Last week we added SG Blocks (SGBX) to the Tailwinds Select Portfolio. At the time I worried our move was premature. I had done some reading on the Company and spoken with several investors, but had yet to do a deep dive into the business, nor had I spoken with management. The story just sounded too compelling to wait, however, hence the early addition.
Having now spent time perusing their SEC filings, having spoken with management, and having watched the stock rally 20% this week, I feel very comfortable saying that it was the right decision. In my opinion, SG Blocks represents a compelling business model and an exceedingly timely investment.
Bringing Modularity to Buildings
To start my investment thesis here, let’s discuss quickly what SG Blocks does; they make buildings out of shipping containers. In doing so they achieve the following advantages over all other traditional builders; cheaper, quicker, safer, greener. Any one of these is a reason for a developer to consider their products. Combined, it’s a compelling advantage.
Side note: I do understand that a lot of high-homes, apartments and offices will require customization beyond that offered by employing containers. This thesis applies to the roughly 50% or more of the $78B US building market that doesn’t have these demands.
SG Blocks has been an innovator in the market of container buildings, having really helped pioneer this industry over the last 10+ years. During that time, buildings built out of containers have come a very long ways. Below, I’ve put some pictures of SG Blocks’ apartments, homes and businesses…these aren’t simply backwoods hunter sheds anymore.
The buildings being constructed by SG Blocks are, simply put, great. They are attractive, stylish and modern. They are also cheaper than traditionally built buildings. Cheap enough to drive rapidly increasing demand.
The are several keys to the cost savings inherent in their buildings. These range from off-site assembly, to recycled versus new materials. However, at the center of all the savings is a paradigm shift in the whole traditional construction business from a location based build to a modular design and construction.
Modular design, or “modularity in design”, is a design approach that subdivides a system into smaller parts called modules or skids, that can be independently created and then used in different systems. A modular system can be characterized by functional partitioning into discrete scalable, reusable modules; rigorous use of well-defined modular interfaces; and making use of industry standards for interfaces. ~ Wikipedia
Throughout history, industries have evolved into modular designs as they have matured. Recent examples include automobiles, computers, solar panels and wind turbines. In each of these industries, the shift to modular design led to a dramatic decrease in costs and time to build.
And, while reduced costs are certainly desired by project developers, it is important to understand the even larger benefits of reduced time to build. In modular building design, construction takes place offsite and simultaneous to site prep work. The build time is reduced by the modular design, but the overall construction time can be reduced by up to 50% by building simultaneous to site prep. The result of this is a potential doubling of the IRR for a project developer, whose cash is going to be tied up for as little as half the time of a traditional construction project.
Thus, by bringing modular production to an industry that hasn’t really changed its building methods ever, container buildings are on the leading edge of a potentially massive shift in the industry.
SG Blocks is an outsourced business model. They engage third parties for design and engineering, as well as for construction of modules. The outsource model is beneficial to them in that it makes for an asset light business. It also allows them to scale quite rapidly.
The Company has two manufacturing sites engaged, one in Pennsylvania and the other in Houston, Texas. Each of these facilities has a current capacity of 500,000 square feet per annum. To put this in perspective, at about $180 dollars a square foot in sales price, SG Blocks has the capability of ramping up to $180 million in revenue with their current partners.
This ability to rapidly scale up is important as a rapid scale up is what is currently happening with their backlog. At the end of Q2, the company had 171K sq. ft. in backlog. They now have almost 3 times that amount, as per a recent press release. The pipeline is also growing exponentially, creating a situation where this Company could be looking at a huge 2018.
Beyond the known backlog lies the potential for even more business that could arise from all the recent disasters. The hurricane damage that was sustained in the Caribbean has left an incredible demand for housing. FEMA and other agencies of the countries hit will be throwing money into disaster repair and many buildings need to be completely replaced.
With SG Blocks being cheaper and quicker to build, especially with the modular, off-site construction, I believe this Company is well positioned to win major business. Considering that containers are designed to withstand rough seas and storms, they are a perfect fit to be the building blocks for a large scale rebuilding effort in the islands.
Execution is Key, but Time is Ripe
SG has proven that they can make attractive buildings out of shipping containers. They have done so with 5,000 of them already and the results are proving themselves through a rapidly increasing backlog.
The Company has readied itself for up to 1MM sq. ft. of construction per annum. This is a big bite for a group that has never done more than a fraction of this number. Over time, this is the biggest risk to the SG Blocks story. The business appears to be there for the taking…can they deliver in size over the long haul remains to be seen.
Tailwinds is on board with SG Blocks right now. We believe that the core business is compelling. Bringing modular construction techniques to the building industry makes sense for some portion of it. With the massive scale of the industry, there is certainly plenty of room for SG Blocks to benefit from any shift to modular design and construction.
Meanwhile, backlog is growing and it appears that the Company is well positioned for some blockbuster contracts for hurricane repair. At this time, the shares of SG Blocks are trading at a $25M market cap. There is ample room for them to go up with the increased business. And, if the Company can execute on a large scale, the upside could be phenomenal.
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