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.