RichLegg/E+ via Getty Images

RichLegg/E+ via Getty Images

On the national news this week I was watching a story about skyrocketing home prices, again. Or should I say, still. My wife has been an active and successful real estate investor for over 30 years and partly because of her work I tend to pay close attention to what is going on in the real estate markets. Home sales are near all-time lows but that is attributed primarily to a lack of inventory. The signs of increasing homebuilder activity are showing an upward trend. Commercial real estate development is also on the rise, and 2022 is looking like it will be a banner year for both residential and commercial real estate activity. In fact, a recent research report from CBRE states:

U.S. commercial real estate is set for an active 2022 amid robust economic growth and higher demand from both occupiers and investors across all property types. We anticipate a record year of investment activity, with intense investor competition, powered by abundant capital and liquid debt markets, driving up values-even as interest rates rise as monetary policy tightens.

Two companies that I have been researching for investment potential that both stand to benefit from this trend are Builders FirstSource Inc. (NYSE:BLDR ) and BlueLinx Holdings, Inc. (BXC).

Both companies are growing, undervalued, profitable, and have very good financial standing with strong and improving cash flows. I believe that both are currently priced fairly for a long-term investment and represent a good buying opportunity. And both companies are the #1 ranked by Quant rating in their respective industry sector. BXC is ranked #1 in the Industrial Trading and Distributor sector and BLDR is #1 in the Building Products sector.

The company is one you may not have heard of unless you are in the construction industry. From the company website:

BlueLinx (NYSE: BXC ) is a leading wholesale distributor of building and industrial products in the United States with over 50,000 branded and private-label SKUs, and a broad distribution footprint servicing 40 states. BlueLinx has a differentiated distribution platform, value-driven business model and extensive cache of products across the building products industry. Headquartered in Marietta, Georgia, BlueLinx has over 2,200 associates and distributes its comprehensive range of structural and specialty products to over 15,000 national, regional, and local dealers, as well as specialty distributors, national home centers, industrial, and manufactured housing customers.

I came across BXC first in my investment research when I was looking at growth stocks with good prospects in May of this year. Lumber prices had started to soar and BXC shot up from the low 40s to the high 50s by the time I caught wind of them. I initiated a small position and then watched as lumber prices retreated and the share price followed, back to the low 40s. The stock looked very inexpensive, and earnings were growing but it seemed the market believed that it would be a short-term, temporary boost from the soaring lumber prices that were now in retreat.

Fast forward a few months and the earnings and cash flows continued to trend upward, despite the correction in lumber prices during Q3, which are now rising again.

Source: Lumber Futures (LB1:COM) Stock Price Today, Quote & News | Seeking Alpha

The costs of materials for home construction and remodeling have been steadily increasing throughout 2021 and show no signs of abating soon. BXC stands to benefit from the higher lumber prices even though it increases their costs as well. Costs of other construction materials for residential and commercial are also steadily increasing.

Source: Construction Inflation Index Tables « Construction Analytics (edzarenski.com)

In general, the rising material costs are passed on to their customers, and by increasing the mix of specialty products offered, the higher prices lead to an increase in revenues due to higher margins on those specialty products.

During the Q3 earnings report conference call, President and CEO of BlueLinx, Dwight Gibson, described the business transformation that is driving the growth and profitability:

We are in the early stages of implementing standard repeatable work processes with an emphasis on data-driven decision making. Over the past few months, we implemented improved processes and tools to guide purchasing and pricing actions while also centralizing key decisions to drive consistency across our locations. The benefits of this approach were evidenced in our third quarter performance. We continued our approach to keep structural product inventory low to mitigate the risk of wood-based commodity price deflation. The wisdom of these decisions was on display in Q3 as we nimbly managed the decline of greater than 60% in commodity wood prices and still delivered positive gross margin on structural product sales.

For BXC, the key areas of management focus in the early stages of transformation in 2021 (according to the Q3 quarterly results presentation) include:

By executing on these key areas of focus, the Q3 results included:

Specialty product sales grew 29% YOY with gross margins at 23%, up 560 bp from the previous year.

Available cash increased to $352M at the end of Q3 and net debt was reduced by $84M, or 14% YOY.

Looking forward to 2022, the company stands to benefit from the increasing new home construction activity that is continuing to ramp up, as well as remodeling and renovations of existing homes. BlueLinx is a critical part of the supply chain, providing the link between manufacturers and end users, including professional dealers of construction products and national retailers.

The market was skeptical that BXC could survive the big, sudden drop in lumber prices that occurred during Q3; however, the share price rebounded after the quarterly report demonstrated that the company not only survived but executed well on their key focus areas. Even with the runup in share price, the stock is trading at a relatively low P/E ratio compared to its recent past.

Another company whose stock should benefit from the continued resurgence of residential construction activities is Builders FirstSource:

Builders FirstSource is the largest U.S supplier of building products, prefabricated components, and value-added services to the professional market segment for new residential construction and repair and remodeling. We provide customers with an integrated homebuilding solution, offering manufacturing, supply, delivery and installation of a full range of structural and related building products. The Company's manufactured products include its factory-built roof and floor trusses, wall panels and stairs, vinyl windows, custom millwork, and trim, as well as engineered wood that it designs, cuts, and assembles specifically for each home. It also assembles interior and exterior doors into pre-hung units. In addition, the Company offers a range of construction-related services, including professional installation, turn-key framing, and shell construction, spanning all its product categories.

Source: (Builders FirstSource | Building Supplies & Materials (bldr.com))

Basically, they provide all the necessary building blocks for new home construction/renovation - walls, windows, doors, trusses, etc. Their business is directly related to the home construction and remodeling markets.

With record low inventory in the housing market and record low interest rates, that may begin to rise next year, it appears that new home construction will continue to pick up steam in 2022.

New home construction has been on the rise in 2021 and is expected to continue into 2022.

U.S. homebuilding surged to an eight-month high in November amid an acute shortage of properties on the market, though higher prices for raw materials and labor shortages remain a constraint. Housing starts increased 11.8% to a seasonally adjusted annual rate of 1.679 million units last month, the highest level since March, the Commerce Department said on Thursday. Read Newsmax: US Housing Starts; Building Permits Increase in November | Newsmax.com

In January 2021, BLDR completed its merger with BMC Stock Holdings to create the combined company with:

approximately 550 distribution and manufacturing locations, with a presence in 40 states, including 44 of the top 50 metropolitan statistical areas

Highlights from the Nov 4 Q3 earnings report for results through September 30, 2021 included:

The company is deploying capital effectively as well, buying back shares and through M&A activity, as described in the Q3 report:

Peter Jackson, CFO of Builders FirstSource, commented, "During the third quarter, we used a portion of our significant free cash flow to deploy capital in the repurchase of $578 million of stock, and $816 million in acquisitions. Looking ahead, we remain focused on consistently executing our balanced capital allocation strategy with the goal of meeting our commitment to deliver long-term shareholder value."

During the 3rd quarter, the company sold off one business and acquired two others:

M&A Update On July 26, 2021, the Company completed the sale of its standalone Eastern U.S. gypsum distribution operations to L&W Supply for total cash proceeds of $76.2 million. The gypsum business generated sales of approximately $160 million in 2020.

On September 1, 2021, the Company acquired California TrusFrame, LLC, (CTF) who was previously the largest independent producer of value-added building products in California, for $193.4 million. CTF reported trailing twelve months' sales of approximately $143.2 million as of July 31, 2021.

On September 9, 2021, the Company acquired the Apollo software assets from construction technology startup Katerra for approximately $4.5 million. The Apollo platform provides design collaboration and workflow, construction budgeting and scheduling, and field task assignment with mobile functionality.

Source: Builders FirstSource Reports Record Third Quarter 2021 Results | Builders FirstSource, Inc. (bldr.com)

BLDR operating cash flow growth from 2020 to 2021 exceeds 230%.

Source: Builders FirstSource, Inc Stock Price Today, Quote & News | Seeking Alpha

On December 7, the company gave a virtual presentation at their Investor Day 2021 event. In that presentation, BLDR discusses their competitive advantages including:

This slide from the Investor Day 2021 presentation gives an idea of the potential market opportunity they hope to capture:

Price targets were raised by several analysts on Dec. 8 after the Investor Day presentation:

Like BXC, the share price rose substantially after the market digested the Q3 earnings results, and especially after the Investor Day presentation.

Both stocks have risen in price in the past 2 months considerably after positive Q3 earnings reports and favorable forecasts for next year. In both cases, the valuation is beginning to get slightly stretched, although both still trade at a good value in terms of fundamentals. If the economy shifts due to continuing impacts from the Omicron variant, supply chain issues, staffing shortages, and/or other lasting impacts from the pandemic the market could turn sour, and a selloff could result.

Similarly, if new home construction should slow down again in 2022 for whatever reason, including ongoing inflationary pressure, rising interest rates, or a shift in the economy for any other reason, both stocks could be impacted.

In the case of both BXC and BLDR, the continuing recovery in the residential housing market and an uptick in new home construction in 2021 have resulted in significant improvements in revenues and earnings growth. Both companies are in varying stages of transformation, with BXC undergoing a business transformation, and BLDR completing substantial M&A activity.

The market is showing continuing signs of recovery in new home construction in 2022 and remodeling and renovations of existing properties are likely to continue into 2022 as more employers support the work from home option for many of their employees. Many of those remote workers can also leverage the rising property values due to higher market prices for homes to pay for those remodeling jobs.

In the case of BXC, the share price has risen from around $50 in early November to the current price, as of market close on 12/30/21, of $91.64. Although the price has risen substantially in less than 2 months, it still trades at a forward P/E of 3.58. The market seems to discount the future earnings potential, but I believe the stock has more room to run. I rate the stock a Buy under $90 and expect the price to pull back a bit below 90 if the market sells off in the first quarter of 2022.

For BLDR, I also feel that the stock has run a bit higher than expected in the past 2 months. But that price action demonstrates that the market likes what they see in the 2021 earnings growth and expectations for 2022. I also rate the stock a Buy, but at a price below $85. The same expectation applies that when the market pulls back in Q1 2022, and I believe it will, this stock should be on your watch list.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of BLDR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may initiate a long position in BXC within the next 3 months and previously held shares in my personal portfolio.