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���������ֳ� - Toronto - 04 Oct 2024: ���������ֳ� has assigned Patrick Industries, Inc. a first-time 'BB' Long-Term Issuer Default Rating (IDR). ���������ֳ� has also assigned a 'BB'/'RR4' rating to Patrick's senior unsecured notes, including its convertible notes. The Rating Outlook is Stable.

Patrick's ratings reflect its position as a leading supplier to the outdoor enthusiast and housing end markets. The ratings also reflect the company's variable cost structure, which supports margins and FCF through the cycle. Additionally, the ratings reflect Patrick's exposure to the discretionary enthusiast recreational vehicle (RV) and marine markets. Patrick's low capex intensity and capital allocation framework supports its financial flexibility. ���������ֳ�'s rating case forecasts annual FCF of $150 million-$300 million and gross EBITDA leverage in the mid-2.0x range.

The Stable Outlook reflects ���������ֳ�'s expectation that the company's end markets have passed the cyclical bottom, and that Patrick's customers will increase production in 2025 and 2026. This should enable the company to grow revenues while generating mid-single-digit FCF margins.

Key Rating Drivers

Reliance on Outdoor Enthusiast End Markets: ���������ֳ� views Patrick's reliance on its discretionary outdoor enthusiast markets as a key revenue and cash flow risk. As of 2Q24, 69% of Patrick's LTM revenue came from the outdoor enthusiast markets, comprised of Recreational Vehicle (RV) (45% of LTM revenue), Marine (17%) and Powersports (7%).

Wholesale RV and Marine production has followed a boom-bust cycle from 2021 to 2023, with shipments falling 48% to 313,174 units (from 600,240 in 2021) for RVs and 7% to 192,346 (from 206,200 in 2022) for Marine. As a result, Patrick's 2023 revenue decreased 29% to $3.5 billion, down from its $4.9 billion peak in 2022. However, ���������ֳ� believes these end markets have likely passed the bottom of their cycle, and expects shipments to increase by the mid-to-high teens in 2025 and 2026, as dealers start restocking inventory in response to rebounding retail demand.

Flexibility Drives Resilient Margins: Patrick's operational and cost structures are highly flexible and largely consists of raw materials and labor. In the event of a sustained downturn, Patrick has the operational flexibility to quickly adjust output based on demand fluctuations. ���������ֳ� expects the company to preserve its gross margins in the high-teens and its ���������ֳ�-calculated EBITDA margins in the mid-to-high single digits. The company also carries limited working capital, with a cash conversion cycle of about 65 days, which helps drive through-the-cycle FCF.

Despite a 29% decrease in yoy sales in 2023, Patrick reduced its labor and raw material costs by 50 bps and 330 bps, respectively, as a percentage of net sales. Moreover, the company's ���������ֳ�-calculated EBITDA margins compressed by only 137 bps to 12.4%, down from 13.8%, as the company decreased its warehouse and SG&A expenses. The company's through-the-cycle FCF generation was evident during the pandemic downturn with $104 million in 2020 and limited variability between 2022 and LTM 2024 remaining at about $300 million.

Acquisitions Strengthen Business Profile: Patrick has significantly grown over the past decade through a series of acquisitions. These acquisitions have increased its size and scale, bolstering its business profile, while strategically diversifying its product mix and end markets. The company reduced its exposure to the RV market to 43% in 2023 from as high as 75% in 2015. During this time, Patrick entered the Marine and Powersports markets, which brought cross-selling and expense synergies through shared infrastructure for different product categories.

Content-per-unit for the RV and marine markets was only $4,966 and $3,935 at LTM 2Q24, respectively. This indicates a significant potential for further consolidation through acquisitions. Patrick's LTM revenue grew to $3.6 billion in 2Q24, up from $2.5 billion in FY 2020, largely through acquisitions, which added an estimated $619 million of revenue and $114 million of EBITDA. Although the company's revenue predominantly consists of sales to the outdoor enthusiast markets, Patrick's exposure to the less-discretionary housing market helps moderate the company's revenue profile through economic cycles.

EBITDA Leverage Expected to Decrease: ���������ֳ� expects Patrick's gross EBTIDA leverage to decrease to about 2.5x by 2025 from its current level of 2.9x as of 2Q24. This is due to improving retail demand and wholesale unit volume growth. ���������ֳ� believes the company will continue executing bolt-on acquisitions within its existing end markets, particularly Powersports, to diversify its product mix, enter new geographies and expand its size and scale. ���������ֳ� also believe the company will rely on its cash on hand and revolver to accomplish this.

The company has the capacity to flex its share repurchases as it balances bolt-on acquisitions, strategic capex deployment and quarterly dividends to stay within its EBITDA 2.25x-2.5x net leverage target.

Mid-Single-Digit FCF Margins: ���������ֳ� expects Patrick's post-dividend FCF margins to run in the mid-single digits over the next few years. This will be driven by ���������ֳ�-calculated EBITDA margins stabilizing in the 12%-13% range over the intermediate term. The company's FCF margins will also be supported by its low capex requirements and by working capital management. Revenues declined by 29% in 2023, but the company flexed its receivables, payables and inventory to generate about $100 million cash. ���������ֳ� estimates Patrick's average FCF conversion rate between 2020 and 2023 was about 46%.

Derivation Summary

Patrick is a leading component supplier to OEMs in the outdoor enthusiast and housing markets. Compared to Harley-Davidson, Inc. (BBB+/Stable), Brunswick Corporation (BBB/Stable) and Polaris Inc. (BBB/Stable), which are OEMs that manufacture motorsport vehicles, Patrick's revenue has similar demand risks, while margins are more stable. This comparative margin resiliency is linked to the company's ability to pass through changes in its costs to its OEM customers.

Patrick is more acquisitive than the three OEMs, with mid-cycle leverage running about 1x-2x higher, leading to some incremental leverage variability, although the company retains favorable through-the-cycle financial flexibility.

The Azek Company (BB/Positive) and MasterBrand, Inc. (BB+/Stable) are suppliers of housing-related products. Each has a leading market position in its product category and is exposed to cyclicality in housing construction and remodeling. However, this volatility tends to be lower than in the outdoor enthusiast market. Both companies' product offerings are more limited than Patrick's. Azek is considerably smaller than Patrick, with lower leverage but also lower margins. MasterBrand is larger than Patrick, with higher leverage and lower margins.

Key Assumptions

Production grows at a moderate pace through 2024 as OEMs demonstrate operating discipline to support elevated, but declining dealer inventory levels in certain markets particularly marine and powersports;

Production rates increase in 2025F and 2026F as retail demand recovers;

Moderate cost-linked price increases from 2025F onwards;

Gross margin remains stable through 2025F due to elevated material costs, followed by expansion driven by lower labor costs and overhead as a % of revenue;

Operating margin expansion driven by tight control of expenses and automation initiatives, as well as cost synergies from acquisitions;

���������ֳ� interest rate assumptions: 5.0% in 2024, 4.5% in 2025, 4.0% in 2026 and 3.5% in 2027;

Capex runs at about 2% of revenue throughout the forecast;

Common dividends issued by company steadily rise through the forecast;

Opportunistic share buybacks that remain stable throughout the forecast;

Bolt-on acquisitions in 2025 through 2027 funded by a combination of incremental debt, equity and cash on hand.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

--M&A strategy that continues to diversify product-mix within existing end-markets and strengthens the through-the-cycle cash flow profile;

--Adherence to a balanced capital allocation plan preserving through-the-cycle financial flexibility, including (CFO-Capex) / Debt sustained over 18%;

--Mid-cycle EBITDA leverage sustained below 2.5x.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

--Acquisitions that reduce operational and cost flexibility, and heighten margin and through-the-cycle FCF variability;

--Material shift in capital allocation plan that reduces through-the-cycle financial flexibility, including (CFO-Capex) / Debt sustained below 12%;

--Mid-cycle EBITDA leverage sustained over 3.0x.

Liquidity and Debt Structure

Strong Liquidity: As of June 30, 2024, Patrick has $44 million in cash and $480 million available under its $775 million revolving credit facility.

Debt: Patrick's current debt structure consists of $125.6 million outstanding under its term loan, which matures in 2027, $300 million of 7.50% senior notes due October 2027, $350 million of 4.75% senior notes due May 2029 and $258.8 million of 1.75% senior convertible notes that mature December 2028.

Issuer Profile

Patrick is a leading component solutions provider for the RV, marine, powersports and housing markets.

Date of Relevant Committee

01 October 2024

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

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MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

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APPLICABLE MODELS

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