AWI - Armstrong World Industries: Positive On AUV Growth And Margin Expansion

2023-05-02 06:29:16 ET

Summary

• Despite the uncertain state of the commercial market, AWI's 1Q23 results were encouraging.
• AUV should start to see positive comps tailwind and margin should trend upwards as cost savings impacts start to kick in.
• Valuation is not demanding at 14x forward PE, which is below its average of 17x.

Thesis

Armstrong World Industries ( AWI ) is a company that offers ceiling, wall, and roof solutions for both commercial and residential buildings. Despite the uncertain state of the commercial market, AWI's 1Q23 results were encouraging, and have solidified my confidence in the company's long-term strategy and outlook. I'd like to add that AWI is a company that has grown its AUV and generated positive EBIT and operating cash flow for the past 12 years, even though the economy has gone through several ups and downs during that time. In spite of the more difficult outlook for the office sector, I anticipate long-term growth to remain resilient thanks to a robust institutional project pipeline, especially in the transportation and healthcare sectors. New product introductions and price increases bode well for the company's product mix, which should translate to increased AUVs. AWI should also continue its capital allocation program of buying back shares and issuing dividends. Lastly, the valuation is not demanding at 14x forward PE, which is below its average of 17x. Overall, I recommend a buy rating.

Results review

AWI reported $1.12 in EPS for 1Q23 and $96 million in EBITDA. Volume was the primary driver of 1Q23 results, which is a positive indicator of demand, even though AUV were flat due to a weak product mix. Mineral Fiber saw 12% growth in revenue, while the segment's adjusted EBITDA margin expanded by 31 basis points to 37%. Since gains in revenue were offset by increases in expenses, Architectural Specialties' EBITDA margin decreased by 208 basis points to 15% while revenues grew by 3%. Management remains concerned that a weak macro will have a negative impact on FY23. The previous F23 forecast of $1.26–$1.31 billion in revenue, $395–$420 million in EBITDA, $4.80–$5.05 in EPS, and $230–$250 million in FCF was reaffirmed.

Outlook for FY23

Investors, in my opinion, would look closely at pricing and product mix. Price increases for AUV were in the high single digits in 1Q23, albeit being dampened by a lackluster product mix as lower AUV regions performed better in the quarter. AWI had a tough 1Q22 comp, so I expect this to be an isolated incident; going forward into 2Q23 and beyond, AWI should no longer be affected by a weak product mix headwind. Instead, the impacts from new products and better geographic mix moving forward should begin to show in the near future. As such, this should bode well for pricing growth to flow through to AUV. In fact, management has stated that the February price hike has been well received, and it plans to implement the customary two price hikes in 2023. All of these factors point to AWI meeting or exceeding its target.

As was previously mentioned, management is anticipating a weak macro to have an effect on FY23 due to the current economic climate. I found it encouraging that 1Q23 saw a general uptick in bidding activity, led by bright spots in the transportation, education, and healthcare sectors. We can see that the "positive bidding environment" is supported by the number of products AWI has bid for over the past six months. Over the past six months, AWI has submitted bids on more than a hundred major transportation projects.

Profitability and cash flow

In addition, I appreciate hearing from management about how things are going with the productivity initiatives that are supposed to save $6 million this year. Reduced expenses in 1Q23 related to headcount and certain digital investments should put AWI in a better position to weather any potential volume declines in 2H23. Moreover, since energy accounts for only about 10% of Mineral Fiber's COGS, management has hedged around half of its 2023 natural gas exposure in the first quarter of that year, providing much more transparency. Capital allocation strategies such as share repurchases, dividend payments, and strategic M&As should remain stable if management's FY23 FCG guidance is any indication. The reaffirmation of FCF guidance is a signal to the market that, despite the uncertainty surrounding FY23, the company remains confident in its ability to generate cash. Cash flow investors (those looking for FCF yield) will likely remain shareholders as a result, which will help support valuation.

Valuation

I believe the stock is also somewhat protected by its current valuation. Today, AWI is trading at 13.6x forward earnings, which is about 22% lower than its average of 17.3x. In the previous decade, the lowest AWI ever traded was 12x in early 2016 and early 2020s. In both cases, valuation quickly returned to average. I expect no different this time, with the end of this weak macro acting as a catalyst for upside rerating. AWI is also a larger company with less net debt than in 2016 and 2020, so it should trade at a higher multiple.

Conclusion

AWI is a business that has demonstrated strong resilience and long-term growth potential despite the uncertain state of the commercial market. 1Q23 results were encouraging, driven by volume and supported by a robust institutional project pipeline in the transportation and healthcare sectors. Although management is anticipating a weak macro to impact FY23, productivity initiatives and hedging strategies, as well as the reaffirmation of FCF guidance, indicate confidence in its ability to generate cash. Moreover, the current valuation of AWI is not demanding, providing potential upside rerating. Overall, I recommend a buy rating for AWI based on its strong fundamentals and long-term growth prospects.

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