Insulation: A boring but surprisingly profitable investment

As winter approaches, homeowners are confronted with the need to turn on their heating systems and the higher costs of additional heating. This winter, many US consumers will likely pay even more to heat their homes because of surging fuel prices and colder weather forecasts.

The National Energy Assistance Directors Association predicts increased winter heating expenditures across the board, with electricity up 1.2%, propane 4.2% and heating oil 8.7%. Natural gas is expected to be down 7.8%. Air conditioning and heating are by far the biggest sources of home energy use, comprising 51% of household energy bills. A main reason energy bills spike in winter is due to inadequate insulation.

This is where Installed Building Products (IBP) comes in – and why we’ve invested in this company. This week, we’ll share insights into our investment process and approach to selecting companies like IBP that we believe are poised to generate shareholder value.

Who is Installed Building Products (IBP)?

Founded in 1977 and based in Columbus, Ohio, IBP is one of the largest insulation installers in the US. In the late 1990s, the company embarked on an ambitious acquisition strategy to expand its reach nationally. IBP went public in 2014, at which point it was generating $432 million in revenue with earnings of 2 cents a share. Last year, its revenue reached $2.6 billion with adjusted earnings of $8.95 per share.

Besides insulation, which makes up 60% of its revenue, IBP has diversified into complementary building products (waterproofing, fireproofing, garage doors, rain gutters and more) for both the residential and commercial construction markets.

Target market

• Combined single family and multifamily insulation market has a ~$6 billion total addressable market (TAM).
• Complementary products add another $4 billion TAM ($1.4 billion for garage doors, $1.1 billion for shower shelving and mirrors, $800 million for window blinds and $700 million for gutters).
• Amount of insulation per home is increasing due to a greater focus on energy efficiency and stricter energy codes.
• IBP’s largest competitor is TopBuild (they each rank #1 or #2 in different markets).

IBP has a cost advantage

Industry suppliers lack power. The fiberglass insulation manufacturing industry is highly consolidated, with four players accounting for all sales (Owens Cornings 40%, CertainTeed 20%, Knauf 20%, Johns Manville 20%). While the supplier concentration would suggest high pricing power, insulation manufacturing is a capital-intensive business with high fixed costs. Ovens cannot be easily shut on and off. As a result, manufacturers are incentivized to run their lines at high capacity to cover their fixed costs and get leverage. This makes the industry more competitive despite its concentration. Given IBP’s scale, it can buy insulation foam at a larger discount than smaller competitors and save big on costs.

IBP’s growth strategy

• Organic growth is achieved through increasing penetration in developing markets.
• On average, an established IBP branch generates ~$4,400 per residential permit versus $2,200 for a new developing branch.
• Inorganic – M&A is part of IBP’s expansion story and it aims to acquire ~$100 million of revenue annually.

Strengths

• Leading positions in insulation installation, with a 28% market share up from 5% in 2005.
• M&A has been a part of its growth strategy since 1990.
• Scale = ability to buy product cheaper than smaller competitors.

Weaknesses

• Distribution arm is relatively small when compared to peer TopBuild.
• No centralized ERP = branches could be competing for the same business.
• Complementary products have lower margin due to current lack of scale.

Opportunities

• Complementary products.
• Capacity to penetrate developing markets.
• Increasing residential building codes = higher revenue per unit.

Threats

• Weakness in US residential markets.
• Current supply constraints cap organic growth.
• Supply shortage (COVID-19 period) or explosion/fire at a supplier plant (2018) can temporarily increase cost of raw material.

IBP management

IBP’s management, led by CEO Jeff Edwards since 2004, is a key part of the business’s success. Edwards, who joined the company in 1994 and became chairman in 1999, is one of its largest shareholders.

When we first spoke to Jeff and he walked us through how he built the business, we quickly realized he was a visionary leader with a solid plan for future growth.

He told us how he saw potential in the niche sideline of foam insulation. His rational was simple: every home, every building, needs insulation. He was not looking to reinvent the industry, but rather focused on delivering the best service to builders while acquiring successful businesses in various cities. The sales pitch to targets was also simple: being part of IBP means they can do what they like and not be bogged down by functions that aren’t core to their business, like insurance, human resources, accounting and payroll.

In 1994, IBP made its first acquisition with Freedom Construction in Columbus, Ohio, followed by several more in the ensuing years. The rest as they say is history.

Unseen value beyond the walls

Investment potential often lies hidden in plain sight, like the insulation in our walls. IBP has all the characteristics we look for in an investment: a small-cap company with what we believe to be tremendous growth potential with low debt, rapid revenue and earnings growth compared to its industry, and strong management.

Insulation may not be exciting, but not only does it conserve energy and reduce bills, it also represents a notable sector in our investment landscape. How often do investors overlook the potential in the ordinary and what opportunities might we uncover by paying closer attention to what others may miss?