Reece shares (ASX:REH): A great company, but significantly overvalued

Reece shares (ASX:REH) represent ownership in one of two plumbing companies in the ASX 200 – the other being Reliance Worldwide (ASX:RWC). Both companies have benefited from the home renovation boom during the pandemic and the ability of companies to pass increased costs on to their companies. While we think Reliance Worldwide is undervalued, do we think the same with Reece? Not necessarily.

Who is Reece?

Reece supplies plumbing, as well as bathroom, waterworks and HVAC-R (Heating, Ventilation, Air Conditioning and Refrigeration) products in Australia, as well as New Zealand and the United States. It serves professional trade, wholesale and retail markets. The company is named after its founder H.J. Reece who started the company in Caulfield, Victoria in 1920. More than a century on, his company employs over 9,000 people across the world. It services plumbing, bathroom, building, civil, pools and irrigation, heating, ventilation, air conditioning, fire protection and refrigeration industries. Since 1969, it has been majority-owned and run by the Wilson family.

Source: Company

The US is leading its growth

It has been the number 1 player in Australia for some time, yet only entered New Zealand in 2006 and the USA in 2018. It entered America through purchasing 171-showroom residential plumbing company MORSCO for $1.9bn, only to retire that brand less than 4 years later and launch Reece USA.

In FY18, the last year before it entered the USA, Reece recorded $2.7bn in revenue and a $225m profit. By FY23, it had recorded $8.8bn in revenue and a $388m profit. Its revenue was up 16% in 12 months and its NPAT was flat – not bad considering high inflation. More than half of its revenue came from the US and sales growth was twice as fast (21%). It paid a 25c per share dividend and recorded a ROCE of 15.3%.

Turning to its 1HY24 result, it grew sales 2.5% to $4.5bn and its profit was $224m, both on a statutory and adjusted basis.

Reece (ASX:REH) share price chart, log scale (Source: TradingView)

But here’s why you shouldn’t buy Reece shares

Reece shares are up over 60% in a year in the aftermath of its result. So should you buy now? After all, it has proven its ability to control costs and expand in the US, hasn’t it?

Consensus estimates expect the company to be flat for the next couple of years with ~1% growth in FY24 and FY25 to $8.9bn and $9.0bn respectively. Sales are expected to grow in the next 2 years, by 5.5% to $9.5bn in FY26 and 16% to $11bn in FY27.

The company’s profit is expected to be flat over the next 2 years, but with $452m expected in FY26, up from the ~$400m anticipated in both FY24 and FY25. The mean target price amongst the 11 analysts covering the company is $17.97, representing a ~30% discount. It is trading at P/E multiples of over 40x for the next 2 years, and even 38x for FY26. Its PEG multiple is 2.5x for that year.

We think investors would be better off in Reliance Worldwide (ASX:RWC) or in Beacon Lighting (ASX:BLX) because they are undervalued. Consider that Beacon is 19.1x P/E and Reliance is 16.3x for FY25. Reliance also runs the benefit of not running brick and mortar stores, and thus would have a lower employee expense.

Look to other companies

In investing, what you don’t buy is just as important as what you do. Companies can be good companies, but still burn investors because investors bought at too high a price. In our view, even though Reece is a good company, we cannot justify paying 40x P/E for a company that is expected to be flat for the next couple of years.

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