Merion Road Capital Management, an investment management firm, published its third-quarter 2021 investor letter – a copy of which can be downloaded here. Merion Road Capital’s long-only large-cap portfolio fell 2.7%, while its long-short small-cap portfolio was up 0.7% for the third quarter of 2021, compared to its Russell 2000, Barclay Hedge Fund, and S&P 500 benchmarks that delivered a 4.3%, 0.1%, and 0.6% returns respectively for the same period. You can take a look at the fund’s top 5 holdings to have an idea about their best picks for 2021.
Merion Road Capital Management, in its Q3 2021 investor letter, mentioned Builders FirstSource, Inc. (NYSE: BLDR) and discussed its stance on the firm. Builders FirstSource, Inc. is a Dallas, Texas-based millwork company with a $12.1 billion market capitalization. BLDR delivered a 43.47% return since the beginning of the year, while its 12-month returns are up by 79.27%. The stock closed at $58.29 per share on October 21, 2021.
Here is what Merion Road Capital Management has to say about Builders FirstSource, Inc. in its Q3 2021 investor letter:
“I added to our position in Builder’s FirstSource (“BLDR”) during the quarter. BLDR is the largest national supplier of structural building products and value-added components to the residential construction market. They have been active in consolidating the industry, most notably with the merger of BMC earlier this year. Like other distributors, BLDR benefits from scale advantages that afford them a robust product offering, enhanced purchasing power, and fixed cost leverage. They will continue to acquire smaller competitors and have announced 5 new deals so far this year.
I view the strategic benefit of these acquisitions in three different buckets. There are the core tuck-in acquisitions of facilities and customer lists that increase scale and geographic reach. An example would be the company’s May acquisition of John’s Lumber, a lumber and specialty product distributor serving the Detroit MSA, at 0.5x revenue. There are product acquisitions that leverage their platform to increase distribution and improve the product offering. For instance, last month BLDR announced the acquisition of California TrusFrame, a designer and manufacturer of prefabricated components like trusses and wall panels, at 1.3x revenue. And lastly BLDR has begun investing in software and services. In June they spent $450mm on the purchase of WTS Paradigm, a software company that addresses the complexity around building configuration, estimating, and manufacturing, at 9.0x revenue. By utilizing software to in the planning process, WTS Paradigm cuts down on material and labor waste, ensures an optimal fit of product and design, and eases the contractor’s workload. BLDR has followed this up with a much smaller software acquisition in September.
BLDR is in the very early innings of their software investment, so it is difficult to pinpoint exactly how it will impact the company in the coming years. Management believes that there is a lot of low hanging fruit, pointing to a McKinsey study ranking the construction industry as second to last on overall digitization. If anyone has had any work done to their house, I am sure they can anecdotally attest to this. BLDR plans to leverage WTS Paradigm to increase internal productivity (i.e. improved estimating leading to fewer visits to the job site), cross-sell the software to existing clients, and drive greater adoption of value-added products. So thinking a few years out I think the goal would be to have higher margins on their commodity business, a greater mix of revenue coming from value added products, a stronger relationship with their customer, and an enhanced competitive advantage…” (Click here to see the full text)
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Based on our calculations, Builders FirstSource, Inc. (NYSE: BLDR) was not able to clinch a spot in our list of the 30 Most Popular Stocks Among Hedge Funds. BLDR was in 24 hedge fund portfolios at the end of the first half of 2021, compared to 25 funds in the previous quarter. Builders FirstSource, Inc. (NYSE: BLDR) delivered a 29.08% return in the past 3 months.
Hedge funds’ reputation as shrewd investors has been tarnished in the last decade as their hedged returns couldn’t keep up with the unhedged returns of the market indices. Our research has shown that hedge funds’ small-cap stock picks managed to beat the market by double digits annually between 1999 and 2016, but the margin of outperformance has been declining in recent years. Nevertheless, we were still able to identify in advance a select group of hedge fund holdings that outperformed the S&P 500 ETFs by 115 percentage points since March 2017 (see the details here). We were also able to identify in advance a select group of hedge fund holdings that underperformed the market by 10 percentage points annually between 2006 and 2017. Interestingly the margin of underperformance of these stocks has been increasing in recent years. Investors who are long the market and short these stocks would have returned more than 27% annually between 2015 and 2017. We have been tracking and sharing the list of these stocks since February 2017 in our quarterly newsletter.
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Disclosure: None. This article is originally published at Insider Monkey.
