Masco: No Credit for Portfolio Transformation & Improved ROIC $MAS

Reading Time: 5 minutes

Masco is a leading building products company. If you own a home, there is a decent chance you’ve bought their products at some point. Products range from Behr and Kilz paint to plumbing products such as the Delta brand, among many others. Masco has undergone a significant portfolio shift overtime, and meaningfully improved the ROIC,  but I don’t think the market is giving them enough credit.


Masco set out on a divestiture plan a few years ago, divesting their cabinets and windows business lines. These were highly cyclical businesses with low-to-average ROICs. Now that they’ve sold those segments, they have meaningfully improved the ROIC (to top-quartile), they have a much more resilient business, and they have more cash on the balance sheet than ever.

Despite this, Masco trades at 14.8x 2022 EPS, or ~13.5x when you exclude cash. Compare this to Sherwin Williams trading at 24x or even the more industrial-exposed PPG trading at 17x. Home Depot also trades at ~20x.

Personally, I think Masco should trade at 20x EPS given how resilient / how high a ROIC business it is, which would put it at ~$74/share – nearly 40% higher than where it trades today.

Re-rating is tough to bank on, but I think a business that earns a 40-50% ROIC that is growing well should trade at least at the market level (the S&P trades at 22x forward EPS).


Background

I won’t go into the full background of Masco, but if we rewind to pre-financial crisis, Masco was made up of 5 segments:

  • Plumbing Products: Faucets, plumbing products, valves, tubs, showers, etc.
  • Cabinets: Kitchen & bath cabinets
  • Installation & Other Services: installed building products like gutters, fireplaces, garage doors and insulation products
  • Decorative Architectural Products: Mainly paint, under the Behr name
  • Windows & Other Specialty Products: Windows and window frame components

Several of these business are not what I would view as “high quality” and some were very cyclical.

For example, in a recession, how inclined are you to change your cabinets? If income is tight and you might not feel good about the equity in your home, then you might not replace them until they fall off the wall.

Cabinets are highly exposed to new build construction or remodel projects. Same goes for windows, some plumbing products and the installation products mentioned. With the benefit of hindsight, we know how many of these segments performed: Cabinets, windows, and installation each went operating profit negative at some point during the great financial crisis:

Here is a chart of the earnings of the main segments. As you can see, the more cyclical businesses got crushed and never really recovered. Plumbing and pant just kept on chugging.

Masco's segment performance varied wildly in the last recession

Plumbing and paint really kept profitability and they are great businesses.


Paint is a great business, as many people have figured out by investing in Sherwin Williams. People love to paint their home for a general refresh, or they may paint it before they sell their home. When a new buyer comes in, they often paint right over it again. It’s a relatively cheap remodel project that can really make your home feel upgraded.

It’s also a really consolidated industry, the housing crisis really showed how resilient the business was, and also showed the industry had pricing power.

Masco essentially competes with Sherwin Williams and PPG (note, Sherwin Williams beat out PPG for Lowe’s exclusive retail business, whereas Masco’s Behr paint has Home Depot’s business. I’d prefer to have Home Depot, for what it is worth.) Sherwin Williams also has its own stores where it mainly sells to the pro paint contractors.

The housing crisis really caused the industry to re-rate. Mainly because the competitors demonstrated such resilient performance, but also when oil spiked in 2008, they were able to raise praise and maintain margin. The industry realized that they could bank on pretty consistent price increases and not crimp demand.

You can see SHW and PPG traded around 8x EBITDA pre-crisis and clearly re-rated since then.

Note, I exclude Masco here because the chart gets messy since some of their segments (now divested) went EBITDA negative. Even though these segments are gone, Masco trades at a 2x discount to PPG and 7x discount to SHW today.


Masco’s paint segment is ~20% EBITDA margin and essentially takes no capital to grow (e.g. the company spent $25MM in capex for $620MM of EBITDA).

Plumbing is similar, albeit it will be more cyclical and more competitive (though its hard to even tell compared to the other segments in the chart above). It too earns really high margins — around 20% and 2% of sales for capex.

Lo and behold, that is the portfolio that Masco has today and those metrics point to really high ROIC. They are clearly solid businesses, as demonstrated by prior performance.

And here is a chart of Masco’s Return on Invested Capital (ROIC) over time and what I expect going forward:

Masco ROIC has improved meaningfully


I personally believe this housing cycle has legs, driven by the limited supply additions post-crisis and tight inventory, which I’ve discussed in the past. However, it’s hard to predict cycles.

Management gets 5 stars from me for divesting these lower margin, more cyclical business lines at arguably the best time possible (maybe not absolute peak earnings, but closer to peak than trough and selling for near peak valuations).


Why Do I Think Masco Is Discounted?

My guess is people think there was a pull-forward of demand in 2020, which is possible, though it’s not as if 2020 was a “gangbusters” year. Sales were up 7% and operating profit increased 19%. Q4 sales were up 13% as the housing market had really strong turnover. I expect this will actually be a multi-year cycle for Masco, as it appears more homebuyers are entering the market.

Masco’s brands, like Behr paint, is more focused on the Do It Yourself (DIY) market, whereas Sherwin Williams is “Do It For Me” (DIFM). The trend is in favor of DIFM right now. Painting is “tough”, or at least time consuming, and it looks as though millennials would rather hire someone to do it than paint themselves (a broad generalization).

I think this DIFM trend is overplayed. Investors / sell-side seems so focused on it, it’s like they are saying Masco’s business will shrink in the long run. If DIFM continues and gets more expensive over time, I think we start to cycle back to DIY, especially has home costs have become more expensive in general. Not hiring someone to paint for you is a quick way to save some money. At the end of the day, I think there will always be a sector of the market that is DIY to save money and to have fun with their own project.

Masco’s paint segment grew 12% top line in 2020 – do I think it will continue at that rate? Probably not. But at the end of the day, Masco is a super high ROIC business that even if it grows at GDP, I think it is worth a lot more than the market is assigning right now.


With a healthy balance sheet and $1.3BN in cash, they can buy back a lot of stock to “help the market realize the right valuation.”

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.