Insiders Are Buying Up Shares of a Construction Giant That Lost 60% of Its Value

Countless factors can cause a stock to plummet or soar, but the people who know more than anyone what is happening in a company are those who manage it. A new column seeks to track the moves of insiders in companies traded on Wall Street. The author of the column is Yoav Safar, CEO of SmartLenses, which developed a platform for decoding insider trading activities in public companies in the US, and currently advises investment managers on identifying unique investment ideas.

One of the questions that occupies investors more than anything is where the next big investment opportunity will be found. Most try to answer it with one question: where is the capital flowing today? I prefer to ask a different question: where has it already stopped flowing?

Markets have a pattern that repeats itself over the years: capital flows into the sectors that generate the high returns of the moment; more and more investors join, new competitors enter, companies expand operations, and the success of the sector attracts ever-increasing amounts of capital. And then at some point, the success itself becomes the problem.

In his excellent book 'Capital Returns', Edward Chancellor, a British financial historian and journalist, describes a simple but profound idea: sectors do not become bad investments because demand disappears, in most cases they become so because success attracts too much capital to them. And then with the increase in competition, at some stage the return on capital is also eroded.

Ultimately, this is mainly a story of psychology: greed attracts capital to the hot sectors of yesterday, and fear pushes to leave them just as they begin to disappoint. But the other side of the equation receives much less attention. When capital leaves a certain sector, competition also begins to weaken - fewer new investments flow, fewer new competitors enter, less expansion of operations. And here begins the part that really interests me.

Today it is hard to think of a sector that attracts more capital than Artificial Intelligence (AI). Hundreds of billions of dollars are invested in data centers, chips, cloud infrastructure, and AI-based models. Some of these investments will turn into exceptional businesses, many others will probably yield a disappointing return.

The issue of whether a bubble has developed here interests me less. I am interested in examining whether, in parallel, entire sectors have been created to which capital has already turned its back. Because history teaches that the winners of the next cycle almost never grow out of the sectors where everyone is already present.

The last time we saw a wave of technological enthusiasm of this magnitude was at the end of the 90s of the last century, with the dot-com bubble. When it burst, the capital did not disappear, it simply moved elsewhere. Interest rates in the US fell, mortgage rates fell with them, the US housing market became one of the big winners of the next cycle, and housing starts for single-family homes reached an all-time high - 1.72 million units per year.

Looking for the quality in the sector

For years, construction companies, and the entire value chain around them, enjoyed exceptional returns, until this sector too attracted too much capital. Today the picture is almost the opposite: mortgage rates have remained high for about three years, and alongside this, stubborn inflation, high financing costs, and a growing government deficit continue to weigh on the housing market. As a result, housing starts for single-family homes have fallen from about 1.13 million units in 2021 to about 895 thousand units today - a decrease of more than 20%.

Capital also reacted accordingly - investors gradually abandoned most of the companies operating in the sector, and many of them lost between 50% and 70% of their value. From my point of view, these are exactly the environments where research begins. Not because every sector in crisis becomes an opportunity, but because capital always eventually returns to the residential real estate sector.

So if you want to look for the next opportunity in an abandoned sector, the question is not which construction company will benefit from it, but who holds the highest quality business throughout the entire value chain.

From the impressive 'capital allocators'

This is exactly the point where I arrived at Builders FirstSource. It is the largest supplier in North America of materials, equipment, and components for residential construction. It supplies almost every component needed to build a private home - from engineered wood products, through beams and roofs, to windows, doors, and a wide range of building materials.

It is no coincidence that Home Depot, Lowe's, and other strategic players have been trying in recent years to deepen their hold on the market catering to professionals, through huge acquisitions at high double-digit multiples. They understand that future growth in the sector will not come from the private customer, but from contractors and professionals.

In my opinion, BLDR (Builders FirstSource) is a very high-quality company throughout the entire value chain of the residential construction sector, thanks to the rare combination of economies of scale, a consistent mergers and acquisitions strategy, high profitability, and exceptional capital allocation.

But what caught my attention was not only the quality of the business, but the people who allocate capital to it. At the head of the company is Paul Levy, one of its founders and owner of the private equity fund JLL Partners, who is, in my view, one of the most impressive capital allocators in the American market.

Levy almost never buys company shares on the open market. The last time he did so, in 2018, he purchased at a price of about 16 dollars per share. In the years that followed, the stock rose to a peak of more than 214 dollars - a return of more than 13 times the purchase price. Recently he returned to buy, and this time invested close to 60 million dollars of his personal money, at an average price of about 109 dollars per share. But his personal purchase is only half the story, as in parallel the company itself carried out one of the most aggressive share buyback programs in the American market.

Without a tailwind

Over the past few years, BLDR has bought back about half of its shares, in a cumulative amount of more than 8 billion dollars, and at an average price of about 81 dollars per share. From my point of view, these are two independent voices that arrive at exactly the same conclusion: the founder thinks the company's stock is cheap, and so does the company itself. And today, at a price of about 66 dollars, investors can buy the stock at a price lower than what both of them paid.

The irony is that all this is happening precisely at a time when macroeconomic conditions are far from ideal: mortgage rates are high; housing starts are very far from the peak; lumber prices no longer provide the tailwind of the corona period. And yet, the company is expected to generate an EBITDA profit (excluding interest, tax, depreciation, and amortization) of about 1.2 billion dollars this year and a free cash flow of about 450 million dollars.

According to the current stock price, this is a free cash flow yield of about 6.5%, meaning investors receive a reasonable return while they wait for the sector to recover.

If we return to the question with which I opened, and which has occupied me in recent years - to which sectors has capital stopped flowing, then capital cycles teach us that the biggest opportunities almost never start in the sectors that everyone is talking about. They start precisely in the sectors that almost everyone has already stopped talking about.

I learned that capital cycles start on the day when almost everyone stopped buying - except for the people who know the business best of all.

This should not be seen as a recommendation or advice, and it is not a substitute for personal investment advice that takes into account the needs and data of each person.