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Mas Memo - Vic

Mas Memo - Vic

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Published by: esmith8899 on Jul 23, 2012
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01/28/2015

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Investment Thesis:
MAS’ unique portfolio of recessionary-proof products (Plumbing, Paint) and leverage to new housing starts provides an opportunity toparticipate in the recovery in residential construction at the same time raw material costs are moderating (base metals flat/down andTiO2 growth slowing) and prior year marketing/investment spending materialize. We believe MAS could trade to ~$21 in 12-18 monthswith additional upside once the housing cycle becomes consensus and MAS proves their prior years’ spending and cost initiatives aresucceeding. 2010-2011 were transitional years for MAS with disappointing Cabinets and Installation, continued weakness in newresidential construction, and margin erosion due to higher commodity costs and marketing investments.
 
Reasonable Multiple on Plumbing and Paint… Brands Matter:
Note that SHW trades ~13x and 11x 2012E and 2013E EBITDA,respectively. SHW has higher growth prospects and more cyclical leverage with the professional contractor market, and we believe8x to be reasonable for Masco’s Paint business given their recent initiatives in the professional contractor market alongside HD.Furthermore, Plumbing has proven its stability thru the downturn and should also command a higher multiple than a cyclical 6x, butconcerns around Europe (45% of 2011 Sales, mainly in Central/Eastern Europe) likely will keep this multiple capped in the nearterm.
 
Limited Downside, Estimated ~$11:
MAS traded to ~$8 (~3.5% Dividend Yield) in both 2Q09 and 4Q11 when housing startswere annualizing at 615K, Paint was facing unrelenting commodity increases, and Cabinets/Installation were annualizing at 160MMof negative EBIT. Since then, MAS has demonstrated their ability to pass thru rising commodity costs at Paint (though lagged) andclearly articulated their road to profit improvements at Cabinets/Installation.
Business Overview:
MAS manufactures, distributes, and installs home improvement and building products, with emphasis on brand-name consumerproducts, and is among the largest manufacturers in North America of faucets, cabinets, architectural paints and windows. In addition,the Installation segment holds a leadership position in insulation installation in the new home construction market. In 2011, ~25% ofSales were for new construction and 24% of Sales were international (45% of Plumbing and 25% of Cabinets and Specialty), which wasmainly in Central Europe (37%), UK (23%), Emerging Markets (12%), and Eastern Europe (9%). The flagship brands of Delta andHansgrohe in Plumbing and Behr in Decorative Architectural (Paint) are resilient businesses that have a proven ability to implementprice increases and pass on rising commodity costs, product differentiation among competitors, and are non-cyclical consumerproducts. The company is organized into 5 segments as follows:
 
Cabinets (16% of 2011 Net Sales; 25% International; UK, Denmark)… Leverage to New Housing Starts + Turn-around:
 includes value-priced, stock, and semi-custom cabinetry for different price points and preferences, and recently includedcountertops to include the full vanity product. Home Centers currently account for a significant portion of sales due to low levels ofnew housing construction, but MAS has maintained and expanded relationships with homebuilders such as PHM and DHI and will
 
MASCO CORPORATION (NYSE: MAS)12-18 Month Price Target ~$21… Stress Case ~$11
CAPITAL STRUCTUREVALUATION & PRICE TARGETPro FormaDilutionEst 12/31/132014 EBITDA
Stock (7/18/12)$14.23$14.23
EBITDA(x)EV
Shares Outs (MM; 4/26/12)35729386Cabinets192
6.0x
1,149
MARKET CAP (MM)5,0825,494
Plumbing646
6.0x
3,873Installation176
6.0x
1,053
Cash (Sources)
Decorative Architectural400
8.0x
3,202+ Total Funded Debt4,379-4,379Other Specialty80
6.0x
477- Cash at 3/31/12(1,788)-(1,788)Corporate(125)
6.0x
(748)- Stock Options Cash- (284)(284)
MAS Adj EBITDA (MM)1,3689,007
- Financial Investments Carrying Value(107)-(107)- Net Claims @ 2013-E(1,617) + C2Q12:3Q12-E Cash Burn / - Flow- (220)(220)
Equity Value (MM)7,390
+ 2013-E Cash Burn / - Flow- (363)(363)/ FD Shares (MM)386
PRO FORMA NET DEBT (MM)2,4841,617Per Share$19.14ENTERPRISE VALUE (MM)7,5667,111Norm US Housing (000) Starts VS Norm Europe
$19.14 
8001,0001,2001,4001,6001,800DEBT STACK3/31/12MaturityUnused5%
$15.00$16.45$17.91$19.37$20.83$22.291.25B Revolver (Zero Outstanding; L + 50)-Jan-141,250
10%
$15.41$16.86$18.32$19.78$21.24$22.705.875% of 2012 (Repo 59 Par in 2010; 46 in745Jul-12- 
15%
$15.81$17.27$18.73$20.19$21.65$23.117.125% of 2013200Aug-13- 
20%
$16.22$17.68$19.14$20.60$22.06$23.524.8% of 2015500Jun-15- 
25%
$16.63$18.09$19.55$21.01$22.47$23.936.125% of 20161,000Oct-16- 
30%
$17.04$18.50$19.96$21.42$22.88$24.345.85% of 2017300Mar-17- 
35%
$17.45$18.91$20.37$21.83$23.29$24.746.625% of 2018114Apr-18- 
40%
$17.86$19.32$20.78$22.24$23.70$25.157.125% of 2020500Mar-20-  5.95% of 2022400Mar-22- 
2014 FREE CASH FLOW
7.75% of 2029296Aug-29-Free Cash Flow (MM)675  6.5% of 2032300Aug-30-Per Share$1.75 Zeros Converts of 2031 (Accreted Value)- --(x)
12.0x
Floaters of 2010- -- 
Per Share$20.97
Other24-- 
TOTAL FUNDED DEBT (MM)4,3792014 EPS
GAAP Adj EPS (All-in 36% Tax)$1.37(x)
15.0xPer Share$20.60
 
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.
o
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)
Potential Tailwind:
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.
Risks:
 
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.
 
 
Competitors (Akzo / Glidden) Aggressive Expansion at HD
Pricing Erosion:
Behr is the dominant brand at HD with colorcenters and computer kiosks, and HD accounts for all of Behr sales. The likely candidate would be Akzo / Glidden, but they areencountering their own profitability/restructuring issues in North America and seem unlikely to displace Behr as the dominant brandat HD. While prior peak EBIT margins of ~22% are not expected going forward due the lower-margin growth at professionalcontractors and TiO2 flattening (at high levels), the cost per gallon of paint is similar across competitors and there is no verticalintegration.
 
Raw Materials Inflation
Margin Erosion:
no competitors in Plumbing or Paint are vertically integrated, so this affectseveryone. Although MAS may not be able to implement pricing as quickly as SHW, for example, they have proven their ability toraise pricing thru HD and other channels. MAS meets with HD “as needed” with a 1-2Q lag. Paint prices have historically beenstable and pricing has not fallen with raw materials.
 
Plumbing (Delta, Hansgrohe, Brizo) Failure to Innovate and Command Premium Pricing:
brands matter and if MAS fails toinnovate and design up to par (or ahead of) competition, consumers could easily trade down to private label or competitors.
 
US / Europe Macro & Recession:
Residential Construction Slowdown; Stressed Consumer Trade-down to Private LabelPlumbing and Deferral “Big Ticket” Purchases (Cabinets)
Valuation Method:
 
EV / EBITDA:
we believe MAS should trade at 8x mid-cycle EBITDA on “Branded Consumer Discretionary” (DecorativeArchitectural) and 6x mid-cycle EBITDA on “Cyclical” segments levered to housing starts (Cabinets, Plumbing, Installation,Specialty). Over the past 12 years, MAS has traded ~10x EBITDA on average and ~6x EBITDA on 2006-2007 peak earnings. Webelieve 8x Decorative Architecture EBITDA is conservative given SHW’s valuation at ~13x 2012-E EBITDA and the provenresiliency of the Behr brand and HD/DIY paradigm.
 
Free Cash Flow, P/E:
multiples of 12x Free Cash Flow (8% Yield) and 15x EPS are generally within market multiples and MAShistorical multiples.
Financial Projections:
 
MAS Assumptions:
 
Macro Assumptions:
 
 
INCREMENTAL EBITDA % 2008 2009 2010 2011 2012-E 2013-E Norm 2Q12-E 3Q12-E 4Q12-E 1Q13-E 2Q13-E 3Q13-E 4Q13-E
Cabinets51.0%17.8%23.8%18.9%217.4%40.0%
40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0%
Plumbing5.4%6.8%40.6%(4.1%)16.3%102.5%
30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0% 30.0%
Installation23.3%21.2%(6.5%)61.1%46.4%25.0%
25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Decorative Architectural59.2%88.2%123.8%291.3%(4.9%)157.0%
25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Other Specialty21.0%7.6%(66.7%)75.0%62.7%25.0%
25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%MANUAL EBITDA ($MM) 2008 2009 2010 2011 2012-E 2013-E Norm 2Q12-E 3Q12-E 4Q12-E 1Q13-E 2Q13-E 3Q13-E 4Q13-E
CabinetsIn Addition to Macro Above: Revenue Opps, Cost Improvements-151515----  PlumbingIn Addition to Macro Above: Mix, Price, Hedge-(14)--1212--  InstallationIn Addition to Macro Above: Revenue Opps, Cost Improvements-666----  Decorative ArchitecturalIn Addition to Macro Above: Raw Materials Inflation Recovery-(18)--3535--  Other Specialty-------- 
MACRO ASSUMPTIONS20022003200420052006200720082009201020112012-E2013-ENormU.S. Housing Starts (000's; SAAR)1,7051,8481,9562,0681,8011,3559065545876097018501,200 % Y/Y
- 
8.4%5.9%5.8%(12.9%)(24.8%)(33.2%)(38.8%)5.9%3.7%15.1%21.3%41.2%Census: Construction ($MM; Not SAAR)Total Private Residential396,698446,039532,903611,900613,729493,247350,258245,913238,803237,267253,255265,918350,000 % Y/Y
- 
12.4%19.5%14.8%0.3%(19.6%)(29.0%)(29.8%)(2.9%)(0.6%)6.7%5.0%31.6%Census: Retail ($MM; Not SAAR)Furniture & Home Spending94,61096,882103,979109,362112,960111,33599,91386,65788,22990,05994,35397,184102,043% Y/Y
- 
2.4%7.3%5.2%3.3%(1.4%)(10.3%)(13.3%)1.8%2.1%4.8%3.0%5.0%Census: Retail ($MM; Not SAAR)Building Mat, Garden Equip, Supplies Dea248,888263,660295,884321,356334,520321,313305,085268,206283,970300,184315,575325,042341,294% Y/Y
- 
5.9%12.2%8.6%4.1%(3.9%)(5.1%)(12.1%)5.9%5.7%5.1%3.0%5.0%"Euro Area" Residential Construction:-(15.9%)(0.9%)0.0%20.0%

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