Ferguson

Ferguson's second-quarter results reflect the strength of its franchise and reinforce our confidence in the firm's ability to steadily outperform industry growth in its end markets. We are also encouraged to see the momentum and discipline on the inorganic growth front.

Why it matters: Revenue growth came in at 4.6% during the quarter, with organic growth accelerating to 3.8%. Nonresidential end markets continue to drive the results as Ferguson reported 8% growth during the quarter while residential revenue grew 2% on a year-over-year basis. Commercial/mechanical and industrial segments were particularly strong during the quarter, with growth rates of 15% and 18%, respectively. We note that these categories are prime beneficiaries of large capital projects including the AI-related buildout. Large capital projects, which constitute about a mid- to high-single-digit percentage of Ferguson's revenue, are driving a significant portion of growth. Segments with higher exposure to residential markets, such as Ferguson Home and its residential plumbing unit, remained weak.

The bottom line: We are increasing our fair value estimate to $235 from $225 for narrow-moat-rated Ferguson on account of the time value of money and a slightly higher midcycle profitability estimate. We think that investors should wait for a margin of safety as they consider this company. Ferguson continues to gain share and has grown faster than its end markets. Margins have also held up in a relatively challenging environment, as adjusted operating margins were reported at 10.7% during the quarter, down 10 basis points compared with the previous year.

Key stats: Management slightly increased its 2026 guidance to mid-single-digit revenue growth and adjusted operating margin of 9.5%-9.8%.

Between the lines: HVAC segment results were especially encouraging, as revenue growth of 11% outperformed peers like Watsco and are partly a testament to management's dual trade strategy.

BLANK PAGEInorganic growth is an important part of the firm's long-term growth strategy, and we are pleased with the recent acquisition activity. Ferguson completed five acquisitions during the quarter and signed a definitive agreement to acquire FloWorks, a leading distributor of highly technical valves and flow control solutions. FloWorks is one of the larger bolt-on transactions in the last few years and fits squarely within the firm's acquisition playbook. We think these sorts of deals are value-accretive to shareholders and further strengthen Ferguson's competitive advantage within a consolidating industry.

The cash transaction values FloWorks at an enterprise value of approximately $1.6 billion and represents an acquisition multiple of approximately 10 times EBITDA (including expected synergies of approximately $45 million). With the acquisition, management expects to drive revenue synergies across industrial, commercial mechanical, and waterworks segments, as well as achieve certain cost synergies from network optimization, logistics, and technology.

We are slightly increasing our fair value estimate for the company to $235 from $225 per share. Our fair value estimate equates to around 21 times our adjusted EPS estimate for 2026 and a forward EV/adjusted EBITDA of around 14 times. We use a weighted average cost of capital for the firm of 8.2% based on 8.9% cost of equity, 5.3% cost of debt, 25% long-term tax rate, and an 85% equity weight in the WACC calculation.

We project revenue to grow at around 8.5% five-year compound annual growth rate, reaching about $47 billion in 2030. We expect acquisitions to remain an important part of Ferguson's capital allocation strategy, and we model acquisitions to account for about 2% of the firm's annual sales over the next five years. For future acquisitions, we use a conservative enterprise/sales multiple of 1.5 times. We expect an organic sales growth CAGR of about 6.5% during the explicit forecast years. Our projections imply that the firms’ end markets will grow at around 4%-4.5% CAGR, with the remaining growth coming from organic market share gains. We give the company credit for its ability to steadily grow faster than the end markets it operates in, but we think that the rate of market share gains will decline as the industry consolidates.

We expect the residential repair and remodel market to benefit from several tailwinds over the long term. Those tailwinds include aging housing stock in the US and increased acceptance of smart home and energy-efficient products and solutions. Despite near-term affordability challenges, we have a constructive long-term view of the US residential construction market. We project that new residential construction will rebound in 2028 amid healthier economic conditions and lower interest rates. Our housing forecasts expect annual housing starts to exceed 1.5 million by 2030. Over a longer horizon, we think that an annual production pace of 1.4-million-1.5-million units is a reasonable assumption.

Ferguson has a strong share in the commercial market through its waterworks, commercial/mechanical, and fire and fabrication businesses. Ferguson benefits from a robust pipeline of mega capital projects in North America, including the fast-growing data center vertical, that will deliver solid growth for the company. The firm also has high exposure to water-related spending and will benefit from buoyant utility spending on aging water infrastructure in North America. Overall, we believe Ferguson’s growth initiatives will propel its revenue growth above the market average (weighted for Ferguson's end-market mix).

Ferguson's fiscal 2025 adjusted operating margin (which excludes amortization of acquired intangibles) expanded 50 basis points year over year to 9.6% as the firm realized strong pricing (favorable price/cost) and operating leverage. We expect margins to remain flattish in 2026 as the housing market remains somewhat stressed. In the near term, we think that Ferguson is a margin-resilience and share gain story rather than one of cyclical recovery. Having said this, we think that the firm should be able to realize efficiencies over the medium term as the market continues to consolidate and the firm benefits from its scaled branch network, dual-trade strategy, multicustomer group approach for large projects, additional bolt-on acquisitions, and increasing exposure to value-added services. Due to all these factors, we project that the midcycle adjusted operating margin in our model will expand to about 10% by 2030.

The second stage of our valuation model assumes that Ferguson can generate an average of 20% RONIC and 6.5% earnings growth for 10 years after our five-year explicit forecast period. The second and third stage assumptions within our DCF model imply a terminal EV/EBITDA multiple of 12.4 times.

The North American construction and industrial distribution market is highly fragmented, with the largest players benefiting primarily from scale-driven cost advantages over smaller competitors. With over $30 billion in annual sales in the US and Canada, Ferguson is one of the largest building products distributors in North America, primarily focused on serving specialized professionals. Ferguson’s distributional scale is exemplified by the fact that 95% of the US population lives within 60 miles of the firm’s branches. It is a leading player in many of its end markets with particular strength in plumbing, water infrastructure, and HVAC products. Its strong market position is apparent from management's estimate that 75% of the firm’s revenue comes from segments where the firm holds either the largest or second-largest market position.

Ferguson distributes specialized products and value-added services to professionals and operates in niches within the industry where competitive intensity is relatively lower. We believe that smaller local and regional competitors will struggle to win share in these niche markets, allowing Ferguson to maintain its strong market position. Ferguson has steadily gained market share in a consolidating market, and we expect the firm to continue doing so, thereby further strengthening its scale advantage. We award Ferguson a narrow Morningstar economic moat rating and expect it to generate excess returns over the next decade.

Industry Dynamics: Ferguson has a leading position in the US water infrastructure (waterworks) market, which accounts for about 23% of its US sales. This market is highly fragmented beyond the two largest players (Ferguson and Core & Main), which have continued to gain share. On a relative basis, we think that the waterworks business is the most moaty segment for the firm. Ferguson Home is the second-biggest end market and accounts for about 21% of US sales. Ferguson Home focuses on premium and professional-grade products in a showroom setting, whereas Home Depot and Lowe’s have much broader product offerings with a self-serving shopping experience.

The residential trade plumbing and commercial/mechanical segments each account for about 15% of US sales. Ferguson is focused more on serving professionals like plumbers, contractors, and engineers across its footprint within these segments. Ferguson’s branch model strength lies in providing professionals with quick access to top plumbing SKUs, a product catalogue for niche use cases, product expertise from sales associates, and flexible delivery options from distribution centers and suppliers. Ferguson’s HVAC segment accounts for about 12% of its US revenue, and the firm is estimated to have a 5% share of this market. Other segments like fire & fabrication, facility supply, and industrial are much smaller segments for Ferguson and account for 3%, 4%, and 7% of the total US revenue share, respectively.

While the primary focus of box retailers like Home Depot and Lowe’s are DIY homeowners, these players have professional-focused offerings and have been increasingly investing to capture this market. Having said this, Ferguson is often perceived as being more specialized in areas like plumbing, HVAC, waterworks, and mechanical trades. Value-added services and a more consultative selling process make Ferguson competitive with its larger peers. Ferguson has consistently increased organic revenue above the market rate of growth due to more customer wins, a higher proportion of own-brand sales, and more cross-selling opportunities with professional contractors as Ferguson expands its footprint and product offering. Its steady market share gains indicate a relative competitive advantage over smaller players in the market.

Cost Advantage: We believe the cost advantages enjoyed by Ferguson and other large distributors stem from preferential supplier pricing, global product sourcing, in-house brands, and efficient and scalable distribution networks. Larger distributors can leverage their purchasing scale to globally source products and take advantage of volume-based rebates and other sales incentives that result in better gross profit margins relative to smaller distributors. Larger distributors also operate scalable distribution networks and centralized order-fulfillment centers, which allow these companies to cost-effectively serve their customer base, including large customers that require consistent product availability and service quality across North America. The fragmented North American market consists of many small local and regional distributors that find it difficult to compete with Ferguson’s superior scale, product breadth, and geographical footprint.

Another key tenet of Ferguson’s scale-driven cost advantage is its branch model and distribution network, which allows Ferguson to cost-effectively serve its sprawling customer base that requires quick access to a large assortment of products. Ferguson has used its scale to introduce more of its own brands within its distribution channels. Management estimates that around 10% of its revenue comes from its own brands (which have twice the gross margin), and this revenue is expected to grow at twice the rate of the firm's overall business.

Disruption From Online Retailing: Over the past decade, internet-based competition has increased competitive pressure among offline retailers. However, we think niche players like Ferguson are well equipped to fight off competitive pressure from other internet-based retailers. Ferguson’s entrenched position in Waterworks and plumbing will be hard to upend as customers conducting large projects require specialized products and value the technical expertise of sales associates and other value-added services that the firm brings to the table. Given that Ferguson’s core customers are contractors that value its branch offerings, we see little threat from online retailers.

Ferguson’s competitive advantage and bolt-on acquisition strategy in the US should drive consistent market share gains, boosting revenue growth in excess of the market average.

Ferguson’s strategic shift to the US away from international markets has strengthened the firm’s growth outlook, returns profile, and consolidated operating margin.

Ferguson generates strong free cash flow throughout the economic cycle despite serving cyclical end markets.

Ferguson’s exposure to new construction markets can pressure revenue growth and margins during cyclical downturns.

The success of Ferguson’s mergers and acquisitions strategy is uncertain. A variety of factors may destroy shareholder value, such as unfavorable deal terms, integration issues, and acquisition underperformance.

Ferguson faces stiff competition from Amazon in its e-business operations and from Home Depot in its residential business. Home Depot’s increased investments targeting professionals can increase competitive intensity in some segments.