Time will tell what actually happens in the real world, but the plans under consideration for significant commercial building renovations in North America and Europe, as well as reshoring and automation adoption, add potential growth drivers to a story at Rexel (OTCPK:RXEEY) (RXL.PA) that I’d already thought was under-appreciated by market. Add in potential efficiency gains from digitalization and share gains in North America, and there’s still a good bull story to tell here.
Rexel shares have done well since my last update, with the ADRs up about 75% and the local shares up closer to 35%. I still see appreciation potential in the low double-digits on a long-term annualized total return basis, and although Rexel has certainly recovered from the worst of the COVID-19 panic, I don’t believe the shares yet reflect the true potential of the business.
Pressure On All Fronts, But Not As Bad As Feared
The second quarter was indeed challenging as sell-side analysts expected, and I can understand why some investors may have been disappointed that the company didn’t beat by a wider margin (though the same could be said of WESCO (WCC). Still, for the company to hold its margin decline to just 140bp on a double-digit revenue decline is a good result relative to past cycles.
Revenue declined about 18% in the second quarter and about 11% in the first half – like many European companies, Rexel provides margin information only on a half-year/full-year basis. Revenue in the second quarter declined 17% in Europe, led by a 25% decline in France, while North America declined 23% and Asia-Pacific declined about 1%. While the North America decline may seem a little steep to some readers relative to broader trends in industrial and non-residential sectors, I’d remind them that Rexel is over-indexed to industries like autos, aerospace, and oil/gas in its North American business.
Looking at the half-year numbers, gross margin fell only 50bp from the prior year, while EBITDA declined 27% (margin down 120bp) and adjusted EBITA fell 40% (margin down 140bp). The adjusted EBITA number was good for a nearly 3% beat versus sell-side expectations. By geography, Europe saw a 42% decline (margin down 190bp), North America declined 33% (margin down 90bp), and Asia-Pacific declined 60% (margin down 90bp).
Rexel management reported that they were able to reduce variable expenses (25% of the base) by 10% in the second quarter and flexible expenses (more than half of the base) by 20%; some of these costs will certainly come back with volume recoveries, but management believes they may have some upside to long-term efficiency targets.
Some Near-Term Recoveries Underway
When I last wrote about Rexel, I said that I expected V-shaped recoveries in the residential housing markets in the U.S. and France, and so far that seems to be the case. In France especially, construction sites are back to normal operations (the shutdowns were more extensive than in the U.S.), with some sites trying to accelerate their activity to catch-up. While the outlook for private non-residential construction is cloudy, municipal spending looks stronger.
In the U.S., commercial construction activity has remained healthy so far, as developers push to get projects completed. About half of Rexel’s U.S. business is in commercial construction, and I would note that the project pipeline for 2021 is shrinking across the sector as developers are hesitant to commit to new projects in the current environment.
Looking at the industrial business, Rexel is more cautious than most industrial companies. While many companies are expecting a pretty strong short-cycle industrial recovery, including autos, Rexel is looking for autos, aerospace, and oil/gas to remain depressed for an extended period of time. I believe that’s an accurate call for the latter two, but I see more near-term upside in autos as build rates recover.
Longer-Term Opportunities Look Positive
I’m more bullish now on Rexel’s longer-term opportunities in non-resi construction. While there are definitely risks to new-builds in both the U.S. and Western Europe, there has been movement toward “green building” retrofits. There is a “Green New Deal” plan under consideration in the EU, and candidate Biden’s platform includes a meaningful effort to renovate commercial buildings to be more energy-efficient.
In both the U.S. and Western Europe, commercial buildings account for significant electricity consumption, primarily in areas like HVAC-R and lighting, and there are a host of new technologies, including automated building controls, that can drive significant energy consumption reductions after retrofits. As companies like ABB (ABB), Carrier (CARR), Eaton (ETN), Honeywell (HON), Johnson Controls (JCI), and Schneider (OTCPK:SBGSY) all rely on distributors like Rexel, the company is well-placed to supply a multiyear renovation trend (on the electrical side). I’d also note that this trend isn’t as politically-dependent as it may seem – there has already been a strong trend in both regions of tenants increasingly demanding higher building efficiency minimums, with less efficient buildings garnering lower rents.
Rexel is also leveraged to a growing trend of automation in industrial markets, including markets like non-resi construction and oil/gas that have been slower to adopt digitalization, electrification, and automation so far. Automation demands more advanced electrical components/supplies, driving more demand for Rexel, and I’d note the company is also leveraged to potential reshoring in North America, with companies potentially looking to establish new, highly-automated (and electrified) manufacturing facilities in the U.S..
Share growth and digitalization are also still potential drivers to watch at Rexel. On the share side, Rexel is more leveraged to ABB in the U.S., and that company has been performing better of late as the integration/turnaround of GEIS proceeds. With digitalization, Rexel is already seeing share gains in Europe and North America driven by digitalization (driving high single-digit growth this quarter), and I expect this to continue. Digitalization also offers more long-term upside on costs and working capital, as it allows the company to better anticipate customer needs (improving sourcing and branch assortment) and reduce back-office labor for functions like ordering and billing – on the back-office side alone, ongoing digitalization could drive a 5% or greater reduction in headcount over the next five to 10 years.
Rexel management expects more green energy, more electrification, and more automation, and I agree across the board, and would also mention that the greening of commercial buildings involves all three. While industrial distributors as a group have de-rated since the last peak, I believe Rexel’s leverage to electrification/automation and digitalization can reverse that trend for the company, and I believe it can likewise drive share growth as smaller, less capable vendors are driven out of the market.
I do expect fierce ongoing price competition in the distribution space, though, and I’m only expecting low single-digit growth for non-resi capital-in-place. So with all of that, I’m still only expecting low single-digit growth from Rexel across the long-term, though I do expect growth closer to the mid-single-digits in the post-COVID-19 recovery. With increased volumes and the margin and working capital benefits of digitalization, I expect FCF margins to improve over the next decade by about 100bp on average, helping drive mid-single-digit FCF growth.
The Bottom Line
Between discounted free cash flow and margin/return-driven EV/EBITDA, I believe Rexel is still undervalued even after this strong rebound off the COVID-19 panic lows. Rexel’s leverage to commercial building retrofits and industrial automation still seems under-appreciated, as do the potential long-term benefits of its own digitalization effort. With that, I still think this is a stock worth buying today, though the U.S. ADR volume/liquidity is poor.
Disclosure: I am/we are long ABB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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