2 Unknown Stocks Taking Over Their Industries
Based on the dollar volume of the deals announced this year so far, it appears that M&A activity is heading for a record year in 2015. As a long time market watcher and investor, this is a major “watch out” item for me because this sort of deal flow tends to happen near market tops such as during the previous peaks in 1999 and 2007. Of course, as the CEO of Citigroup infamously once said “As long as the music is playing, you have to dance.”
There are good reasons M&A is seeing such robust activity levels. Growth is hard to come by as worldwide demand levels this year should post their lowest levels since 2009. Interest rates also remain extremely low making purchases, even very large ones possible.
In addition, companies are responding to weak organic growth potential by making acquisitions to consolidate fragmented industries, gain market share, take capacity out of the system hopefully leading to greater pricing discipline and provide economies of scale. You can see this in the semiconductor industry where over $120 billion in transactions have been announced this year. This includes Avago Technologies (NASDAQ: AVGO) buying Broadcom (NASDAQ: BCOM) for almost $40 billion earlier this year and the just announced purchase of Sandisk (NASDAQ: SNDK) by Western Digital (NYSE: WDC) last week.
I think playing the consolidation wave sweeping through various industries right now can be a profitable investment theme. Investors should stick with companies that are doing this the right way by not racking up a huge amount of debt to make purchases, that have shown they are good at integrating these acquired companies into their overall structure and that also can grow organically as well. Obviously, their stocks should also have reasonable and/or attractive valuations before being considered for an investment.
One of my favorite plays on this investment theme is United Rentals (NYSE: URI). The company, which has just a $7 billion market capitalization, is the unquestioned market leader in the very fragmented equipment rental industry. The company has more than twice the market share as its next biggest competitor yet only has 12% of the overall sales in this segment.
The industry is projected to grow in the mid-single digits annually over the next half-decade. The company should add a couple of points of additional sales annually by buying out small players in the industry. United Rentals should be able to grow sales in the high single digits during an average year as long as the economy continues to muddle along.
As it integrates new purchases, the company will continue to get more efficient. During its last completed quarter, United Rentals’ adjusted EBITDA margin was just north of 50%; that was an all-time quarterly record. The company also posted earnings of $2.57 a share, almost a full quarter a share over the consensus. As long as the country does not sink into recession, United Rentals should see earnings gains of 10% or a bit better. At approximately $75 a share, the stock trades at just over nine times this year’s profits and is down from nearly $120.00 a share late in 2014.
Next up is CarMax (NYSE: KMX) which has fallen to under $60.00 a share from its high of $75.00 a share recently and sports a market capitalization of around $12 billion. The company has just a tad more than 150 domestic “super stores” and is one the biggest sellers of both new and used vehicles. This is another extremely fragmented space with CarMax only reaching just over 60% of the population. It has a five percent market share in the cities it serves and around three percent of overall market share.
There are a lot of things to like about CarMax with annual new car sales running higher than before the financial crisis. The economy is seeing solid but not spectacular job growth, interest rates remain very low on a historical basis and the average vehicle on the road is over a decade old. The company has plenty of growth opportunities in major cities like Boston and Seattle both of which it plans to expand to in 2016. Overall, the company plans to open up approximate 15 new superstores nationwide annually over the next few years.
CarMax has significant economies of scale compared to a lot of the “Mom and Pop” dealerships that are still a big part of the landscape in this sector. Revenues are growing in the high single digits annually. The company has a very solid balance sheet and bought back $250 million of its own shares last quarter. It has some $2 billion left on its existing stock authorization program – more than 15% of its outstanding float at current prices.
The company has grown sales an average of just over 10% annually over the past decade while profits have rose just under 20% annually over that time span. Even with that growth, the company still has plenty of room to grow and could garner 10% of overall market share a decade out. The stock does sell for 16.5 times forward earnings, about in line with the overall market multiple. Given the company’s continued growth trajectory the recent dip in the stock is an attractive entry point for long-term investors.
Disclosure: more