BC - Brunswick: Buy Rated As I Believe FY27 Is Achievable

2023-09-25 02:53:45 ET

Summary

• I recommend a buy due to Brunswick's potential to achieve its ambitious FY27 targets.
• The Propulsion segment is expected to see robust growth, driven by BC's preference for Mercury and expanding market share in high-horsepower outboard engines.
• Inventory normalization and growth potential in the Engine Parts & Accessories segment, including the Navico Group, present opportunities for recovery.

Overview

My recommendation for Brunswick ( BC ) is a buy rating, as I expect BC to achieve its FY27 targets given its product leadership in the Propulsion segment, benefit from the inventory normalization dynamic in the Engine Parts & Accessories segment, and also see growth accelerate from the electrification trend.

Business

BC is a leading player in the field of crafting recreational marine products that redefine the world of leisure on the water. Its extensive offerings encompass outboard, sterndrive, and inboard engines, along with a comprehensive range of controls, rigging solutions, and precision-engineered propellers. We also provide a wide array of engine parts and consumables, electrical components, and essential boat parts and systems.

BC revenue streams are structured into three distinct categories:

1. Propulsion: This segment serves as the bedrock of BC business, accounting for a significant share of EBIT. In FY22, Propulsion generated an impressive $522 million in EBIT, constituting 49% of total EBIT.
2. Engine Parts & Accessories: This category is pivotal to enhancing the performance and longevity of marine engines. In FY22, it delivered a substantial $336 million in EBIT, representing 32% of total EBIT.
3. Boat: In FY22, it generated $212 million in EBIT, comprising approximately 20% of total EBIT.

Over the past two years, Brunswick Corporation has experienced a remarkable surge in growth. Total revenue for FY22 reached a staggering $6.8 billion, reflecting a substantial increase from the $4.3 billion recorded previously.

Recent results & updates

Revenue fell by 7.3% year over year for BC in 2Q23, and the company reported an adjusted EBIT margin of 14.4% and adjusted EPS of $2.35 as a result. When broken down further, the Boat subsegment saw a decline of -1.3%. While the Propulsion division did see a decline of -4%, it could have been even better if not for production stoppages and the deliberate decrease in sales and production of lower horsepower outboard and sterndrive engines. Last but not least, revenue in the Engine Parts & Accessories division fell by 13%, with the IT security incident accounting for $20-25 million of the shortfall.

Management provided an updated 4-year outlook for the company at the investor day . Specifically, they set a revenue target of $8.7 billion and an EPS target of $15 for FY27. Translating this into a CAGR perspective, the new outlook calls for a revenue CAGR of 6-7%, an EBIT CAGR of 9%, and an EPS CAGR of 12%. When compared to the historical performance (pre-covid, from FY15 to FY20), where revenue saw a CAGR of 1%, an EBIT of 6%, and a net income of 8%, the new outlook is a positive step up. After reviewing the most recent investor day, I am confident that BC can achieve these goals.

First, I'd like to discuss Propulsion. If BC's continued preference for Mercury continues, I anticipate this segment to continue growing at a healthy pace. BC's unmatched lineup of outboard engines ranging in power from 175 to 600 horsepower gives it a competitive advantage in the market and should allow it to command higher prices. At the investor day, BC's management expressed optimism about the company's prospects for expanding its market share of high-horsepower outboard engines. I anticipate that this expansion will come from the international market, where there is a strong demand from European boat builders and consumers.

Our leadership position is most notable in the high-horsepower outboard category, where we integrate our superior prop-to-helm solutions to really lead in that category and we're the undisputed front runner. From: 2Q2023 earnings call

As inventory levels normalize, production capacity rises, and robust demand for high horsepower outboard engines boosts parts sales, BC is in a strong position to reclaim market share lost in the Engine Parts & Accessories segment (due to inventory issues at the retailer and consumer level). It's also worth noting that within this segment, BC operates the Navico Group, which achieved approximately $1 billion in revenue and approximately $500 million in the first half of 2023. When retail inventory levels are stable, I believe this business will thrive as well. Additionally, as marine OEMs reduce production, I believe BC is in a good position to take market share as management plans to increase the frequency with which new products are introduced.

I did want to take a bit more time to talk about our Engine P&A business and our Navico Group because they are a core part of our resiliency strategy. And they have been, to be honest, subject to pretty unusual market dynamics over the past year. Particularly the stocking correction, if you like, or de-stocking that is occurring in our retail channel. Essentially the retail channel built a lot of inventory during the supply chain crisis and now is de-stocking, which means that even though retail orders are fairly solid, we get fewer wholesale orders, although that is abating.

As we get towards the end of Q3, we are still seeing pretty solid boat retail in the U.S., but we are also seeing that our customer OEMs, customers to Mercury and customers to Navico Group are being very cautious about their production planning and their inventory levels. From: 2Q2023 earnings call

Furthermore, I believe there is a significant growth catalyst on the horizon that will fuel both an acceleration in growth and an extension of the potential growth trajectory. During the recent investor day, the management team articulated a strategy to attain $600 million in revenue from electrification by 2027, drawing attention to a substantial $2 billion total addressable market [TAM] for electrification within the marine propulsion sector. It's important to note that this opportunity exists alongside the potential for electrification in the auxiliary power segment, with a $100 million TAM spanning energy and vessel integration in various boat applications, as well as a substantial $5 billion TAM in the recreational vehicle market.

Additionally, management has set a target of achieving $400 million in shared access revenue by 2027, composed of $200 million from Freedom Boat Club and over $200 million from ecosystem revenue and synergies created by enhancing customer lifetime value through a comprehensive suite of BC products and services. Collectively, these initiatives present an immediate addressable revenue opportunity of $1.2 billion, constituting approximately 18% of FY22 revenue.

Valuation and risk

According to my model, BC is valued at $135 in FY27. This target price is based on my belief that BC will be able to achieve its FY27 target of $15 EPS. I believe this target is achievable given the product leadership of BC, the inventory normalization dynamic, and the growth catalyst from electrification across various parts of the value chain that BC is present in. BC is now trading at 8x forward earnings. If BC were to meet its FY27 targets, I believe multiples should re-rate upwards from here, re-rating back to their historical average over the next few years as the market gains confidence that BC is on track to meet its FY27 targets.

The downside risk here is that the vast majority of BC business is cyclical. With the economic picture uncertain in 2024, if the economic picture is worse than expected it definitely impact upcoming sales in the near-term. Also, while inventory normalization is positive for BC, the timeline required might be longer than I expected, which means near-term growth could be weaker than I expected. Since the core part of my thesis is that BC will hit its FY27 target, the longer it takes for management to show results, the longer it would take for the stock to re-rate upwards.

Summary

My recommendation for BC is a buy rating, primarily driven by the potential achievement of its ambitious FY27 targets. While BC faced a 7.3% revenue decline in 2Q23, recent developments and management's outlook are promising. The Propulsion segment's future appears robust due to BC's preference for Mercury and an expanding market share in high-horsepower outboard engines, especially in international markets. Inventory normalization and growth potential in the Engine Parts & Accessories segment, including the Navico Group, signal opportunities for recovery. Furthermore, BC's electrification strategy, targeting a $600 million revenue milestone by 2027, adds to the growth narrative, along with shared access revenue goals.

For further details see: