Building Materials Holding Corp Moat Check

I’m finally back on track with my review of potential wide moat companies. I’ve been distracted with my work on Value Investing News but things are starting to settle down now. There is already quite a bit of activity on Value Investing News, so I encourage you to check it out.

Today, I’m going to take a closer look at Building Materials Holding Corp. (BMHC). Justin from the Rule One Investment Community has already calculated the Big Five numbers for BMHC. Now that I’m looking at the numbers from the previous link a bit more closely, I’m a bit surprised that Justin considered this a wide moat company. The return on invested capital (ROIC) for BMHC was below 10 percent for each year between 1996 and 2003. Only when the housing boom really got going did Building Materials Holding’s ROIC break into the double digits. ROIC is the most important numbers I use to determine whether or not a company has a sustainable competitive advantage (i.e., wide moat).

Never the less, it still important to look at exactly what a business does to determine if it might have a hidden wide moat. Building Materials Holding Corporation is one of the largest providers of residential construction services and building products in the United States. The company is divided into two subsidiaries, BMC Construction and BMC West. BMC Construction provides construction services to high-volume production homebuilders and BMC West distributes building products and manufactures building components for professional builders and contractors. Both of these business lines have benefited from the recent housing boom, so caution must be taken in evaluating this business.

Competition is going to be fierce in the housing sector over the next few years as demand drops. Building Materials Holding Corporation considers its “ability to provide construction services and distribute building products… a competitive advantage to builders seeking full-service providers.” However, the real question is whether Building Materials Holding gains a sustainable competitive advantage from its integration of construction services and building products distribution. I’m not convinced.

In construction services, BMHC competes with local crews and larger regional construction companies.  In its latest 10-K, Building Materials Holding believes that its ability to provide multiple trade offerings such as framing, concrete, and plumbing gives it an advantage. However, I believe that service is easily replicated. The company also argues that their certifications from the National Association of Home Builders help them compete. I’m sure that helps but it does not preclude others from providing services. Finally, BMC Construction states “we are recognized in our markets for our reputation, quality and reliability of our services and products as well as capital resources.” That may be the case but I am not that familiar with the home building industry to evaluate the value of their reputation. Furthermore, while reputation can provide a competitive advantage, in business-to-business transactions it often does not convey pricing power since business are often more careful about prices than consumers since their sole purpose is to generate profits.

Looking at the BMC West side of the business, it looks like BMC West faces competition from local, regional and national building products distributors. My guess is that this also is starting to include competition from consumer hardware mega-stores such as Home Depot (HD).  In their 10-K, BMHC states the following about their building products distribution business, “We believe being a full-service provider to many of our customers distinguishes us from our competition and is a competitive advantage.” I believe that the only way a distributor can really have a competitive advantage is either to be the only supplier of a product or to be the lowest cost supplier. BMC West claims to be neither of these.

Given my review of Building Materials Holding Corporation, I do not believe that it has a sustainable competitive advantage. Actually, it doesn’t look like it really has much of a moat at all.

8 thoughts on “Building Materials Holding Corp Moat Check

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  • October 13, 2006 at 1:42 pm
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    I agree. No moat. But is it a bargain around this price? You mentioned if Apache got down to the right price even though it was in a commodity type business it might interest you.

  • October 13, 2006 at 2:00 pm
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    The difference between Building Materials Holding Corp and Apache is that I think Apache could possible be a low cost producer. In addition, Apache controls some of the supply of nonrenewable resource that is currently essential for commerce. Building Materials Holding Corp does not share that characteristic.

  • October 13, 2006 at 4:19 pm
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    OK. I did really get a sense , stronger than ever both in an interview the author Miles had with Clayton of Clayton homes where he was so strongly influenced by Buffetts’ emphasis on increasing their moat, and in a speech and question and answer session Buffett had at U of Florida. At that one he really seemed to me to say that moat was more important for him and price didn’t have to be that cheap (although that was a bonus) because the competitive advantage would over the long run really pay off better and was more of a sure thing. By the way. Again, thanks for and good luck on Value Investing News. I like it. Ron

  • October 13, 2006 at 4:47 pm
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    Hi Ron –

    I’m glad you like Value Investing News. If you’ve already seen the Clayton video I guess you are already actively using the new site. Please provide any feedback you have on Value Investing News in either the forum or just send me a message.

    Thanks!

  • October 13, 2006 at 7:40 pm
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    I agree with you on BMHC’s moat – there is none. However, I did make a mistake when I ultimately decided not to buy it about three years ago. I wrote about this mistake in a post entitled “On The Two That Got Away”:

    http://www.gannononinvesting.com/2006/01/on_the_two_that_got_away.html

    If you look at BMHC’s historical valuations, it has often traded at low price-to-earnings, price-to-book, and price-to-sales ratios. The difference today is that both the earnings and the stock price have jumped over the past couple of years. While the company may look cheap at these levels, I was a lot more interested when it had a low p/e and an EBIT of about $30 million (a number it had been close to several times before) than I am now that it has an EBIT of about $225 million – something it never came close to doing in previous years. As I see it, the huge jump in earnings casts real doubt on the utility of the current P/E ratio.

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  • October 15, 2006 at 6:24 pm
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    Hi Geoff,

    Thanks for stopping by. I hadn’t realized you wrote about Building Materials Holding Corp earlier this year.

    I agree with you take on this company. I also share your doubts about the use of the current P/E ratio given the huge jump in earnings.

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