Kingspan: Influential Irish Insulation - [Business Breakdowns, EP.128]

21:01And I guess to your point, it's largely been through acquisition that they've been able to build that out. So it's a combination of acquisitions on organic development. So they would buy to get the footprint, to do foothold in the country. So there's been acquisitions in Brazil. There's been acquisitions here in Australia. There's been acquisitions in Colombia. There's been acquisitions in Eastern Europe. And then ultimately, once they're there, they would build the facilities at the quad core plant on top, at the other facilities that they need to basically increase the penetration. And then lastly, obviously, I'm sure this will come up, but this family ownership issue is still super important to their DNA.

21:34how the family and how the management team continue to acquire these business and then get these businesses to perform at quite frankly, such a better level, both organically, but also profitability wise is astounding. And it comes back to, as I said, that 30 year track record that I talked about. They've done this from effectively 30 million euros, the sales all the way to 8 .3 billion, yet they've never really bought anything that had much more than 500 million in sales. And most of the time they're buying things that have less than 100 million in sales. So it is this amazing secret sauce that you do get with these family -run businesses, particularly in Europe.

22:09Is there any of that secret that you can share with us in terms of from what you've seen, how they've been able to do that? Because as you say, it is remarkable over a long stretch of time as well. And you assume as businesses get bigger, it just becomes harder and harder to do. The thing I'd point to, I'd say two things. One, they did have that near -death experience back in 2008, where they effectively took on too much debt. And they talk about it a lot when you talk to them. So it's still very prevalent in their mind. A fresh scar. All the way back here in 2022. So they're very keen to keep the leverage below 1 .2 times EBITDA, and it's currently 1 .4 times.

22:39So they're very keen to keep the leverage down. And so they're very disciplined on that front. They're also incredibly disciplined with the price they pay. So you'll quite regularly see them not let things go that they don't want to buy because of this near -death experience they had back in 2008. So they're very disciplined on that front. They're very disciplined on return on capital employed. So despite all these acquisitions, the return on capital employed in this business is still hovering around 15%. and they've managed to hold that even with the amortization that they have of the things they buy.

23:05So those would be a couple of things. The other thing inside, apparently, there's very few people working on these acquisitions. So there's a very small group of people involved in each one from what we gather internally. And then lastly, most importantly, when they do buy a business, they would tell us that they would turn up and say, hey, guys, what do you want to do? What have you always wanted to do with this business? How would you make it better? and they support these businesses. So in many cases, they continue to trade in turn products under their same name and then other products are added, the King's Sand products are added in.

23:34Or in most cases, obviously, they leave the existing management team there and maybe add some of their product and add some of their skills on top. So they're very open around that. And again, I said, this is not uncommon in Europe, whether it's Eurofins or DeLonghi in Italy, and obviously most famously in Louis Vuitton, which I know you guys have previewed as well. So from that point of view, this is not uncommon and is repeatable over a long period of time. And these guys have proved it for a long period of time. And the same people are involved as when the second gene is still, I believe, in his 40s.

24:02And there's another gene to come after that. So from our point of view, we feel that they can continue to do this for a very long period of time. And outside of just the penetration uplift, this is obviously going to come through, particularly in the United States. Unlike LVMH, it looks like succession has been well and truly planned in this instance. You talk about their acquisitions, and it sounds like they're reasonably decentralized, which makes me think about the economies of scale as the business has grown and they've been able to channel more product through different places. How much are they able to achieve on that side of things?

24:31Has their buying prowess increased as they've been able to grow or because each piece that they've bolted on has remained relatively independent? Has that meant that their economies of scale has maybe not been as big as you might assume? I'd say it's more the latter. The economies of scale are not as big as what you assume because every region is domestically different in terms of how they source products, et cetera, and how they build products. I think what they've proved over a long period of time is their go -to -market strategy is working. There's 66 % direct. Going to architects particularly is working and allowing them to separate themselves from the building materials industry to a certain extent.

25:05And no more is this prevalent today at the moment, whereby ideally we are effectively, you would assume we're in a commercial property recession, if that makes sense, or things would be slowing. But in everything, they've actually continued to grow through 2023. So if you ever wanted a better example of the structural growth of the industry that we're looking at is the fact that this company has grown through 2022 and grown through 2023. And they're doing that mainly at the moment because of the penetration of their products in the US and mainly because of these marquee projects around the Chips Act or whether Tesla Gigafactories, et cetera, et cetera, and that vindication of their strategy of how they go to market and how they grow.

25:44In terms of economies of scale, though, they're very keen and at least the 12 years I've spoken to them, but you should think of the margins of this business at 10%. And that's where we try to keep it as we continue to grow across different eros. So yes, the margins will be higher in some places, but that uplift is being spent on continuing to grow on different parts of the world. You've talked a bit about it there and you talked about their near -death experience in OA. How cyclical is this business? Obviously, they've got some structural tailwinds in terms of energy efficiency and climate change behind them.

26:11But ultimately, they're still selling into people building new structures, which is going to be cyclical to some extent. So how cyclical has it been and how well have they been able to manage that through different periods? They're getting better at it. Let's be clear. This is building materials. It's a cyclical industry. It's just there's nothing you can do to change that, but they are definitely getting better at it. As I said, they learned lessons from 2008. If you go back through previous cycles, downturns in sales and earnings have been minimal. And often that's with holes plugged by acquisitions, but still being minimal.

26:40And this last cycle in particular, well, virtually no downside to sales so far or earnings through this period. So it's definitely getting better over time, but their share price is in the building material sector. So it ultimately does track that to a certain extent. People don't believe them as much as what their results actually show. Yeah, that makes sense. And if we take a look at the quantitative lens, I guess, what, when you go through the financial profile of this business, strikes you as particularly interesting or important that we should discuss? So from my point of view, it's really that revenue growth that makes a big difference to us.

27:11Ultimately, when we look at the financial profile of this business, it starts with revenue, which is, as I said, compounded at the 17 % per annum for 30 years. And it's even compounded at 15 % per annum in the last 10 years. So it's not like big things in the previous period. So that revenue growth, which is driven by a combination of acquisitions and organic growth, basically flows through the P &L. And as that flows through the P &L, it ultimately gives you the double -digit earnings growth. Lastly, the cash flow dynamics effectively are pretty good. Effectively, earnings equal cash flow over time.

27:39So that cash flow pays down the debt that they do for the acquisitions, which they ultimately recycle to do more acquisitions. So this has been the winning formula for some time, all while keeping returns on capital employed in the 13 % to 15 % range. If you're looking for a dividend, that's probably not there. At the moment, it's quite small. And then multiple -wise, interestingly, the company does trade at a small premium to say the building material sector. So trading at usually around 20 times earnings or 11 times EBITDA, but that financial profile or that financial model continues over the medium term.

28:09And then it's really just the compounding of that that ultimately gets you the return on the investment you're looking for, because it ultimately compounds at a much faster rate than what everyone thinks they will, because analysts basically don't model acquisitions generally over time and they come in. And secondly, analysts usually underestimate the organic growth over time, which is actually, we suspect, under the surface here getting better. You talked about revenue growth being 15 % to 18 % there pretty consistently. How would you split that out in terms of inorganic and organic growth? Great question.

28:39So it's probably two -thirds inorganic and one -third organic. From that point of view, it's important to stress that the continued acquisitions are important to keeping that double -digit revenue growth through time. If not, it'll slow to mid -single digits or potentially slightly higher if penetration accelerates in the next 10 years above what it did in the previous 10 years. And I think there's a reasonable argument to suggest that will occur. And I think the company is already investing for that through some of their organic investments. So it's important to stress that yes, there are acquisitions here, but yes, there's organic investments happening at the same time.

29:08And so if anything, the next decade, if you think about it, should be better for Kingspan than the last one. And that's, I suppose, what we like so much about the business. And do they generally use most of their excess cash that they earn to fund acquisitions you talked about? They don't really pay much of a dividend at all. I think that seems to be a stated aim. It's not like you should be expecting that to grow, we're going to keep funding the inorganic growth that we can find as well as some of the organic stuff that you talked about. We should probably talk about this. Yes, there's the inorganic growth that we talked about.

29:35There's the organic growth we talked about around insulation. And then there is the adjacencies. So in the last five to 10 years, they've moved into the other adjacencies. And so this is where, again, I do think the next 10 years for Kingspan will be out of the last 10. So they've moved into things like technical insulation. What's technical insulation? Technical insulation is the stuff you put around the pipes, the heating pipes in your building to effectively stop them losing heat. They've moved into light and air, which is effectively skylights in buildings. People wouldn't have thought of putting a skylight in a building before.

30:05Now it's commonplace. They've moved into roof membranes. Roof membranes are important, particularly important if you try to put a garden on the roof or you try to grow grass on the roof of your building. These are things that people are trying to do now. They've moved into water management, et cetera, so light and air, water management. And then lastly, they've got their data flooring business, which is actually the largest data flooring business in the world. And they've actually had that for quite a long time. And so these adjacencies are, again, it points to the forward thinkingness of the management team in our view, is basically seeing what the best operators or the best commercial building operators are doing and saying, well, guess what?

30:41The other building is going to do this as well. And we deal with these architects already. So we should either acquire the business that's doing this on this building already. And secondly, once we've acquired that, then basically following the same playbook that we did with installation panels and acquire other players around the world, increase the technical specification of the products, which ultimately means that you have a better suite to offer the architect going forward. And the last thing, just a flag here that's super important that you're going to see more and more of is warranties.

31:08So when you build a six -star energy building and Microsoft moves in or we move in or someone moves in, if it doesn't perform to its capabilities, then that's a real problem. look, it's a real problem for the tenants. There's recourse, et cetera, et cetera. So as the specifications get bigger and better, that's going to favor Kingspan products over time because the customer is actually, the simple and the silly way to think about this is you used to complain to the person who looked after your building about the lights and the air conditioning not working or not happy with the security guy downstairs.

31:38And now you're going to complain to them about the thermal footprint that the building has and that it's not in line with what you promised. And that's a completely different conversation to one we had five or 10 years ago. And so that's why we do think the next decade looks better for them. How much visibility does Kingspan or any of these other businesses have over that? Is it fairly certain that if we put this product in, we're going to see this type of efficiency out of that building? Or is it quite variable depending on the chemical composition or the location? So Kingspan does have warranties already.

32:07Roughly $20 or $30 million a year does go out for products that didn't perform at spec. And this is obviously something they continually work and improve on over time. But how does that relate to the Grenfell Tower disaster that happened in London a few years ago? When you read about the business, it strikes me as one of the biggest risks. What impact has or could that have? Yeah, so not necessarily a warranty issue, but it's important to recognize that something we should talk about when we talk about Kingspan is looking back in 2017, the Grenfell Tower block in North Kensington, West London caught fire.

32:36And ultimately, the fire spread outside the outside of the building through the cladding and through the installation. This was a huge tragedy. 72 people died. It was the largest incident in the United Kingdom outside of Piper Alpha. Kingspan got embroiled in this tragedy mainly because their installation boards were installed in part of the building underneath the cladding. When the inquiry looked into how this happened, Kingspan, as one of the only listed companies in this process, effectively got dragged through the mud a fair bit here. From our point of view, it's important to recognize here that this was an installation board on this building, not an installation panel.

33:14And so somewhat counterintuitively, installation panels are actually popular because they are fire resistant. In this case, it's an installation board, which is the one without the steel on the outside. And it was installed incorrectly underneath the cladding. And it was installed not in the regulations that Kingspan would like it to be installed. And it was also installed on a building of height that Kingspan would not normally install it on. So the companies defended themselves fairly vigorously against this. The inquiry finished over a year ago, but is still yet to hand down its findings in January.

33:43And there's an ongoing saga with the UK Home Affairs Minister trying to get some of these companies to pay to get the cladding fixed on a number of other buildings. And Kingsband quite rightly says, we have nothing to do with the cladding. We were just the insulation on this product. So that's just what Grenfell is. That's why it's important. It's just important that people know that this is an ongoing inquiry and we'll get the results back in January. but ultimately we feel that there's potentially a small fine to be paid here. And I think the company can move on. And finally, when we think about Grenfell Tar and the companies involved in it, this is ultimately an ESG issue.

34:13It's an ESG issue that's proved fairly significant for the company over the last three years. It's definitely calmed down in the last year or so. It's something that our own responsible investment officer has looked at and he's fairly comfortable with, but we recognize that other people potentially have different views. And I'd just encourage people to look at the company's website if they're interested, because there's a lot of information out there to help you form your own views on their involvement in this particular tragedy. Yeah, well said. And if we think about the other costs in the business as well that are worth discussing, how capital intensive is this business?

34:41It seems to me like it could be, but I'm also not sure. Yeah, not really. So from that point of view, they're spending probably 400 to 500 million on organic projects over a number of years. The actual capex is slightly lower than that. So what they're doing here is building, as I said, these plants or these production lines for making that quad core product, as opposed to the stuff that they buy, which is already existing facilities, etc. So the capex is not that big. The maintenance capex is not that big. And it points to, as I say, the gross margins being not that high. It's product in, turn it insulation, product out, collect the margin.

35:14If we were projecting 10, 15 years out and we come back and have the same discussion, what would you expect Kingspan's product mix to look like? 80 % of the moment comes through the insulated products that we've talked about at some length, and you've got these smaller divisions, the data center seems like a structural area that should be growing nicely. Would you expect those four or five different divisions to look roughly similar? Or would you still expect the insulated part of this business to be far out in excess of the rest of the company? From our point of view, they would show a slide showing the envelope of an entire building and that they want to be on that envelope.

35:46So they want to be in the light and air side of it. So the screen on the roof, they want to be in the membrane of the roof, they want to be in the insulation boards. So I think over time, insulation would drop down towards 60 % over time, and these other businesses would hopefully get up to 40 % over time. But ultimately, I come back to what I've said earlier, it will be commercial industrial, and it will be being more and more direct, and it will try to move up the curve. The other thing to say is you look at their highest insulation product, which is quad core, which is their most thermal efficiency, roughly a quarter of the insulation panel sales today.

36:18And at insulation boards, the same products called Cool Therm, again, is roughly a quarter. You'd want to see that going up over time as well, which meant they were selling higher and higher margin products to higher and higher margin customers. And the rest of the business is roughly similar gross margins and operating margins as the insulated business, or are they structurally more advantaged? Thank you. Good question. Yeah. So margin -wise, let's just go down the scale really quickly. The insulated panel business is the highest margin at roughly 11 % to 12%. Insulation boards is not far behind that, but is more cyclical.

36:50And if you look at the light and air roofing and waterproof roofing business, which are the newest businesses, they're still in the mid single digit margins with the goal to grow them towards 10. And here you're backing the management team to do that. But in a couple of these areas, they literally just entered with acquisitions. The dating and flooring business is actually the highest margin business, but it's been around a very long time at 14%. And that's essentially that gets you to that 10 % or slightly above 10 % number. Again, they would be very clear that they don't expect the margins of business to get much above 12 through the cycle because what they do make an extra margin in developed areas where they've developed, they will invest in going into new areas and new adjacencies.

37:27And that's really been the model for as long as I've known this company. And to be fair to them, they've stuck to it pretty truly. They don't really like to let the operating margins to get too high. Is any of this story to do with going back and redoing buildings that they've done? What's the life cycle or the half -life of their insulated products specifically in the Apple building, for example, that you mentioned? the beginning, in 10 years time, do they have to go back and redo it? Or is it 30, 40 year product? And so once it's in, it's going to be there for a long time. It should be there for a long time.

37:55So like I said, it's 77 % new build. From that point of view, it should be there for a long time. It is again important to flag that if you look at this UK problem that happened with the Grenfell Tower, the government in the UK is keen to reclad a lot of buildings in the United Kingdom and hand that build to some companies that they feel culpable. And that's definitely an ongoing in conversation with Kingspan and other builders in the United Kingdom. But ultimately, no, it all goes on new build. And then a lot of these buildings, it's important to flag, they're very low rise. Okay. So most of them, again, coming back to Grenfell, it never should have been on a building that big anyway.

38:28Most of them are low rise buildings. So think data centers, think e -commerce facilities, warehouses, think battery facilities, think stadiums. That's where their product goes. It's not really going on. It is on some office towers, but it's more going on buildings that are lower rights. So from that point of view, those buildings, once we're done with them, they ultimately get pushed over and rebuilt, if that makes sense. They didn't rebuild Highbury, as far as I can tell. They're up at the Emirates. And they generally go down again and go up again. Yeah, it's probably good business as well for Kingspan.

38:59You've mentioned Grenfell a couple of times, and we talked a bit about the cyclicality of the industry. What else do you think about when you consider the risks that relate to this business in particular, what keeps you up at night that you could point to? I think the core business is a proven track record of growing over a long period of time, and I think it will continue. From our point of view, the thing that has changed in the last five years is these adjacencies that they've moved into, and they would bristle at this, that you would say, oh, because you can't, we've run out of acquisitions and insulation.

39:27I don't think that's true, but if you take them at their word, and I think you can have it over a long period of time, as they've seen a good opportunity here to add their skill set and to add what they can sell to architects inside that warranty issue that I talked about that's getting bigger and bigger. But from our point of view, they're not proven that they will get to the same margins as the existing business. So that would keep us up at night. Grenfield, I flagged, that's still a remaining issue, but hopefully goes away in January. I suspect it will. And then lastly, yeah, the family ownership.

39:54The family ownership has stayed incredibly stable for a long period of time. It is, as I said, 16 % of the company. Eugene Senior is 15 % of that 16. And he has five children. And I believe only two of them in the company. So there may be an issue there down the track as well in terms of succession. So from that point of view, but otherwise, knowing this company for a long time, its share price might not be that stable, but how they run the business is incredibly stable and have done for a long time. And you're generally talking to the same people every time you see them. And they're very hands -on managers.

40:23They have a business here in Australia, so they come and see us in Australia when they come down. So the actual business is much more stable than the industry that they're in. And that's, I think, their gift that they've managed to bring to it over such a long period of time. Yeah, their consistency shows. And if we think about the secret sauce, and I think you've talked about all of that, I just want to wrap a bow on it. So if we think about their ability to do acquisitions, I'll see their product development, they've got the best in the market, particularly in the insulated division. And then I guess there's family ownership.

40:50Is there anything else that you'd point to as being one of the key markers of your investment or interest in the business? I'll go back to what I said right at the very start. And I think it's important. So, okay, why is insulation penetration in commercial buildings in the high teens in the United States? Okay, it makes no sense. if they're effectively signing the same sustainability points as the European companies are, then that penetration is going to increase. And if anything, it's going to accelerate. And so again, I go right back to what I said at the start. This company came to my attention because of how uniquely positioned they are for that opportunity.

41:20The family ownership and the secret sauce, all that came later. All that came having got to know them over a long period of time. And so if you ask them directly, the CHIPS Act, these new chip facilities that are built in the US, Tesla Gigafactories, Microsoft Datacenters, Amazon Datacenters, their relationship with these customers is getting better and better. So the best companies in the world design Kingspan products into their buildings. And the best companies of the world are moving into these different adjacencies. So Kingspan's moving into them. And so from our point of view, this company is uniquely positioned.

41:52And the reason why it's uniquely positioned is because the family that runs this company that's basically come from an agricultural trailer business into environmental products and then continued to roll that same game forward is still running the show today and is still moving into these different adjacencies. And then I suppose the last point I'd make and the reason why we still like it and happy to talk about it on this call is some of this has only just started. So this US penetration story that I'm the kid talking about literally only started in the last year or two. So in theory, part of the reason we bought, having looked at this company for a long period of time, we've been waiting for this moment for, in some cases, a decade.

42:29And for the first time in the last year or so, they're starting to say, actually, we're starting to see us slightly separate some of these decisions from this simple building cycle. And they're finally, that structural characteristic is starting to come through. And that's particularly going to see it in the US. And hopefully that continues to be the success story of the company going forward. When you come to modeling the business and thinking about valuation, I'm not looking for a number here at all, just more interested in your preferred method for it. You said a lot of the sales side analysts don't include any acquisitions.

42:56How do you think about putting together a reasonable framework to get you a ballpark price? So from our point of view, we forecast the earnings. We're using the earnings. You could do EBITDA as well or cash flow. All three would work fine. We forecast the earnings going forward. We pick a multiple. In our case, the company's averaged roughly 20 times since inception, which is a premium, I know, to a building materials company, but a premium I think deserved. And you effectively do earnings times multiple equal share price target. You can make it more complicated than that if you want to. But that's what's worked for us for a long period of time with this company because of that compounding characteristic I talk about.

43:30And the other thing that's important, obviously, unlike some of the other principles, this is a small company, still earning a 14 billion euro company today. So from our point of view, the runway for growth is still long. And you should treat it like a growth company, not necessarily a value company or a buildings materials company. And we're a growth manager, so that's what we do. Fascinating. I guess one question that sprung to mind there is to do with competitors. Which competitors do you watch most closely as it relates to your interest in the Kingspan? So this is a good one. You can look at Rockwell in Denmark, which is a different type of insulation, but ultimately will give you an indication of what the European environment is like.

44:04Main competitor in the US in insulation panels is actually Nucor, which is a steel company, but similar to what they've competed with previously. And you could look at Owens Corning in the US as a competitor on the cycle, but not necessarily a competitor on products. And then the last one that's probably lifted their game a bit in the last few years, and definitely potentially will move into these higher end products over time is Saint -Gabin in France, which is much more of a residential company and much more of a broad building materials company, but has aspirations here. And for a long time there, we always thought Saint -Gabin would buy Kingspan, but we don't think that's the case anymore.

44:38So I think that opportunity is passed, but that's a bigger competitor in Europe that's much more broad based, but ultimately talking about a lot of the same things that Kingspan is talking about now. Whereas for a long time there, Kingspan was the only one talking about this stuff and no one else was talking about it. Now, obviously, climate's more in vogue, more companies are talking about it, more companies are doing it. And so to a certain extent, more people are now looking at what they're doing. And we expect more competitors to come along over time. Naturally. Nick, well, this has been a really fascinating discussion, not a business that I was very familiar with at all, but I've really been interested in learning about it, both from the macro story and also just the company itself.

45:13What over the past 12, 13, 14 years of you studying this business and following them speaking to the management team, what have you learned from them that you could tell other investors or operators that would help them in their careers? So from our point of view, and I'm sure you see this in a lot of the business breakdowns you do, and it's the same in building materials, it's the same in dot -com businesses, is alignment, it's everything. This company is a family -run company, the family still controls the company, and that alignment, not just at the family level, but at the senior management level, and then all the way through their staff, literally thousands of employees are Kingspan shareholders.

45:48So the company has been very good at maintaining that alignment within their all two programs among senior management and also amongst the staff. And that alignment also extends to the companies that they buy. And that ultimately allows them to outmaneuver their competitors, which in this case has mainly been steel companies and large building material companies, which quite frankly, don't have the same alignment. So it's, I suppose, the same secret sauce that you see in the tech industry works in the building materials industry. It's just your competitors aren't doing it as well. So it's actually easier to outmove them.

46:17And I think that's definitely what Kingspan's done best over the 10 years we've been following. Yeah, it's a simple, very powerful message that Charlie Munger says, tell me the incentive and I'll show you the outcome. I think that rings true for most businesses. Look, it's pretty much the same in every company we ever look at. We're obviously growth investors. People don't think we buy Bill Maduro's companies. We do. Why? Because they've got the secret ingredients we're looking for, which is the compounding revenue growth, the compounding earnings growth and the alignment to suggest it can continue.

46:42And the structural driver in the background being decarbonization that helps it happen. So that's why we like this company. And yeah, it's been a pleasure talking about it with you for an hour. Amazing composition. Thank you so much for doing this with us. Really appreciate it. I'm very excited to share with everyone. Thanks very much. To find more episodes of Breakdowns ranging from Costco to Visa to Moderna, or to sign up for our weekly summary, check out JoinColossus .com. That's J -O -I -N -C -O -L -O -S -S -U -S .com. Thank you.