Ferguson Reports Solid Second-Quarter Results Despite Weakening Residential Backdrop

After reviewing Ferguson’s FERG fiscal second-quarter results and outlook, we’ve raised our fair value estimate for New York Stock Exchange-listed shares approximately 1.5% to $136 per share, primarily due to the time value of money. The change in the GBP/USD exchange rate since our last update (1.19 versus 1.22) caused us to raise our fair value estimate for London Stock Exchange-listed shares about 4% to GBX 11,500.

Reported revenue growth of approximately 5% exceeded our expectations for approximately 1% growth as Ferguson’s United States nonresidential end markets remained strong (with 11% sales growth) and U.S. residential sales growth remained positive (1% growth) despite a weakening backdrop. Recall that approximately 20% of Ferguson’s revenue is tied to new residential construction, 35% is linked to the residential repair and remodel, or R&R, market, and 45% of revenue is from the nonresidential market.

We were particularly interested in management’s assessment of the R&R market because there have been divergent views on this market’s 2023 outlook. For example, The Home Depot sees the R&R market down by a low-single-digit percentage in 2023, while Masco (a large supplier for Ferguson) sees the market down by a low-double-digit percentage. Management said R&R spending remains resilient, especially for high-end remodel projects. During the quarter, residential building and remodel revenue (Ferguson’s showroom business) increased sales 12% year over year, while residential digital commerce revenue fell 10% and residential trade (primarily branch sales) declined 5%.

Ferguson’s adjusted operating margin declined 50 basis points year over year to 8.5%. We continue to believe the firm’s ability to reprice inventory in an inflationary environment led to peak operating margin in 2022 (10.3%), and we still think a long-term normalized full-year operating margin is closer to 8.5%-9%.