I like to look for potential value opportunities amid stocks with divergent valuation metrics, as such stocks might be misunderstood by the market. Thus, using the GuruFocus All-in-One Screener, a Premium feature, I searched for stocks that meet the following criteria:
1) A "possible value trap" rating on the GF Value chart, which implies that even though the stock looks undervalued, it may deserve the low valuation due to worsening financials and/or a slowdown in business.
2) A GF Score that is in the top 20% among all corporations; according to a historical study by GuruFocus, such stocks have a higher likelihood to outperform.
Pool Corporation (POOL, Financial) is one of the stocks that checks these two boxes. Its debt levels doubled in 2021 while cash didn't improve at all, which may be what caused the value trap warning. However, I believe the high debt shouldn't scare investors away; here's why.
About Pool
The company describes itself as follows on the investors' page of its website, “Pool Corp. is the world's largest wholesale distributor of swimming pool and related outdoor living products operating over 410 sales centers in North America, Europe and Australia.”
In the Wedgewood Partners’ second-quarter 2022 letter, guru investor David Rolfe (Trades, Portfolio) summed up the company’s business model as simple and easy to understand business models:
“The Poolcorp strategy is beautifully simple; build a pool and become its customer for life. Once the major discretionary expenditure of building a pool is made, that high-maintenance asset becomes an annual annuity for your local pool service company. Increasingly, that local pool service company could well be owned by Poolcorp.”
Rolfe also points out that as pools age, they get increasingly expensive to maintain. And then there comes a point where it makes more sense to replace the pool, rather than paying more for maintenance. That’s also good for the company.
Pool also benefits from a recent trend toward turning pools and backyards into entertainment centers and more.
Founded in 1980 and taken public in 1995, the company has a market cap of $14.48 billion and had trailing 12-month revenue of $6.119 billion. It is based in Covington, Louisiana and also offers irrigation, landscaping and outdoor living products.
It also reports on its investors page it has produced a compounded average annual shareholder return of over 29% per year since 1995. Expansion has been driven by organic growth, expanding market share, strategic acquisitions and disciplined operating execution.
GF Value
The GF Value chart rates Pool's stock as a possible value trap. On Feb. 15, the share price was $378.81 while the GF Value was $584.27:
That’s a significant difference, which provides a big margin of safety for potential investors. The value trap warning was triggered by the combination of the declining share price and the drastic increase in debt. The price retreat was driven largely by investors’ retreat from the markets.
Pool’s price-earnings ratio is 19.04, which is more expensive than the median of 13.33 for the industrial distribution industry. On the other hand, the PEG ratio, which is calculated by dividing the price-earnings ratio by the average five-year Ebitda growth rate of 24.20%, indicates undervaluation at just 0.8.
One more consideration is the stock is trading below its trendline based on the 10-year price chart:
Overall, the stock certainly seems undervalued - that is, if the underlying company's quality and outlook are both good.
GF Score
To assess the fundamentals of the company, I like to refer to the GF Score, a unique metric from GuruFocus. Pool gets a high GF Score at 94 out of 100, driven by top score for growth and profitability, a solid score for GF Value, a middling rating for financial strength and a poor momentum rank:
Within that fundamentals environment, we see its financial strength ranking is lower than those for its profitability and growth. In essence, the financial strength ranking mainly reflects the degree of a company’s indebtedness. And, as mentioned above, the company's debt doubled in 2021.
That rising tide of red might be a concern if it were not for the fact that the company earns much more from its invested and borrowed capital than it pays for said capital:
According to the most recent earnings numbers, its earns $30.26 in return on invested capital for every $6.03 in weighted average cost of capital. That’s a very good ratio and a recipe for creating shareholder value.
But what about the short term? Should we be concerned about Pool’s ability to pay its monthly bills? No, as the Altman Z-Score is well into the safe zone at 6.77.
In regards to the debt, the company uses it to run its asset-heavy business (inventory, property, buildings, etc.), make acquisitions and reward shareholders.
Dividends are an important element in shareholder rewards, and over the past five years, Pool's dividend per share has risen by an average of 19.5% per year. As for share repurchases, they have averaged 2.04% per year over the past five years.
Both elements show the board of directors believes in shareholder returns and believes the company is strong enough to grant them. They are simply passing along some of the company’s growing fortunes, as shown by the growth rates for the past three years:
- Revenue: 22.1% per year
- Ebitda: 37.5% per year
- Earnings per share without non-recurring items: 41.6% per year
This is certainly a company that can, and is, sharing its wealth with shareholders.
Conclusion
I feel confident in my asseessment that Pool Corp. is an undervalued stock, not one that is destined for fundamental failure. Based on its exceptional growth from the top to the bottom lines, it should be able to manage its debt. The debt level is too high to make this much of a "traditional value" stock, but for those who like good companies at a bargain price, Pool may be worth consideration.
