Something curious lurks within the otherwise positive earnings call transcript of Core & Main (CNM). While analysts focused on gross margin normalization, M&A activity, and the anticipated impact of the Infrastructure Investment & Jobs Act (IIJA), a subtle shift in strategy appears to be underway, one with the potential to significantly impact the company's long-term growth and profitability.

Core & Main, a leading distributor of water infrastructure products, has historically relied heavily on acquisitions for expansion. However, a close examination of the Q4 2023 transcript reveals a growing emphasis on organic growth, particularly through the development of its private label product line.

While acquisitions have been a successful strategy, they are inherently volatile and subject to market fluctuations. Building a strong private label portfolio, on the other hand, provides Core & Main with a more stable and predictable revenue stream, increased control over margins, and potentially higher customer loyalty.

"This shift towards organic growth is not merely a fleeting notion. The transcript is peppered with evidence, subtle but significant. Steve LeClair, Chairman and CEO, speaks of accelerating the adoption of new products, highlighting a 16% growth in smart metering and above-market growth in fusible HDPE offerings. He further emphasizes the focus on customer-specific solutions, suggesting a move beyond simply distributing products to providing value-added services."

Mark Witkowski, CFO, reinforces this strategy by revealing a substantial investment in private label capacity. Core & Main has added over 80,000 square feet of distribution space and more than 1,000 private label SKUs in the past year alone. This is a clear indication of a long-term commitment to building a substantial private label business.

The numbers tell an intriguing story. Private label products currently represent over 2% of Core & Main's cost of goods sold (COGS). The company's goal is to grow this to over 10% in the coming years. Considering private label products typically yield 1.5 to 2 times the gross margin of core products, this could translate into a significant margin expansion opportunity.

Projected Impact of Private Label Growth

To put this into perspective, let's assume Core & Main achieves its $10 billion net sales target by 2028. A 10% private label penetration would represent $1 billion in sales at a potentially doubled gross margin. This could boost gross profit by hundreds of millions of dollars, significantly bolstering profitability and potentially exceeding the company's 15% adjusted EBITDA margin target.

This shift is particularly noteworthy considering the anticipated challenges in the M&A market. Higher interest rates and increased competition for quality assets are likely to make acquisitions more expensive and potentially less accretive. By prioritizing organic growth, Core & Main is not only diversifying its growth strategy but also mitigating the risks associated with an over-reliance on acquisitions.

Furthermore, the transcript reveals a renewed focus on strategic accounts, typically large-scale projects demanding technical expertise and specialized procurement. This segment often commands higher margins and provides an opportunity to showcase Core & Main's capabilities beyond simple distribution. By combining this focus with its growing private label portfolio, the company is positioning itself as a comprehensive solutions provider, strengthening its competitive advantage and paving the way for sustained profitability.

Private Label Growth and Gross Margin Expansion

The following chart illustrates the potential impact of private label growth on Core & Main's gross margin.

The transcript suggests a clear hypothesis: Core & Main is quietly shifting its focus from acquisition-driven growth to a more balanced strategy emphasizing organic growth through its private label portfolio and strategic accounts. If successful, this strategy could lead to significantly higher margins, increased cash flow, and ultimately, a re-rating of the company's valuation.

While analysts are focused on near-term headwinds like gross margin normalization, the real story might be the long-term potential unlocked by this strategic shift. Could Core & Main be the sleeping giant about to flood Wall Street with value? The evidence, subtly embedded within the transcript, suggests this could be the case.

"Fun Fact: Core & Main's history dates back to 1874, predating the invention of the telephone and the automobile. It began as a small plumbing supply company and has evolved into a national leader in water infrastructure distribution. This longevity and adaptability are perhaps indicative of the company's ability to evolve and capitalize on emerging opportunities, such as the burgeoning private label market."