DNOW - DistributionNow

[Fat Pitch]

How much business are they doing online vs mortar store? Does DNOW has similar advantages of auto retail stores? Where customers usually wants their items right away (as in NOW)?

 

Auto retail suppliers hold on to obscure auto parts for years before a customer comes in that door asking for it, but they will get a 75%+ margin on that item. DNOW deals with commoditized industrial supplies for O&G. You have no edge if you are making pricing concessions to keep customers.

[MrB]

After some digging in it appears these distributors are nothing more than off balance sheet working capital “leasers” for their customers. DNOW management mentioned pricing concessions on their calls so this seems like a low quality business. Other companies (GWW, FAST, MSM) provide other services that tie themselves to the customer aside from renting out their balance sheet.

 

While the potential for M&A is massive it looks like a double edged sword when looking at potential competitors. An industry that generates 1 trillion+ in annual revenue globally is going to catch Benzos attention and his company has the edge in shipping and logistics. There’s a high chance that the industry gross margins are going to be lower 10yrs from now.

What you are describing reminds me a bit of what NOV looked like when Miller arrived.

[kab60]

And another one - NOW Inc. Announces Challenger Industries Acquisition: http://ir.distributionnow.com/phoenix.zhtml?c=252871&p=irol-newsArticle&ID=2075322

[Wilson-TPC]

After some digging in it appears these distributors are nothing more than off balance sheet working capital “leasers” for their customers. DNOW management mentioned pricing concessions on their calls so this seems like a low quality business. Other companies (GWW, FAST, MSM) provide other services that tie themselves to the customer aside from renting out their balance sheet.

 

While the potential for M&A is massive it looks like a double edged sword when looking at potential competitors. An industry that generates 1 trillion+ in annual revenue globally is going to catch Benzos attention and his company has the edge in shipping and logistics. There’s a high chance that the industry gross margins are going to be lower 10yrs from now.

 

I have a few problems with your statement. Let's start with your statement about Bezos wanting to get Amazon into this business.

 

The shipping and logistics and the customers' need for immediate access to supplies makes any business model that requires a customer to wait but receive at a lower price obsolete. This is also why contractors buy through Home Depot and Lowes as opposed to ordering on Amazon or getting it directly from suppliers. As IOCs consolidate, there will be more consolidation in the "contractor" space, so the suppliers with the biggest scale will get the most benefits while smaller competitors get squeezed out. Consolidating in a commodity business or investing heavily in a commodity business during a downturn is where you earn the highest return on invested capital. To quote an outsider CEO Darren Gee, "The time to invest in a commodity business is when no one is investing."

 

Your statement about DNOW and MRC being working capital leasers are true in many sense, but does not prohibit a business from earning an adequate return in the process. Price concessions to keep customers wouldn't be the right way to frame it given that supply costs are also down. Given the fixed costs remain stable, this explains why EBITDA margins will be reduced.

 

I think there's a key part of the thesis people don't think about. How can a distributor have a competitive advantage? Scale. If you have scale, then everything else will fall into place. If you don't, you are shit out of luck. From DNOW's recent acquisitions, it seems to me they are using their additional acquisition currency for companies in the mid and down stream industry. DNOW has a considerable exposure to upstream, so it only makes sense to further integrate into the other segments. Once DNOW reaches sufficient scale in all three segments, the business won't be nearly as impacted in the next downturn as opposed to this one. Downstream and midstream offers more stable margin opportunities and insulate the company from future commodity price swings. This will add value. 

[mateo999]

From DNOW's recent acquisitions, it seems to me they are using their additional acquisition currency for companies in the mid and down stream industry. DNOW has a considerable exposure to upstream, so it only makes sense to further integrate into the other segments. Once DNOW reaches sufficient scale in all three segments, the business won't be nearly as impacted in the next downturn as opposed to this one. Downstream and midstream offers more stable margin opportunities and insulate the company from future commodity price swings. This will add value.

 

Odessa closed Q3, and its unclear when Challenger will close.  Both all cash with terms not disclosed.  Assuming Challenger closes Q3 also, we likely won't get clarity on the prices paid until November (last Q3 10-Q filed 11/7.  What if they're tiny?  Or DNOW overpaid? 

 

Question for the board: 300 and 160 employees respectively.  Any idea how large those operations might be?  And what's the right way to get to valuation for a mom and pop?

 

This all gets to my biggest question on the theory of DNOW emerging stronger: Is DNOW actually paying fire sale prices for mom and pops?

 

PS, Wilson, when you say acquisition currency, are you referring to cash/balance sheet?  I certainly wouldn't want DNOW to pay with stock.  If they do, I'd be nervous that the opportunity set isn't as wide open for the taking, as bulls might believe.  If I were selling my business to DNOW, i know certainly do my best to negotiate for equity here.

[Wilson-TPC]

From DNOW's recent acquisitions, it seems to me they are using their additional acquisition currency for companies in the mid and down stream industry. DNOW has a considerable exposure to upstream, so it only makes sense to further integrate into the other segments. Once DNOW reaches sufficient scale in all three segments, the business won't be nearly as impacted in the next downturn as opposed to this one. Downstream and midstream offers more stable margin opportunities and insulate the company from future commodity price swings. This will add value.

 

Odessa closed Q3, and its unclear when Challenger will close.  Both all cash with terms not disclosed.  Assuming Challenger closes Q3 also, we likely won't get clarity on the prices paid until November (last Q3 10-Q filed 11/7.  What if they're tiny?  Or DNOW overpaid? 

 

Question for the board: 300 and 160 employees respectively.  Any idea how large those operations might be?  And what's the right way to get to valuation for a mom and pop?

 

This all gets to my biggest question on the theory of DNOW emerging stronger: Is DNOW actually paying fire sale prices for mom and pops?

 

PS, Wilson, when you say acquisition currency, are you referring to cash/balance sheet?  I certainly wouldn't want DNOW to pay with stock.  If they do, I'd be nervous that the opportunity set isn't as wide open for the taking, as bulls might believe.  If I were selling my business to DNOW, i know certainly do my best to negotiate for equity here.

 

Yes, not equity. I was referring to debt and cash.

 

In the houston news, it said that it's laying off half the employees. 8ks are typically filed only if its a significant event. Given that even DNOW and MRC are trading at a depressed multiple to sales, I'm assuming that's what they are most likely buying a lot of these private companies at (.3-.4x sales).

[mateo999]

Arlington sold 10.3% of his DNOW in Q2.  fyi

 

he's gonna have a tough Q3- added to CMPR and OUTR in Q2.

[spartansaver]

Two headwinds I see this company facing.

-The consolidation of their suppliers.

-The push of their suppliers to expand their aftermarket businesses putting pressure on the MRO business.

[Homestead31]

could you comment more on your fears regarding consolidation of suppliers?

 

there are literally thousands of them, and for the most part they are supplying commodity products, meaning if that they consolidate and are able to earn higher returns on equity, new entrants are likely to join the fray and mean revert ROEs...

 

any thoughts appreciated.  thanks

[spartansaver]

As an example their MRO business provides services for pipes valves and artificial lift among many others. This will most likely lose customers as Cameron one of the largest suppliers of valves and a portfolio of artificial lift was recently acquired. This will provide Cameron with more points of contact in selling their distributed valves and services on their other equipment. This is just one example of consolidation as there is likely more to come. I understand I may not completely understand the portfolio of DNOW's products so please shed light if I am thinking too granular about the products they provide.

[Homestead31]

i agree that consolidation is likely, but i disagree that it will matter. in the case of cameron specifically, they are primarily a services company, not a distributor.  maybe HAL wants to keep the distribution side going, but maybe they don't.  Regardless, distribution in a "many to many" ecosystem is a great business b/c neither side of the ecosystem wants to deal with micro managing the thousands of touch points on the other side.  Additionally, there are no barriers to entry on either side of the ecosystem, so if consolidations occur, it is likely only a matter of time before new entrants re-introduce a wide diversity of players.

[ABM]

I believe the capital structure would be the #1 factor driving the selling in this environment from mom & pops; as such, I would be most interested in understanding the balance sheet of the acquirees once the 10-Q comes out. 

 

If the mom and pops are running levered than they may have no choice but to sell their business/asset.  In which case, DNOW should be scooping up assets at big discounts to IV.  If these distributors are running lean than most would not be sellers here leading me to believe DNOW is paying a fair price for these acquisition which limits the upside. 

 

Bottom-line, are these distressed sales or not?

[Homestead31]

if you go through the conference calls, management talks about how they are getting incoming calls from companies that they approached and were rejected by when oil was still $100 or whatever.  at that time, these targets had no interest in the prices that DNOW was willing to pay.  Now they are coming back to ask if DNOW is still interested.  That doesn't mean the prices are "distressed" but it certainly indicates they are favorable.  Also, on the recent KLXI call, management said they are seeing lots of little guys going BK.  They are more services businesses than distribution businesses, but the point is that the pain is very real for the underscaled players who don't have rock solid balance sheets.  it is a great environment to have the best balance sheet on the block.

[AzCactus]

DNOW--officially my largest holding.  In a good environment they make a good amount of money.  In a poorer environment they can make smart/cheap(er) acquisitions. 

[cogitator99]

DNOW--officially my largest holding.  In a good environment they make a good amount of money.  In a poorer environment they can make smart/cheap(er) acquisitions.

 

Care to share how large it is for you and how you got to your level of conviction?

[undervalued]

DNOW--officially my largest holding.  In a good environment they make a good amount of money.  In a poorer environment they can make smart/cheap(er) acquisitions.

 

Care to share how large it is for you and how you got to your level of conviction?

 

How large a position by itself is not an indication of conviction. Could you also add the current dollar amount you're managing and your income per year? lol I am wondering how much time you will need to regain those loses if you're wrong.

[AzCactus]

It's around 30%.  That could obviously change based on any buys/sells as well as general movement of my portfolio in general.  I am pretty young (26) so not too concerned with short term price movements.  I think you have a larger company in a fragmented industry with solid management and a long term vision that makes sense to me. If you view their recent transactions they were during market lows so the biggest thing is that management a) paid a fair price and b) is apple to effectively integrate these acquisitions. 

[DavidVY]

Is MRC balance sheet such an issue considering they are actively deleveraging 100ishMM/year.

 

I personally like MRC because it is the largest PVF supplier. Distribution = scale.

 

The debt is from the LBO spinoff from Goldman Sachs and is on a steady way down.

 

I like that they are just paying down debt and have no real acquisition plans until 2016.

 

Odds are that it will be MRC and DNOW that are the #1 and 2 players in distribution and will take most of mkt share from other players.

[kab60]

I think MRC looks attractive as well, but I went with DNOW due to the pristine balance sheet. Buying it a bit above NCAV seems pretty safe (even though I bought too soon in hindsight - cost around 19.5). I think there is more upside to MRC but having no opinion as to where oil prices are heading I mainly look at downside. Now it's just about waiting. :)

[rkluwer]

Q3 report is out.

 

http://ir.distributionnow.com/phoenix.zhtml?c=252871&p=irol-newsArticle&ID=2105678

 

Big impairment of 255 mio - that brings Q3 as massive loss.

 

If u look thru is, there revenue is flat in US and Canada, even with rig Counts still dropping, which i find positive - the generate FCF of 161 Mio in Q3 which also should bring some positive vibes - but still, its hard times for DNOW under the current "oil-storm". I like what i see and think this shows the are still taking in market-shares with revenues flat, in a still dropping rig-Counts market.

 

My position in a multiyear holding, so for me this is nice to see, and show that DNOW is making an effort to reduce cost, but still gain new clients, so they will be ready when the cycle turns.

 

How u Guys see it ?

[Txvestor]

I think the revenues have declined by a third on a YoY basis, and perhaps 2-3% on 2nd to 3rd Q sequential basis.

261m of FCF year to date probably from reduction of working capital and general shrinkage of the business which they can now put towards favorable acquisitions in this environment is about the only positive I see, that as well as their vague promise to address their cost structure.

They sure have a lot of spare capacity on their balance sheet and as low as their stock price has fallen, it would be nice to see them put in a 100M or so share buyback as well, to give shareholders some solace while awaiting the firming of the market.

[AzCactus]

I think the revenues have declined by a third on a YoY basis, and perhaps 2-3% on 2nd to 3rd Q sequential basis.

261m of FCF year to date probably from reduction of working capital and general shrinkage of the business which they can now put towards favorable acquisitions in this environment is about the only positive I see, that as well as their vague promise to address their cost structure.

They sure have a lot of spare capacity on their balance sheet and as low as their stock price has fallen, it would be nice to see them put in a 100M or so share buyback as well, to give shareholders some solace while awaiting the firming of the market.

 

The thing I want in a business like this is a company that has the ability to go on offense and make smart, long term acquisitions.  The biggest and as far as I'm concerned only real question is how well does management integrate these new businesses?  I do agree with the above though that I would like to see some buybacks if possible or an additional acquisition in the $250-500 MM range. 

[rkluwer]

I do agree, that buy-backs would be great at this point. But M&A activety should only be done, if the feel that it gives them more the the are paying for. So the reason why im not concerned about this is, that allready maid 9 since the sin-off, and will def do more.... but i believe in management - so im sure the buy more, when the feel the time and price is rite!

[Guest notorious546]

if you annualize management's free cash flow #'s you get about an ~17% TTM FCF yield.

[Txvestor]

You really can't annualize FCF yield at a time like this. Some of this FCF is due to shrinkage of the business and derived from a reduction on working capital/inventory liquidation etc. it will go the other direction when the cycle turns and they need to stock up to meet demand etc.

DNOW however has an enviable balance sheet despite the recent acquisitions, which I hope they are making at substantial discounts to intrinsic value, carefully measured against their depressed stock price. Otherwise from a shareholder's perspective we would be better off with share buybacks with adding a little leverage. I definitely see them having some space to do both. Compared to their main competitor they have next to no debt, and almost another billion dollars they could borrow.

 

This is the perfect time and opportunity for a capable management to earn their keep. Cutting costs, increasing efficiencies, grabbing market share, making accretive and opportunistic acquisitions, and buying back shares can and should perhaps all be done, and they have the amunition to do it all with the liquidity. Of course opportunity is a double edged sword, and in incapable hands the results can be disastrous. Judging from the conference calls to date, their attention seems focussed on acquisitions more than any of the other items, but they did mention cost cuts. Thus far i haven't heard anything about share buybacks.