Seeking Compounders 3

Taking a look at my watchlist

In this little post, I’ll quickly introduce three Compounders from my current watchlist. These are companies that I already researched a decent bit and would love to either own or would research further (do the last 20%) if they dropped a good bit. Compounders are companies that can generate high capital returns for a long time and generally have a high-quality business and deep moats. Most of my portfolio is invested in compounders and I go into more detail about it in this article.

W.W. Grainger GWW 0.00%↑

W.W. Grainger is a well-managed distributor of Maintenance, Repair and Operations [MRO] products and services in North America. The company also has a smaller operating business, focused on an e-Commerce approach to distribution.

Their main business focuses on longstanding relationships with large to mid-sized customers, while the e-commerce approach targets small businesses and also has a Japanese division. The company also offers value-added services like an inventory management solution, specialist consulting and electronic procurement with the EDI standard. These VAS serve as a moat, much similar to Watsco WSO 0.00%↑ digital platform and marketing solutions.

The company has a great and simple capital allocation framework:

1. Organic reinvestment

2. A growing dividend (dividend king with 51 years)

3. Opportunistic buybacks or M&A

The company archives high ROIC and ROCE of 30%+ and is high up on my watchlist. I recently covered them on SA here.

Ferguson FERG 0.00%↑

Like Grainger, Ferguson is a distributor, but with a focus on the housing supply market. This focus leads to a much lower multiple due to the cyclicality of the housing market. Ferguson is broadly diversified being the leader in 4 of its 9 segments and in the top 4 in all others. Although the market perceives them to be cyclical, they actually have around 60% of revenues in Repair and maintenance. Ferguson has a history of accretive bolt-on acquisitions and keeps investing capital that way. One of the downsides of Ferguson is the lack of insider ownership, which is high at Grainger and Watsco. If you want to read more, check out my SA article going into detail.

Verra Mobility VRRM 0.00%↑

Verra Mobility outsources toll management, fleet management and traffic violations among others. The company is the market leader in the US and is also growing into new markets (Europe and Australia). The business has a very low churn between 2-5% throughout its segments because it automates tasks that take up much manual labor and could be spent much better. Trading at a low multiple, while expecting to grow at HSD-LDD makes the company attractive. VRRM remains just on my watchlist for two main reasons:

1. There is a lack of insider ownership and although the company seems to be well-managed, I’d prefer an owner-operator.

2. The company is highly levered around 3.8x net debt/EBITDA. The issue is that 800/1200 million of debt is unsecured at LIBOR + 325 bps (right now 8%). This will eat into free cash flows with around $90 million of interest payments. If Interest rates rise higher, this could get ugly.

The business is very interesting and I’ll keep monitoring it, but I don’t have a position now. For a deeper dive, check out this excellent post by user Vestrule.

I hope you found some value in this small piece, let me know if you like these kinds of posts. This was my close watchlist, but I got lots of companies on my to-do list, which I could quickly teaser.