Ferguson Stock: A Slowdown Coming In 2023 (NYSE:FERG)

The slowdown in new construction starts is going to continue to be a major headwind for Ferguson plc (NYSE:FERG) in 2023, as higher interest rates, strong inflation, and uncertainty in the job market will remain significant challenges in the year ahead.

While Ferguson did enjoy a good fiscal Q2 revenue beat, being up $159.00 million, or 4.87 percent, year-over-year, signs are showing that is slowing down. Taking into consideration tough comps, it’s going to be hard to continue to outperform going forward, even with its acquisitions.

The company missed by $0.04 with EPS, pointing to contracting gross margins, which I see as remaining under pressure throughout the year.

I don’t see the housing market recovering anytime soon, with the Federal Reserve sure to raise interest rates at least a couple of more times, depending on how inflation responds to the increases. Under that scenario, the housing market is probably going to get a lot worse before it starts turning around.

And if the job market continues to worsen in regard to employee terminations, especially in high-end and high-paying tech jobs, the market could degrade much more. That would, of course, hit FERG hard.

In this article, we’ll look at some of its latest numbers, and what the next year or so looks like for Ferguson plc.

Some of the numbers

Revenue in the second fiscal quarter of 2023 was $6.8 billion, up 4.9 percent year-over-year. Organic growth accounted for 2.7 percent of the increase in revenue, and acquisitions contributed another 2.6 percent. Foreign exchange offset some of that by negative 0.3 percent, and another negative 0.1 percent came from one less sales day in Canada during the reporting period.

Revenue in the U.S. market was up 5.4 percent, with organic growth accounting for 2.6 of revenue growth, and acquisitions for 2.8 percent of revenue growth in the reporting period.

With residential housing starts and permits down, maintenance and repairs did better in the quarter. Total revenue from residential was up about 1 percent.

Adjusted operating profit in the U.S. market for the second fiscal quarter came in at $579.00 million, up $3.00 million year-over-year.

Revenue from Canada was down 4.5 percent, with organic revenue growth of 3.0 percent, which was down 1.2 percent because of one less sales day, and down 6.3 percent from foreign exchange rates.

Residential in Canada was also weak, while non-residential markets did better.

Adjusted operating profit in the Canadian market was $14.00 million, down $9.00 million from the second fiscal quarter of 2022.

Gross margins were 30.2 percent, down 40 basis points from the second fiscal quarter of 2022. That was attributed to strong comps.

Operating profit in the reporting period was $549 million, with an operating margin of 8.0 percent. Operating margin was down 1.1 percent year-over-year.

Diluted EPS in the second fiscal quarter of 2023 was $1.80, down 8.6 percent from diluted EPS of 1.97 from the second fiscal quarter of 2022.

As for 2023 guidance, the company is looking for very modest growth in the low-single-digit. Adjusted operating margin is projected to be in the range of 9.3 percent to 9.9 percent. CapEx is estimated to be in the range of $400.00 million to $450.00 million.

Management said it expects its rate of growth to continue to compress through the remainder of the year. Further out, it was noted that approximately $650.00 million in construction activity is estimated to come online over the next five years, and the company is positioned well to take advantage of that.

At the end of January 31, 2023, Ferguson plc had net debt of $3.4 billion.

Acquisitions

There were four acquisitions Ferguson plc completed in the reporting period, including Airefco, an HVAC distributor located in the Pacific Northwest; Guarino Distributing Company, which competes in Louisiana and Mississippi; Pipelines, a distributor of waterworks which operates in Eastern Ohio and Western Pennsylvania; and Power Process Equipment, an industrial distributor that will bolster its position in the upper Midwest region.

In total, the four new additions will generate approximately $300 million on an annual basis.

For a company that distributes heating and plumbing products in the U.S. and Canada, I particularly like these types of regional acquisitions that expand its footprint in specific markets it has the potential to increase share in after the deals are closed. This should improve its organic growth numbers going forward.

Share price movement

Looking at a 2-year chart of FERG, the Ferguson plc share price traded at approximately $124.00 per share on April 5, 2021, soared to a 2-year high of about $184.00 per share on January 3, 2022, and from there plunged to its 2-year low of $99.16 on October 17, 2022, before rebounding to approximately $150.00 per share on February 13, 2022, and since pulling back by about $10.00 to $140.00 per share as I write.

Based upon expected ongoing weakness in new housing starts, I think the share price of $140.00 per share is elevated and is likely to pull back below that through 2023 as interest rates climb and the job market remains under pressure.

Don’t let the unemployment numbers fool you, the labor participation rate is at its lowest level since the latter 1970s, which means those people aren’t producing income. Combined with the loss of high-paying, high-tech jobs, it points to a housing market that is going to remain under pressure until the Federal Reserve finally pivots, which may take longer than expected.

With Ferguson plc guiding for growth in the low single-digits for 2023, at best the share price of the company could move up modestly. But with that probably being the best-case scenario in my opinion, I think it’s going to go lower before finding a sustainable bottom.

Conclusion

As the housing market goes, so will go FERG, and that doesn’t bode well for the company over the next year or so, as it appears there will be at least a couple of more interest rate hikes before the Fed may eventually pause and waits to see the impact on inflation.

Under that highly probable scenario, the next couple of quarters, at least, should be challenging for Ferguson plc, as mortgage rates should rise more and those looking to buy new homes put their plans on hold until economic conditions improve.

With that in mind, I believe Ferguson plc is going to struggle to grow at even its guided low-single-digit rate and will be fortunate to break even for 2023.

Over time, Ferguson plc should rebound when the new housing starts increase, but until then it’s going to struggle to regain any momentum. It would be best to wait for a much better entry point, in my view before considering taking a new position in Ferguson plc, or adding to an existing one.