Intentionally or not, Fortune Brands has created a Good Co, Bad Co with their spin-out of Masterbrand Cabinets stock. It is very easy to be cautious on 2023 and say, cabinets are F’d. Instead, cling to your Fortune Brands shares which sell into plumbing, security products, and decking.
Cabinets are a super cyclical business. I tend to think a cabinet sale occurs during new construction… or when they fall off the wall. But really they are also replaced when there is heavy remodeling work done. All require some discretionary income.
The cabinet business proved its cyclicality back in the financial crisis. Featured below is Masco’s (since divested) cabinets business operating income. It took until 2016 to get back to Op income profitability! Woof.
Now, of course we were in a housing bubble back then… Masco also added in a ton of capacity right before the market turned. This number includes some impairments and restructuring charges. In addition, China started to nip at the heels of the industry by competing in the really commoditized, “stock”, low-end product (ready-to-assemble cabinets).
American Woodmark’s EBITDA perhaps is a better example:
Typically, competition is pretty localized in cabinets as shipping costs can be really expensive. That’s still true, but the industry had to flush out losing some of that lower-end business.
Fast forward a bit to today, American Woodmark (AMWD), Masterbands (MBC) and Cabinetworks (private, but bought the former Armstrong and Masco cabinet businesses along with Elkay), now dominate the industry. Definitely flip through Masterbrands investor day deck if you want more background
It is still a tough business, no question.
In 2021, they were hit by labor costs (building cabinets is labor intensive), freight, as well as hardwood costs. It’s a high fixed cost business too, so when operational issues occurred (omnicron absenteeism for example), it really hit them on the chin as throughput suffered.
As such, the industry has been trying to get price to recover this. Backlogs have been huge, but that wasn’t necessarily a good thing as the price on the backlog didn’t match the new input-cost reality.
The industry is doing better to recover margin. As you can see from American Woodmark’s EBITDA margin, they are slowly but surely getting back to a reasonable margin level.
We’re talking big price increases rolling through now.
Volumes for the industry are pretty flat lately, but price increases are 15-20%. That will help margins going forward. KCMA publishes data and in October, volumes fell 2.6%, but price was up 17%
AMWD’s FQ2’23 (ended Oct’23), showed EBITDA margins expanding from 6.8% to 12.0% Y/Y. And therefore EBITDA $ more than doubled.
Taking a step back, I think this tends to surprise people – demand was so strong for cabinets that it hurt profitability. And as demand has cooled a bit now, that’s helping? WEIRD.
Back to Masterbrand – Fortune Brands decided to spin the company out. My guess is for a re-rating. Get rid of the more cyclical, lower margin business. Heck, that’s what Masco did (though it didn’t really re-rate).
But my guess is everyone is thinking the same thing on MBC. “Get away”
Masterbrand, I will say, has outperformed its peers on maintaining margin. They have a long history of that. I believe they are THE best run cabinet player in the space. Even so, they think they can get to 16% EBITDA margins over time.
I like low hurdles to jump over. So I did some rough math. I used their estimate for “high-single digit” sales decline next year, 25% decremental. But then I basically say no growth from there. I give no credit for W/C being a benefit either, after a couple years of a large build. Maybe that’s too aggressive? I don’t know, I think expectations for Masterbrand Cabinets stock are probably pretty low…
That looks like a lot of cash…. And when I compare it to the current market cap, we’re talking nearly a 20% FCF yield for Masterbrand Cabinets stock.
Historically, cabinets businesses have traded for 6-8x, in some cases higher for private M&A. It intuitively makes sense given what we’ve discussed. But I think this valuation, IF YOU HAVE A LONG TIME HORIZON, makes a lot of sense.
Obviously there are risks. The cycle could be a nasty one. The spin could have some stutter-steps (though MBC was a separate segment for a long time). But I like the risk-reward here and the forced selling.
The other major risk is I am writing this the day of the spin! That’s a no no. Wait for it to bleed out, Dilly D! This is a $1BN market cap and hated industry right now!
Ehhhhhhh whatever. AMWD is trading at 7.3x ’23 and in my view, has performed worse. Capital intensity is also higher there. I like the risk reward.