In this analysis we will jump into the UK kitchen industry. We will explore Howden Joinery, a company that stands out with his unique business model with solid loyalty effect and ROICs above 25%.
As the undisputed leader in its sector, Howdens commands approximately 30% market share, a figure that continues to expand over time, underpinned by its sustainable and increasingly significant competitive advantages.
I have estimated a share price of ~ยฃ15.50 by 2030 on a conservative basis with plenty of optionality for the long term.
Introduction:
Howdens is a UK kitchen supplier specialist serving in the Repair, Maintenance and Improvement Residential market. Its operating model allows it to increase market share ๐จ๐ฏ๐๐ซ ๐ญ๐ข๐ฆ๐ (currently above ๐๐%) while generating the highest return and assuming the least risk.
Business Model:
The hearth of its strategy is that they ๐ผ๐ป๐น๐ sell to the ๐ฝ๐ฟ๐ผ๐ณ๐ฒ๐๐๐ถ๐ผ๐ป๐ฎ๐น ๐ฏ๐๐ถ๐น๐ฑ๐ฒ๐ฟ. By operating this way, Howdens can build on repeat purchases and long-lasting relationship with builders. By contrast, the retail kitchen market typically sells to a customer once every 15 years or so. ๐ก๐ผ ๐ผ๐๐ต๐ฒ๐ฟ ๐ฝ๐น๐ฎ๐๐ฒ๐ฟ ๐ต๐ฎ๐ ๐๐ต๐ถ๐ ๐ฏ๐๐๐ถ๐ป๐ฒ๐๐ ๐บ๐ผ๐ฑ๐ฒ๐น.
Serving the builder is the most intelligent move in this industry because each builder brings dozens or even hundreds of new customers through a long period of time, minimizing the customer acquisition cost and make everything more efficient, creating strong ๐น๐ผ๐๐ฎ๐น๐๐ ๐ฒ๐ณ๐ณ๐ฒ๐ฐ๐๐.
But what makes a builder happy? And the answer, as always, are incentives! Letโs first understand the needs of a typical builder:
The builder aims to earn profits and establish a good reputation by ensuring every project is of high-quality, completed on time, and within budget.
To achieve the objectives, the builder must be able to rely on having truly local stock of everything he needs, from cabinets and ovens to screws and glue.
Time is money so he canโt afford to waste time returning things and everything he buys must also be capable of being fitted quickly and accurately.
Howdens aims to help the builder ๐๐ฎ๐๐ฒ ๐๐ถ๐บ๐ฒ ๐ฎ๐ป๐ฑ ๐บ๐ฎ๐ธ๐ฒ ๐บ๐ผ๐ป๐ฒ๐ by offering the following:
Great product range with ๐ต๐ถ๐ด๐ต ๐๐๐ผ๐ฐ๐ธ ๐ฎ๐๐ฎ๐ถ๐น๐ฎ๐ฏ๐ถ๐น๐ถ๐๐. The customer can get everything in one stop shop.
๐ฉ๐ฒ๐ฟ๐ ๐ฐ๐ผ๐บ๐ฝ๐ฒ๐๐ถ๐๐ถ๐๐ฒ ๐ฝ๐ฟ๐ถ๐ฐ๐ฒ๐ and ๐ด ๐๐ฒ๐ฒ๐ธ๐ ๐ผ๐ณ ๐ฐ๐ฟ๐ฒ๐ฑ๐ถ๐ ๐๐ฒ๐ฟ๐บ๐
Howdens sells pre-assembled cabinets, increasingly with pre-fitted elements, ๐๐ฎ๐๐ถ๐ป๐ด ๐๐ถ๐บ๐ฒ to the builder (hours or even days).
A typical Howdens depot is on an edge-of-town location - more ๐ฐ๐ผ๐ป๐๐ฒ๐ป๐ถ๐ฒ๐ป๐ for the builder, and cheaper to rent. Around 85% of UK customers live within 5 miles (8Km) of a Howdens depot.
A Howdenโs designer will visit the customerโs house free of charge to make sure that everything will be fit properly, giving ๐ฝ๐ฒ๐ฎ๐ฐ๐ฒ ๐ผ๐ณ ๐บ๐ถ๐ป๐ฑ to the builder.
Operations:
Howdens has a reputation for offering lower prices than the competition. The secret lies on its ๐๐ฐ๐ฎ๐น๐ฒ.
It designs and manufactures all its cabinets and some worktops and skirting boards. We are talking big numbers here, around ๐ฑ ๐บ๐ถ๐น๐น๐ถ๐ผ๐ป ๐ฐ๐ฎ๐ฏ๐ถ๐ป๐ฒ๐๐ in 2022.
The company produce roughly ๐ฏ๐ฑ% of what they sell and they plan to reach up to ๐ฑ๐ฌ%. Howdens has high bargaining power with over 200 suppliers due to its bulk purchases. The company sells more than 1m appliances, 700k sinks and taps, 2.5m doors and about 4 million m2 flooring.
This scale is massive in the UK. No other competitor come close to it, and this is precisely why they beat everyone in price.
Distribution:
It has a big network of 840 depots in the UK and 75 in other European countries (68 in France, 5 in Ireland and 2 in Belgium). All leased and managed by ๐ฒ๐ป๐๐ฟ๐ฒ๐ฝ๐ฟ๐ฒ๐ป๐ฒ๐๐ฟ๐ถ๐ฎ๐น ๐ฒ๐บ๐ฝ๐น๐ผ๐๐ฒ๐ฒ๐. Managers run their depots as they think best as per their local conditions, with incentives tied to profit and margins.
The company has their own warehouses and distribution operations with trucks delivering to Howdens depots only. ย In the past, the company used to run weekly deliveries. However, they recently added ๐ก๐ฒ๐ ๐ ๐๐ฎ๐ deliveries using third party infrastructure.
This new system combined with scale offers a ๐ฏ๐ถ๐ด ๐บ๐ผ๐ฎ๐ as it is hard to get copied by other players. This will reduce the stock of low rotation products at depot level and gives more accurate information flows to the manufacturing plants, which then translates into a more efficient use of the production infrastructure, lower costs, and the possibility to introduce new products more effectively.
Industry:
The UK has a market size of about ยฃ11.5Bn. This is divided in ๐๐ถ๐๐ฐ๐ต๐ฒ๐ป-๐ผ๐ป๐น๐ market of about ยฃ7Bn and ๐๐ญ๐ก๐๐ซ ๐๐๐ญ๐๐ ๐จ๐ซ๐ข๐๐ฌ (such as appliances, sinks, doors, flooring and so on) of ยฃ4.50Bn.
The Kitchen-only market is further divided in three categories:
1)ย ย ย ย ย ๐๐ง๐ญ๐ซ๐ฒ ๐ฅ๐๐ฏ๐๐ฅ โ market of ยฃ1.6Bn: Kitchens with a ranging price up to ยฃ4k.
2)ย ย ย ย ย ๐๐ข๐-๐ซ๐๐ง๐ ๐๐ฌ โ market of ยฃ3.15Bn: Prices between ยฃ4-8k.
3)ย ย ย ย ย ๐๐ข๐ ๐ก๐๐ซ ๐ฉ๐ซ๐ข๐๐ โ market of ยฃ2.25Bn: Prices over +ยฃ8k.
Most of Howdenโs revenue comes from the โEntry Levelโ market. I estimate a market share way above ๐๐% in this segment.
The business is now focusing on gaining market share on the โMid-rangesโ where they are ๐ฎ๐ง๐๐๐ซ-๐ซ๐๐ฉ๐ซ๐๐ฌ๐๐ง๐ญ๐๐. The management believes that they can increase total depots from 840 to 1000 in the UK.
The Kitchen-only market is expected to grow ๐.๐% CAGR from 2023 to 2027. Some drivers are:
Ageing UK housing stock will drive renovation - (Ave. age of UK stock is ๐๐ ๐ฒ๐๐๐ซ๐ฌ).
Hybrid working leads to increased wear and tear in the home and most of the time is spent in the kitchen area.
When house prices are high, people are less likely to move and more likely to spend money on improving or renovating their current home:
Competition analysis:
Kitchens are ๐๐จ๐ฆ๐ฆ๐จ๐๐ข๐ญ๐ข๐ณ๐๐ ๐ฉ๐ซ๐จ๐๐ฎ๐๐ญ๐ฌ. ย The company offering the cheapest price at a similar quality has the upper hand.
This is a high fragmented industry. There are over 5.000 small independent kitchen retailers in the UK today. We can see below some financial comparison against 4 competitors.
The biggest competitor is Wren Kitchens, which sells directly to end customers. Its total Revenue represented just 14% of Howdenโs in 2013 but it managed to increase to 50% in 2022.
However, Howdens usually beats Wren for as much as ยฃ500-ยฃ700 per kitchen (on a similar range and size) and ๐ฌ๐ญ๐ข๐ฅ๐ฅ generating superior margins. This is a signficant discount of 15-20% for virtually the same product.
No doubt that Wren deserves a lot of credit. I believe its key ingredient is that their stores are in expensive areas, close to ๐ฌ๐ก๐จ๐ฉ๐ฉ๐ข๐ง๐ ๐๐๐ง๐ญ๐ซ๐๐ฌ, making them noticeable to the retail customer.
With the implementation of โNext Day Deliveryโ, Howdens will open smaller depots closer to ๐๐ข๐ญ๐ฒ ๐๐๐ง๐ญ๐ซ๐๐ฌ ๐๐ซ๐๐๐ฌ. This should increase the end consumer awareness and help builders to gain market in these hard-to-reach places.
Lastly, Howdens has been investing through web advertisement. The website had 1.2m visits in December 2023 compared to just 796k of Wren.
KPIs:
The two key metrics to follow-up the performance of the business are ๐๐๐ฏ๐๐ง๐ฎ๐ ๐ฉ๐๐ซ ๐๐๐ฉ๐จ๐ญ and ๐๐๐๐ ๐ฉ๐๐ซ ๐๐๐ฉ๐จ๐ญ. Both have healthy positive trends and I believe it can keep increasing for a long time. EBIT per Depot has a ๐ก๐ข๐ ๐ก๐๐ซ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก, showing economies of scale at work.
The table below shows stable gross margins above 60%, EBIT margins of 17% and ROIC north of 25%. Most importantly, much of the revenue variation comes from ๐๐จ๐ฅ๐ฎ๐ฆ๐ ๐๐ง๐ ๐๐ข๐ฑ. In 2021, Volume & Mix increased total revenue by ยฃ๐๐๐๐ฆ and it was able to maintain it in 2022, plus an extra ยฃ30m.
This is a ๐ซ๐๐ฌ๐ข๐ฅ๐ข๐๐ง๐ญ business barely affected in 2009 and 2020:
Competitive Advantages
Low-Cost Operations:
Howdens cost structure cannot be matched by any other player in the business. It is the biggest player by far and it keeps improving its distribution system which will translate into lower costs, higher stock availability and higher market share.
Loyalty Effects
It maintains relationships with roughly 500k builders in the UK (~๐๐% of all independent builders). A happy builder is likely to make ๐ซ๐๐ฉ๐๐ญ๐ข๐ญ๐ข๐ฏ๐ sales over a ๐ฅ๐จ๐ง๐ ๐ฉ๐๐ซ๐ข๐จ๐ ๐จ๐ ๐ญ๐ข๐ฆ๐. This then helps Howdens to get more scale which means lower costs and more stock availability, reinforcing the loop all over again.
Builders also offer feedback to Howdens about the latest styles from the end-consumer. This gives ๐ ๐จ๐จ๐ ๐ข๐ง๐ฌ๐ข๐ ๐ก๐ญ๐ฌ to launch new ranges and products.
For a competitor to inflict damage, it will need to invest heavily on manufacturing assets to match the cost structure. It will also have to get hundreds of depots and then it would have to operate at a loss by several years to be able to attract builders from Howdens.
Culture:
Howdens maintains a decentralized system where sale decisions are taken at local level. This enables it to adapt and gain market share by addressing each community on a standalone basis.
It ranked ๐๐๐ญ๐ก in the top 100 UK's Best Big Companies to Work-For in 2021 (15th in 2020).
In words of the CEO, Andrew Livingston
โUltimately, it comes to this. The builder is our brand. Our job is to resource the builder, and to resource our staff, so that they can help the builder in the best way they canโ.
Anti-Amazon:
By its nature, kitchen design and installation is a ๐ฌ๐๐ซ๐ฏ๐ข๐๐-๐ข๐ง๐ญ๐๐ง๐ฌ๐ข๐ฏ๐ business that is tough for an online competitor to break into. ย Given the intricacies of the business, the supplier needs to offer design solutions and keep communications with the contractor installing the kitchen.ย If not, thereโs a high likelihood the kitchen equipment wonโt fit correctly.
Technological change:
It is worth mentioning that there are no technological risks in this industry. Kitchens will continue to be used the same way they are used today. On the contrary, new modern equipment and designs will increase ownerโs expenditures going forward.
Growth in France
The management is expanding in France, a โฌ๐.๐๐๐ง Kitchen-only market. I believe this could be a great source of value for the next decade because of the following leverage points:
๐๐% of products are ๐๐จ๐ฆ๐ฆ๐จ๐ง with UK range. This will allow scale benefits. The idea is that Howdens will use the UK infrastructure to serve this market. The best part is that this growth ๐๐จ๐๐ฌ๐งโ๐ญ ๐ง๐๐๐ ๐๐ฑ๐ญ๐ซ๐ ๐๐๐ฉ๐๐ฑ ๐ข๐ง๐ฏ๐๐ฌ๐ญ๐ฆ๐๐ง๐ญ. The production assets can support the whole French market because peak periods between UK and France are ๐๐ข๐๐๐๐ซ๐๐ง๐ญ.
Gross margins in France are ~65% and transports costs are the same as some areas of UK.
The market has low penetration rates of integrated kitchens, and most are purchased through DIY outlets and small independent business. This leaves plenty of opportunity for Howdens to grow and generate value to builders, just like it did in the UK when it was founded.
Howdens has a current market share of about ๐%.
Management:
Its current CEO is Andrew Livingston who joined in 2018. He comes from Screwfix Direct Ltd, a home improvement company with over 1400 stores, where he previously held the position of Commercial and Ecommerce Director.
Management is financially incentivized. They get an annual bonus equivalent of up to 200% its salary. At least 30% of the bonus is paid in shares and vests over two years. The metrics to assess the bonus are:
60% Profit before taxes
20% Total Shareholder return.
10% Return on Capital Employed.
10% Environmental measures.
Executive Directors are expected to build up and maintain a personal shareholding in the Company of at least 200% of salary. Andrew has exceeded this minimum threshold by holding 263% of salary as of 31 December 2022.
Capital allocation is simple. Dividends are usually 25-30% of total earnings. All remaining cash above ยฃ250m is allocated to buybacks. My concern is that these purchases are made without any strategy at all, just to give back the cash. Fortunately, the stock generally trades at decent multiples.
Valuation:
For my initial valuation, I excluded international growth and assumed that they will reach 1000 depots in the UK by 2028 (opening 33 new depots per year. They opened 33 and 30 in 2022 and 2021).
Iโm projecting flat revenue for 2023 but then an annual average increase of 5% up to 2030. This implies a kitchen-only market share of ~๐๐% (up from ~30%).
Using conservative EBIT Margins of 17% and ROIC of 24.50% in line with the past, Revenue per Depot and EBIT per Depot would be as follow:
Regarding capex, the management has been in investment mode to gain market share in the Mid-Range market. I estimate that they will invest ~ยฃ90m annually for the next 6 years. By the year 2028, the business will have all required machinery to produce 50% of what they sell, 1000 UK depots and all depots revamped to support the new distribution system.
From this point forward, Howdens will start to accumulate big amounts of FCF, about ยฃ400m per year. The stock has traded around 20x FCF/Share during the last 5 years. Given that future growth will be lower, I contracted this multiple to x17 to be conservative resulting in a stock price of ยฃ13 by 2030.
I also believe the management would be able to buy back at least 15% of the company by 2030, this could potentially increase the price to ~ยฃ๐๐.๐๐, generating a 10% annual return against the current price of ยฃ8. This is ๐๐ฑ๐๐ฅ๐ฎ๐๐ข๐ง๐ ๐ข๐ง๐ญ๐๐ซ๐ง๐๐ญ๐ข๐จ๐ง๐๐ฅ ๐ ๐ซ๐จ๐ฐ๐ญ๐ก.
Finally, I believe France can be a great value source. A market share of 5% by 2030 (which I believe is achievable) would increase the price by ยฃ1.50 to ยฃ17. The future is uncertain, but I consider we shouldnโt neglect its ๐จ๐ฉ๐ญ๐ข๐จ๐ง๐๐ฅ๐ข๐ญ๐ฒ. If France goes well, the company can also start making its way to other European countries using its manufacturing assets in the UK.
ย Conclusion:
Unique business model granting solid Loyalty Effect from builders.
Industry with fragmented customers and suppliers.
The biggest and cheapest player in the industry by far with durable and widening competitive advantages.
Very efficient distribution system unmatchable by other players.
Great culture with decentralized decision-making process at depot level.
Great FCF generation.
Resilient business.
Good international optionality without the need of significant investments.
DISCLAIMER: This analysis is not an investment recommendation. Please, do your own due diligence.