PII - Fox Factory Q3 Earnings: Where Is The Absorption?

2023-11-03 15:45:49 ET

Summary

• Fox Factory Holding Corp. announces bombshell Q3 earnings report, with revenues falling 19% and adjusted earnings down 30 cents per share.
• The company cuts full-year sales guidance and announces a $572 million acquisition of Marucci Sports.
• Despite the poor earnings and acquisition, now is the time to be optimistic about Fox Factory's future.

In February, I believed that Fox Factory Holding Corp. ( FOXF ) was seeing bouncy trading action. The long-term growth play in suspension and related products has benefited greatly from post-pandemic trends and has quickly built up a solid M&A track record.

Liking the long-term potential of the business, I was awaiting a better entry point with shares trading just above the $100 mark in February. After stagnant revenues in the first half of the year, the company has now announced a bombshell third quarter earnings report on the back of UAW strikes and general uncertainty, so now investors furthermore have to digest a mega deal as well.

Some Perspective

Fox Factory designs and produces high performance suspension products which are used in mountain bikes, snowmobiles, off-road vehicles, and related equipment. The company supplies these products to specialized names like Polaris Industries ( PII ) as well as generic (automotive) OEMs like Ford ( F ) , among others, branching out to trucks and SUVs, among other things.

The company tripled sales between 2013 and 2019 , having grown sales from a quarter of a billion dollars to three quarters of a billion, on which it posted operating margins in the mid double-digits in 2019. A $70 stock pre-pandemic was awarded a premium multiple at around 30 times earnings.

After an initial knee-jerk reaction lower amidst the outbreak of the pandemic, FOXF shares quickly recovered as the company acquired SCA in a $328 million deal in 2020. This deal and organic revenue growth made that revenues rose from $890 million in 2020 to $1.30 billion in 2021, on which operating profits of $197 million were reported. On these operating profits, the company posted GAAP earnings of $164 million, close to $4 per share.

The company guided for 2022 revenue to rise by some 10% to $1.45 billion, with earnings seen close to $5 per share. With shares trading at highs around $180s late in 2021, it was clear that valuations were quite demanding.

Forwarding to 2023, the company posted 2022 sales to levels as high as $1.60 billion, on which net earnings of $205 million, equal to $4.84 per share, were reported. Adjusted earnings came in at $5.49 per share, as net debt was very modest at just $55 million, all while EBITDA surpassed the $300 million mark.

The guidance for 2023 was less impressive with sales seen up modestly to $1.67-$1.70 billion, although that adjusted earnings were expected to come down a bit to $5.30 per share.

2023 - Tough So Far

Trading at $112 per share in February, the company traded at 20-21 times adjusted earnings, as the 2023 guidance was not convincing. In fact, earnings were seen down a bit, even as a smaller $131 million deal for Custom Wheel House could not alter the investment thesis.

Concluding that I might see appeal at levels below the $100 mark, I lost coverage on Fox during the year, as shares have largely traded around the $100 mark, or even a bit above that so far this year. Shares fell to the $80 mark in October, before selling off to just $52 per share at the moment of writing, with shares cut in half over the past month.

In May, Fox Factory posted a near 6% increase in sales to $400 million. That was about the good news as margins took a small beating, with adjusted earnings down twelve cents to $1.20 per share.

In August, Fox Factory posted a more than 1% fall in sales to $401 million, with adjusted earnings down seventeen cents to $1.21 per share. For the year, the company maintained the full-year sales guidance, but saw earnings come in towards the lower end of a $5.00-$5.30 adjusted earnings per share guidance. Net debt ticked up to $220 million following the deal with Customer Wheel House as well as poor cash flow conversion.

The bombshell report arrived early in November, as Fox Factory announced very soft third quarter results. Revenues fell some 19% to $331 million and, given the pressure on the top line, a thirty cents decline in adjusted earnings to $1.05 per share looks relatively modest. Moreover, solid cash flow conversion meant that net debt came down to $100 million.

The soft third quarter is attributed by UAW strikes and slower bicycle channel inventory de-stocking effects, as execution in terms of margins and cash flow conversion looks solid given the tough circumstances. Following the soft quarter, the company cut the full year sales guidance to a midpoint of $1.45 billion, with adjusted earnings per share seen at a lower end of a $4.20-$4.45 per share earnings guidance. The reduction in the full year sales guidance implies that fourth quarter sales are seen at a midpoint of $318 million, suggesting some further declines.

The 42 million shares now trade at $52 per share, granting equity of the company a mere $2.2 billion equity valuation here, all while net debt is relatively limited at $100 million. The $2.3 billion equity valuation is equivalent to about 1.5 times sales and 12-13 times earnings.

A $31 move lower in the share price (to $52 per share) in reaction to the results cut the valuation by a $1.3 billion, which feels a bit of an overreaction as the UAW issues create a one-time headache to the firm. I believe that part of the reaction lies with the fact that Fox Factory announced a big acquisition as well.

A Big Deal

Alongside the third quarter earnings report, Fox Factory announced the $572 million cash acquisition of Marucci Sports from Compass Diversified ( CODI ) . Marucci is a designer, manufacturer and marketer of highly engineered premium wood, aluminum and composite baseball bats.

Compass acquired the business in a $200 million deal in 2020, while having made another $75 million in further acquisitions, creating a nice round-trip for Compass. This makes that Compass more than doubled its purchase price here in a time window of less than three years.

Marucci posted sales of $165 million in 2022, on which it posted EBITDA of $37 million. For the first three quarters of the year, sales are up 18%, creating a run rate of $195 million in sales, as EBITDA might top $50 million.

With the own business on track to post about $280 million in EBITDA, while Marucci will add about $50 million in EBITDA, the $330 million pro forma EBITDA performance should be seen in relation to a roughly $670 million net debt load, for a leverage ratio around 2 times. While this is worrying given the shortfall in the business, it is manageable. This observation relies on other capital allocation decisions as well, as management announced a huge $300 million buyback program alongside the earnings release as well.

A Final Word

The truth is that now is the time to get upbeat on Fox Factory Holding Corp. While the near-term shortfall in the business is painful, earnings are quite well maintained. With much of the softness isolated to the UAW, although perhaps not all, the price reaction is a bit of an overreaction to the poor earnings and sales news.

That said, the decline in the share price most definitely relates to the Marucci deal as well, and while it is more expensive, it still feels as if the selloff is an overreaction to both the events. This includes the soft guidance and expensive and somewhat unrelated deal. Perhaps investors are worried about too much leverage incurred, certainly if buybacks are executed upon, but overall, now seems to be the time to get upbeat about Fox Factory Holding Corp. shares.

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