61.6 million.
• Finance costs for the second quarter of 2021 were CAD 6.5 million compared to CAD 4.2 million in the second quarter of 2020, an increase of CAD 2.2 million or 52.5%, largely as a result of the additional finance costs related to the Unsecured Notes.
• In the quarter under review, EBITDA was CAD 90.5 million compared to CAD 32.8 million in the comparative quarter of 2020, an increase of CAD 57.6 million.
• Net earnings for the quarter were CAD 53.1 million compared to CAD 12.7 million in the same quarter of 2020, an increase of CAD 40.4 million, due to the foregoing factors impacting the overall financial performance of the Company.

Top-10 Shareholders

Top-10 shareholders in the company together holds 23.86% stake in the company, with Doman (Amardeip Singh) and Dimensional Fund Advisors, L.P. are the major shareholders with an outstanding position of 18.90% and 1.08%, respectively.

Valuation Methodology (illustrative): EV to Sales based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: The company reported solid performance in the second quarter of FY21, on the back of strong sales for the Building Materials segment. Further, EBITDA during the second quarter nudged by 276% on a YoY basis. Lumber, plywood and OSB prices experienced unprecedented increases in the second half of 2020 and during the first half of 2021, primarily impacted by a combination of limited supply and elevated demand, reaching a peak in May 2021.

The company generally prices its products in the competitive construction materials market so that the company’s profitability is based on cost plus value-added services such as wood pressure-treating, distribution, short-term financing and other services provided, which gives a competitive advantage to the company against its peers. Further, the company is generating industry-leading ROE of 32.7%, which is significantly above the industry average of 13.9%. Also, the stock is offering a lucrative dividend yield amid a low-interest rate environment.

However, the recent plunge in the lumber prices are having a weigh on the group’s financials, and that has also priced in the current trading levels as the stock has corrected approximately 21% over the past one month and 25% over the past three months. From here, we see upside potential in the stock as the downtrend is exhausting on the technical chart.

Hence, based on the above rationale and valuation, we recommend a “Buy” rating on the stock at the closing price of CAD 6.52 on September 13, 2021.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached.

Technical Analysis Summary

1-Year Price Chart (as on September 13, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid on September 14, 2021 price as well.

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