An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story

HD Supply (HDS) is, I believe, another example of how sooner or later valuation always matters. While this is a well-run industrial distributor with a lot of positive attributes, the valuation has historically been quite generous, as the Street was all-in on the “growth by M&A/consolidation” story, as well as improved margin leverage through scale. While the company has done pretty well operationally, the shares have sported only a mid-single-digit return (annualized) over the last five years due to what I believe was an inflated starting point.

There’s still a lot to like about this business. I previously worried that the company was too much of an M&A-driven “magpie”, assembling a collection of businesses that didn’t really make much sense together, but the company has since streamlined down to just its quality, relatively less-cyclical, facilities management maintenance, repair, and overhaul (or MRO) business. I do see opportunities for more consolidation-through-M&A, as well as opportunities to leverage advantages of scale to gain share and margin leverage over time. Valuation is now more reasonable, with the shares priced for a high single-digit to low double-digit return, albeit with a noticeable divergence between my cash flow-based fair value and my multiples-based fair value.

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An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story