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Hornbach Holdings operates primarily through its DIY stores and is among the biggest players in Germany (#3) and Europe (#5). Besides the main business of DIY stores, Hornbach Holdings includes Baustoff Union, involved in the trade of building materials, and Hornbach Immobilien, which owns most of the used real estate.
Although the company is active in nine European countries, around 60% of revenue is generated in Germany, where it has 96 of its 161 retail stores.
Industry and competition
The industry is highly competitive as DIY retailers have similar product assortments and customers often choose a store that is closest to them. Competition is also strong due to the fragmentation of the industry, which has begun to consolidate over the past two years, in part due to the bankruptcy of some competitors. Despite fierce competition, Hornbach managed to increase its market share in Germany to around 12%.
In addition to competition from other traditional DIY retailers, competition has also increased online. The German online DIY market has seen double-digit growth in recent years. Many traditional DIY retailers have therefore focused their efforts on e-commerce and managed to gain 21.4% online market share. This figure is up from 18.4% in 2017.
In recent years, Hornbach has experienced revenue growth that has exceeded industry growth in Germany. Sales in European stores have also shown impressive growth, with revenue outside Germany rising from 1.67 billion euros to 2.46 billion euros over the past five years.
Even though revenues have increased over the past two years (CARG of 8.5% over the past five years), net income has remained about the same. This is due to increased price competition in the industry, leading to lower profit margins, as well as a lack of cost control. Although Hornbach has taken steps to control administrative costs and increase margins through private label products (which account for an impressive 24% of sales), it seems unlikely that margins will increase significantly in the next few years. Additionally, the Baustoff Union division, which currently accounts for only about 6% of revenue, is growing faster than the DIY retail business, but has even lower margins.
Hornbach is trying to counter online competition by leveraging their physical locations with an integrated retail approach, which allows customers to order a product online and pick it up in a store hours later. This increased focus on e-commerce has resulted in double-digit growth rates in online revenue, which accounted for 10% of revenue even before the pandemic.
The company believes its retail stores are the future and continues to build new stores, primarily outside of Germany, as these markets show higher growth and are less saturated. The continued demand for physical stores in the DIY industry is driven by several factors. First, DIY products are some of the hardest to buy, which is why people want to take a look at the product before buying in addition to asking employees for advice. Additionally, if customers run out of a product, like paint, during a home improvement project, they often have to purchase more on the same day, making online shopping impossible. This durability of DIY stores is also found in the United States, where DIY giants like Home Depot (NYSE:HD) and Lowe’s (NYSE: LOW) generate less than 10% of their online sales.
Even though the pandemic could lead to a change in customer behavior, I believe that due to the factors mentioned above, online shopping is unlikely to take over the DIY industry any time soon.
In this case, the primary driver of what a smart buyer would pay for the business is not free cash flow, but business real estate. Even though the real estate is listed on the balance sheet with around 1.4 billion euros, the company conservatively estimates the real value at around 2 billion euros. Add to that what the business generates, and the fair value of the business is likely to be closer to 2.6 billion euros.
Hornbach will likely continue to grow revenue as brick-and-mortar stores will continue to be relevant to the industry. However, due to increasing price competition, expect profits to grow much more slowly than sales. Nonetheless, given the company’s likely continued profitability in combination with undervalued real estate, the stock looks like a bargain at current prices.