AWI - Armstrong World: Beneficial Guidance Cheap And Working For Major Clients

Summary

• Armstrong World Industries defines itself as one of the leaders and benchmarks in the ceiling and wall solutions in the United States.
• The company maintains good relationships with leading home centers such as Lowe's Companies, Inc., and The Home Depot, Inc.
• In my view, if management decides to seriously expand its operations through acquisitions of facilities in Europe, Latin America, or Asia, I believe that it knows exactly how to proceed.
• Considering the economic environment expected for 2023, I believe that the company’s figures are overall optimistic.

Ceiling and wall solutions provider Armstrong World Industries, Inc. ( AWI ) works with large clients, and recently delivered beneficial guidance. I am optimistic about the company's innovation and digitization efforts as well as expansion into adjacent business categories and sectors. Besides, considering recent M&A efforts, I believe that management will likely try to enhance growth through acquisition of targets to enhance the Architectural Specialties segment. Even considering potential risks from labor cost increases or new regulatory frameworks, in my view, the stock appears cheap at its current market price.

Armstrong World Industries

Armstrong World Industries is a Pennsylvania-based company that defines itself as one of the leaders and benchmarks in ceiling and wall solutions in the United States. Its main products include fiberglass, wood, metal wool, wood fiber, felt, and glass-reinforced gypsum. These products are commonly marketed to construction companies or retail businesses that resell and serve as distributors for AWI.

I believe that AWI works with massive and well-known clients. The company maintains good relationships with leading home centers such as Lowe's Companies, Inc. ( LOW ) and The Home Depot, Inc. ( HD ). In some cases, they are also sold directly to architects or construction industry professionals who require certain specific products.

In 2022, almost 70% of net sales went to distributors, while sales to large home centers of commerce were 10%. Regarding its clients, we can highlight Foundation Building Materials, Inc. and GMS ( GMS ) which represented almost 10% of the company's annual revenue. I don't believe that client concentration is an issue here.

AWI operates 17 manufacturing plants, of which 15 are located in the United States, and two are located in Canada. Eight of these plants are under its possession, while the rest are under lease. The company has two large operating segments, namely Mineral Fiber and Architecture Specialties. In 2022, most of the company's revenue was generated by the Mineral Fiber business segment.

The Mineral Fiber segment is oriented to the manufacture of ceilings and elements for walls of this material. These products are marketed through distributors or retail centers for home products and contractors.

Architecture segment is in charge of production using restaurant materials that are not fibers, such as wood, metal, or plaster. These products are designed in all the available materials in different colors or particular finishes. Unlike the Mineral Fiber segment, the sales of the Architecture segment are generally marked by projects for specific demands for which the sales channels are usually direct. In this segment, the sales are not carried out through distributors or retail stores.

Most of Armstrong World's revenue is generated in the United States and a small part in Canada. In 2022, 92% of the total amount of revenue came from the United States. In this regard, I believe that international expansion in Latin America, Europe, or Asia could bring significant revenue generation. With know-how accumulated in the United States, I don't see why the products wouldn't be successful elsewhere.

Armstrong World Knows How To Buy Targets: Acquisitions Could Bring International Revenue

I reviewed the company's most recent acquisitions. Armstrong World Industries appears to have expertise in the M&A markets. In my view, if management decides to seriously expand its operations through acquisitions of facilities in Europe, Latin America, or Asia, I believe that it knows exactly how to proceed. The following is a list of recent acquisitions.

In November 2022, we acquired the business and assets of GC Products, Inc.

In December 2020, we acquired all the issued and outstanding equity of Arktura LLC

In August 2020, we acquired the business and assets of Moz Designs, Inc. ("Moz"), based in Oakland, California.

In July 2020, we acquired all the issued and outstanding capital stock of TURF Design, Inc. ("Turf"), with one manufacturing facility in Elgin, Illinois. Source: 10-k

Beneficial Guidance

With that about the company's international potential, the company's recent guidance is worth noting. Armstrong World Industries expects net sales to grow close to 2%-6% along with adjusted FCF close to 4%-13%. Considering the economic environment expected for 2023, I believe that the company's figures are overall optimistic.

I also appreciate quite a bit that management provided a considerable number of financial figures for the full year 2023. Capex would stand at close to $75-$85 million with D&A close to $83-$88 million, 45 million shares outstanding, and interest expense of $35-$37. I used some of these figures in my financial model, so I believe that investors may want to have a look at them.

Highly Competitive Market

Competition in the national market is marked by the quality of the products, the price, the speed of response, and distribution efficiency. This market is highly competitive, and is made up of small regional producers and companies of a similar size and amount of resources as AWI. The most prominent companies in this regard are CertainTeed Corporation, subsidiary of Saint-Gobain ( CODGF ), Chicago Metallic Corporation, owned by Rockwool ( RKWBF ), Georgia-Pacific Corporation, Ceilings Plus, Hunter Douglas, Rulon International, and 9Wood.

Financial Situation: The Total Amount Of Liquidity Increased, And The Total Amount Of Liabilities Decreased

As of December 31, 2022, Armstrong World reported cash of $106 million, 8% more than that in 2021. Accounts and notes receivable were equal to $112.4 million with inventory of $110 million, 21% more than that in 2021. In sum, total current assets were worth $356.5 million, 10% more than that in 2021. I believe that the increase in liquidity in 2021 is quite beneficial news.

Property, plant, and equipment stood at $554.4 million, 2% more than that in 2021. Operating lease assets were equal to $18.8 million with finance lease assets of $16 million and a prepaid pension cost close to $83.2 million. Total assets stood at $1.687 billion in 2022, approximately the same figure was reported in 2021.

It is also worth noting that many liabilities decreased in 2022. Accounts payable and accrued expenses were $172.5 million with operating lease liabilities of $5.9 million. In addition, finance lease liabilities were $2.2 million with income taxes payable of $2.1 million. In sum, total current liabilities were equal to $182.7 million, 13% less than that in 2021.

The long term debt, less current installments, was $651.1 million, a bit more than that in 2021. The operating lease liabilities and finance lease liabilities were lower than that in 2021. Postretirement benefit liabilities were equal to $54.8 million with pension benefit liabilities of $27.6 million and other long term liabilities close to $25.8 million. Finally, total non-current liabilities were equal to $969.5 million, 1% less than that in 2021.

Assumptions In My Financial Model

Under my financial model, I assumed that Armstrong World Industries will successfully offer high-quality and innovative products. I also believe that management will be able to maintain strong brand awareness, and long lasting clients will likely continue to work with the company.

I also believe that further investments in new adjacent business categories and sectors will be successful. Besides, I assumed that the company will have sufficient financing to execute an international expansion. Finally, I assumed that new digitization efforts and M&A would enhance the expansion of the company's Architectural Specialties segment. In this regard, management offered certain commentary.

Our primary focus is on growth initiatives that further leverage innovation and digitalization (including the movement toward healthier and sustainable indoor environments in order to accelerate renovation), in addition to expansion of our Architectural Specialties segment through acquisitions, and overall strong cash flow generation. Source: 10-k

Beneficial Forecast From Other Financial Analysts And My Estimates

Forecast from market analysts includes 2025 net sales of $1.473 billion, EBITDA of $488 million, operating profit of $396 million, and an operating margin of 26.90%. 2025 net income would be $276 million with 2025 free cash flow of $240 million. I used some of the figures from other financial analysts in my financial model, so I believe that readers may want to have a look at the market estimates.

My numbers include 2033 net sales close to $2137 million together with net sales growth of 4.04%, 2033 EBITDA of $739 million, and an EBITDA margin of 34.60%.

I also forecasted operating profit of around $647 million, 2033 operating margin of 30.27%, and net income of $465 million. 2033 FCF would stand at $360 million with FCF/sales of 16.82%.

By assuming a beta of 1.27, cost equity of 12.80%, a tax rate of 20%, and cost debt of 7%, I obtained a WACC of 11.50%. I also assumed an EV/FCF of 29x, which I believe is quite conservative. Let's keep in mind that the company, in the past, traded at 60x FCF.

With 2033 FCF of $360 million, a residual value of $10.4 billion, and WACC of 11.50%, the implied enterprise value would be $4.7 billion. Besides, with cash of $106 million and debt of $653 million, the equity valuation would be $4.2 billion, and the fair price would be $92.94 per share.

Risks From Failed JV Agreements, New Regulation With Regard To The Extraction of Wood, Or Increase In Labor Costs

AWI depends directly on the joint success with Worthington Armstrong Venture. In this regard, it is worth noting that Worthington ( WOR ) announced a new plan to separate into two independent, publicly-traded companies. We don't really know how the new business transformation will affect Armstrong World's business model. If the partners want to renegotiate certain terms, I believe that Armstrong World may see a decline in its free cash flow expectations.

The Mineral Fiber segment also includes the results of our Worthington Armstrong Venture joint venture with Worthington Industries, Inc., which manufactures and sells suspension system ((GRID)) products and ceiling component products that are invoiced by both AWI and WAVE. Segment results relating to WAVE consist primarily of equity earnings and reflect our 50% equity interest in the joint venture.

In September 2022, Worthington announced a plan to separate into two independent, publicly-traded companies. One company is expected to be comprised of Worthington's Steel Processing operating segment, and the other company, which will include Worthington's investment in WAVE, is expected to be comprised of Worthington's Consumer Products, Building Products and Sustainable Energy Solutions operating segments. Source: 10-k

Besides, the inability to carry out new joint strategies or programs could directly affect AWI's productive circuit. Besides, we can also say that the loss of certain key customers could highly condition the future of operations for the company. As a result, if free cash flow expectations decline, I would be also expecting a decline in the company's stock valuation.

New laws regarding the extraction of wood could emerge as a result of new tendencies of care and reduction of gas emissions, and could directly affect the AWI Specialties segment. If the company has to modify its operations, and has to make meaningful investments to respect new regulations, the company's net income would most likely decline. As a result, I would expect a decline in the company's stock valuation.

Armstrong World Industries may also suffer from new labor laws and negotiations with workers or unions. Increases in labor costs may not be the worst problem for the company. Work stoppages and many other types of issues were reported in the last annual report.

Collective bargaining agreements covering approximately 200 employees at one U.S. plant will expire during 2023. We are also subject to the risk that strikes or other conflicts with organized personnel may arise or that we may become the subject of union organizing activity at our facilities that do not currently have union representation. Prolonged negotiations, conflicts or related activities could also lead to costly work stoppages and loss of productivity. Our overall labor costs, which includes costs of the activities described above and employee benefit plans, directly impact our business and financial results. Source: 10-k

Conclusion

With massive clients collaborating with Armstrong World Industries and a lot of know-how accumulated in the sector, I believe that international expansion could occur. I also believe that growth initiatives that further leverage innovation and digitalization mainly in the company's Architectural Specialties segment could happen. Finally, I am quite optimistic about potential M&A operations because the company, in my view, has a substantial amount of expertise in integrating new targets. Even taking into account potential risks from failed joint ventures or labor cost increases, I believe that the stock appears undervalued.

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