Not all businesses in cyclically volatile industries are destined to fail. However, rating agencies may not share this view, as they often exhibit a bias towards some cyclical industries and do not differentiate their evaluations of individual companies within those industries. An instance of this is BlueLinx Holdings (BXC), which has been given a bankruptcy rating in the next few years due to this industry bias from rating agencies. In today’s FA Alpha Daily, we’ll assess BlueLinx Holdings using Uniform Accounting to see its actual profitability and determine its true credit risk.
FA Alpha Daily:
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When we first started analyzing credits at Valens, one of the companies we looked at was Mirant Corporation.
It looked like the market was totally misunderstanding the company as the credit risk of the name was unbelievably high.
When we talked to rating agency people, they explained that they would just “never rate an independent power producer (IPP) company as investment grade”.
This felt like an obvious blind spot because no matter how much you dislike an industry, if the company has no credit risk, it has no credit risk…
That’s what BlueLinx Holdings (BXC) looks like right now, as it is operating in a cyclical industry that rating agencies do not like.
The company is a distributor of building and industrial products in the U.S. It offers a wide range of products such as lumber, insulation, roofing, and siding, among other products that are primarily used in construction projects.
Additionally, BlueLinx provides value-added services like customization and inventory management to help customers optimize their supply chains.
The company benefited from the pandemic and managed to improve its profitability significantly in the last couple of years. Its return on assets (ROA) grew from only 5% in 2019 to 30% in 2022.
However, rating agencies have an industry bias toward the name and rate it for default just because it is a building products distributor.
S&P thinks it is high risk and rates the name a B+, meaning it thinks there is a 25% chance the company will go bankrupt in the next 5 years.
The rating agencies are focusing on how higher interest rates are likely to mean less home building and construction in general, which could hurt BlueLinx’s cash flows.
What S&P misses is that BlueLinx does not have any debt maturities in the next 5 years. Let’s see the company’s credit risk profile using our CCFP framework.
We can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (“CCFP”) to understand how the company’s obligations match against its cash and cash flows.
In the chart below, the stacked bars represent the firm’s obligations each year for the next five years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
The CCFP chart clearly shows that BlueLinx Holdings’ cash flows are more than enough to cover all of its obligations going forward.
The chart shows the company does not have any debt maturities until 2029, and its gross earnings alone are much higher than all of its obligations in the next 5 years.
Additionally, the company is sitting on massive cash on its balance sheet and can easily pay that debt when it’s due.
It is clear that the company has a healthy capital structure and has no significant credit risk going forward.
Due to these reasons, we think that BlueLinx does not deserve to be a high-yield name. Hence, we are giving a rating of “IG3+” to the company.
This rating places the company in the investment grade basket and implies only a 1% chance of default in the next few years.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
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SUMMARY and BlueLinx Holdings (BXC:USA) Tearsheet
As the Uniform Accounting tearsheet for BlueLinx Holdings (BXC:USA) highlights, the Uniform P/E trades at 8.2x, which is below the global corporate average of 18.4x but above its historical P/E of 6.1x.
Low P/Es require low EPS growth to sustain them. In the case of BlueLinx, the company has recently shown a 7% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations, that in general, provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, BlueLinx’s Wall Street analyst-driven forecast is for a -66% and 35% EPS growth in 2023 and 2024, respectively.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify BlueLinx’s $62 stock price. These are often referred to as market-embedded expectations.
Furthermore, the company’s earning power in 2022 was 5x the long-run corporate average. Moreover, cash flows and cash on hand are 6x of its total obligations—including debt maturities and capex maintenance. The company also has an intrinsic credit risk that is 780bps above the risk-free rate.
Overall, this signals a high credit risk.
Lastly, BlueLinx’s Uniform earnings growth is below its peer averages and is trading below its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This analysis of BlueLinx Holdings’ (BXC) credit outlook is the same type of analysis that powers our macro research detailed in the member-exclusive FA Alpha Pulse.