participate in the recovery in new housing construction. This segment has been particularly affected by the downturn due toconsumer deferrals of “big ticket” items and an aggressive promotional environment.
Relative to AMWD and FBHS, MAS has inferior EBIT margins due to the focus on scale and volumes with 200MM of EBITlosses over the past three years while waiting for the recovery. MAS conceded that FBHS is “more nimble” and were moreaggressive in stream-lining their portfolio. In 2011, MAS exited the “ready-to-assemble” products and has embarked on~50MM EBIT initiatives to lower EBIT losses to 22MM assuming 600K housing starts and EBIT break-even at 700K.
Plumbing (39% of 2011 Net Sales; 45% International; 68% Ownership of Hansgrohe AG)… Brand Matters + Lower TicketSpending + No Deferred Maintenance:
primarily faucets and showers under the Delta (USA) and Hansgrohe (Europe) brands,which consistently win various innovation and design awards. Competition in this segment is from private label brands and otherpremium brands such as Kohler and Moen (FBHS). Segment profitability troughed ~300MM EBIT (10% margins) in 2009,demonstrating the resiliency in the branded portfolio versus lower price points, the attractiveness of “lower ticket” re-modelingprojects, and consumers’ inability to “defer maintenance”. Brass (Copper / Zinc) are the primary raw materials and the MAS hasbeen able to re-capture margins in a rising cost environment. Other products include tub/shower systems, spas, and other brassplumbing system components.
Installation (14% of 2011 Net Sales)… Leverage to New Housing Starts + Turn-around:
primarily installation and distribution ofinsulation products. Similar to Cabinets, Installation has been particularly affected by new housing construction (overhead,locations, and headcount) with 270MM of EBIT losses over the past three years. MAS projects 2012 cost and revenueopportunities to improve EBIT by 30MM in 2012 assuming 600K housing starts and EBIT break-even at 800K. Cumulativeinitiatives include the closure/consolidation of 110 branch locations, divesture of non-core services/products, ERP efficiencies, andexpansion into the retrofit and light commercial markets.
Decorative Architectural (22% of 2011 Net Sales) / Paint / Behr @ HD… Margin Re-Capture VS TiO2 Stabilization + Do-it-Yourself Paradigm + Pro:
Behr and Kilz paint brands account for this segment’s profits with an insignificant profit contributionfrom hardware. Behr is sold exclusively at HD and essentially grew alongside HD since the 1980’s and has remained theincumbent brand at HD. The core DIY customers remain strong at HD and recent initiatives and marketing spend are focused onexpanding into the professional segment, which would improve volumes and overhead absorption, though at slightly lower marginsper gallon. Currently, MAS has limited exposure to the professional contractor (SHW leadership) and similar to HD initiatives, webelieve this could be a growth area for Behr going forward. In 2011, Paint experienced TiO2 cost inflation of ~40% Y/Y, but MAShas shown its ability to increase prices on a 1-2Q lag.
Other Specialty / Windows (8% of 2011 Net Sales; 25% International):
primarily windows and doors under Milgard brandmanufactured from vinyl, fiberglass, and aluminum sold thru dealers. Also includes a complete line of staple gun tackers (Arrow)sold thru home centers, retailers, and wholesalers. Specialty has generated slightly positive EBIT over the past few years due tobusiness rationalizations and geographic/product expansions offset by higher commodity costs and lower volumes.
Catalysts & Opportunities:
Cabinets & Installation Profit Improvements Materialize:
for the first time on the 1Q12 earnings call (5/1/12) managementpresented the Cabinets and Installation 2012 EBIT improvement plan of 53MM and 30MM, respectively, assuming 600K starts.While MAS still expects losses at 600K starts, investors can look forward and extrapolate the segments’ earnings power underdifferent assumptions on housing starts. As discussed, these two segments have accounted for almost 500MM EBIT losses from2009-2011, and break-even performance (or close to) would be a significant change in company fundamentals and investorperceptions.
Moderation in Raw Materials (TiO2, Brass / Copper / Zinc)
TiO2 could experience another couple yearsof inflation, but at rates less than the ~40% experienced in 2011. When new TiO2 supply comes online ~2014, MAS should be ableto maintain pricing as they (and SHW) have done historically when raw materials decrease.
Paint’s Successful Growth at Professional Channels w/ HD:
although incremental margins per gallon would be lower atprofessional, these volumes could further help with overhead absorption from lost volumes at Wal-Mart in 2011, estimated at~20MM EBIT. HD strategy and commentary seems focused on building out their exposure to the professional contractors, and webelieve MAS would benefit from this initiative for additional Paint leverage to new residential construction and overhead absorption.
Normalized US Housing Starts:
without re-creating data sets and charts on the case for housing starts, we believe 1.2MMnormalized (2014 in Financial Projections) housing starts is reasonable.
Poor Execution at Cabinets & Installation:
in the 1Q12 earnings call, management clearly laid out a road-map to improve EBITat Cabinets and Installation, which have generated close to 500MM of EBIT losses in the past three years combined. Investorshave become skeptical of management’s operating philosophy of “waiting for housing to come back” and decision not to restructurethese segments more aggressively after 2008. If MAS is unable to execute on their cost and revenue initiatives (discussed insection above), this would further hurt their credibility as operators. If MAS demonstrates they can’t turn these segments aroundwithout new housing starts, investors would likely look elsewhere for leverage to new housing starts.