Beacon Roofing to Outperform

We are upgrading our recommendation on Beacon Roofing Supply, Inc. ( BECN - Analyst Report ) to Outperform, following a modest recovery in the housing market, healthy credit conditions and ramp up in the company’s acquisition activity.

The company reported earnings of 7 cents per share in the second-quarter 2012, easily beating the Zacks Consensus Estimate of a loss of 8 cents. Results improved compared to a loss of 13 cents in the year-ago quarter. Total revenues increased 33.4% year over year to $395.2 million, surpassing the Zacks Consensus Estimate of $346 million. Organic growth improved 28.2%.

The housing market is gradually looking up, reaping the benefits from escalation in employment rates and higher consumer confidence. At the same time, roofing demand is also increasing modestly and is expected to grow at an annual rate of 5.7% through 2015.

Alongside, the demand for re-roofing is also on the rise. The median age of the housing stock is over 35 years old and since an aging housing stock increases the demand for roofing materials, it provides ample scope for Beacon to grow in this market.

Beacon has completed the acquisition of the leading wholesale distributor of building products, Cassady Pierce Company. Cassady Pierce chiefly caters to the professional roofer, remodeling contractor, builder, general contractor and retail home center markets of Western Pennsylvania, Northern West Virginia and the Eastern countries of Ohio.

The acquisition will help Beacon in expanding its business activities in the unexplored regions of Pennsylvania. Further, it will augment the company’s product portfolio in the lines of building products.

Recently, Beacon entered into a new five-year senior secured credit facility that includes a $550 million U.S. credit facility and a C$15 million ($15.1 million) Canadian credit facility with Wells Fargo Bank, National Association, an unit of Wells Fargo & Company ( WFC - Analyst Report ) .

The credit facility refinanced the company’s prior $515 million credit facilities that were provided through GE Antares and an affiliate. The new credit facility’s interest rates are at historically low levels. It provides an attractive LIBOR margin pricing, low interest rates, reasonable financial covenants, as well as substantial liquidity and financial flexibility for the company to pursue acquisitions and growth opportunities.

Beacon’s growth strategy, however, depends largely on acquisitions; the primary growth driver since its inception. The company, therefore, faces challenges from acquisition related risks. For instance, management may have trouble finding suitable acquisition candidates that provide synergies in existing markets and upfront earnings accretion.

Moreover, Beacon has to contend with privately held companies like American Builders & Contractors Supply Co., Inc., Guardian Building Products Distribution, Inc., Stock Building Supply LLC. Our recommendation on Beacon is in line with a short-term Zacks #1 Rank (Strong Buy).