OC - Masonite International Is A Good Buy At The Current Levels

2023-03-16 18:11:21 ET

Summary

• Masonite’s medium to long-term revenue growth and margin expansion prospects look good.
• Near-term concerns should also ease if the Federal Reserve becomes less hawkish post recent developments in the banking sector.
• Valuation is lower compared to the historical average.

Investment thesis

While there are some near-term concerns for Masonite International Corporation ( DOOR ) due to weakness in the residential end market, I see the light at the end of the tunnel as the Federal Reserve is likely to become less hawkish post-Silicon Valley Bank ( SIVB ) fiasco. The company's medium to long-term prospects are promising as it expands into adjacent markets and increases its addressable market. Additionally, factors such as a housing supply deficit, aging housing stock, and elevated home equity levels are likely to support the end-market's rebound in 2024.

The medium to long-term prospects for margins also appears positive with an improving product mix, rising average unit price, and the benefit of easing material cost inflation. The stock is currently trading at a lower than the historical average, and, given its good medium to long-term prospects, I recommend a buy rating on the stock.

Revenue Analysis & Outlook

Post-pandemic, Masonite experienced robust revenue growth thanks to the strong demand in its North American Residential (NA Residential) segment. Nevertheless, weak performance in Europe and the Architecture segment put pressure on revenue.

In my last article , I talked about a potential slowdown in the NA Residential segment, recovery in the Architectural segment, and continued challenges in the European business. The company has reported its 4Q22 earnings since then and directionally things have gone as expected. The NA Residential revenue slowed down from 18.61% Y/Y growth in 3Q22 to 6.75% Y/Y growth in 4Q22. The Architectural segment’s revenue growth accelerated from 3.43% Y/Y growth in 3Q22 to 30.44% Y/Y growth in 4Q22. While in the Europe segment revenue declined -17.73% Y/Y in 4Q22 vs a -22.13% decline in 3Q22. Overall, the total company sales growth slowed from 11.56% Y/Y in 3Q22 to 6.3% Y/Y in 4Q22. The good news is this revenue growth was much better than the midpoint of management’s guidance and sell-side consensus of low single digit Y/Y growth as the NA Residential segment growth slowed less than feared while Architectural growth accelerated more than expected.

Looking ahead, while there are some challenges in the near term with a weak residential end-market, there is light at the end of the tunnel as the Federal Reserve is likely to become less hawkish post-SIVB fiasco, which should pave the way for recovery in the residential end market. While the steep rise in rates has made home loan EMIs dearer and has impacted affordability, once the interest rate cycle turn, I am expecting a swift recovery given the housing supply deficit, the higher median age of housing stock, and elevated home equity levels. The company also derives ~54% of revenue from repair and remodel which is relatively less cyclical. Further price increases, recovery in the Architectural segment, and revenue contribution from recently acquired Endura Products are expected to limit the revenue downside. The current sell-side estimates are expecting a low single-digit revenue decline for FY23, which is much better than many of its building product peers like JELD-WEN ( JELD ), Owens Corning ( OC ), UFP Industries ( UFPI ) and American Woodmark ( AMWD ).

The company’s longer-term growth story is also more attractive compared to many of its peers. The company is expanding its presence in other adjacencies of the door system value chain, increasing the TAM from $5 billion to $20 billion. Additionally, the company's strategy to increase the average unit price by a mix shift to higher-value products should also support its revenue growth. So, once the end-markets bottom, the company’s revenue growth should quickly accelerate to high single digits with secular growth prospects from increasing TAM and average unit prices adding to the cyclical growth from growing end markets.

Margin Analysis & Outlook

During 4Q22, the company experienced a 150 bps YoY decline in EBITDA margins, which was mainly driven by significant material cost inflation, volume deleverage, and higher SG&A expenses. On a segmental basis, the NA Residential and Europe segments saw a 10 bps and 700 bps YoY decline in adjusted EBITDA margins, respectively due to material cost inflation and volume deleverage. In contrast, the Architectural segment witnessed a 900 bps YoY expansion in margins, mainly due to easy comparisons with the previous year and strong revenue growth.

Looking forward, easing material cost inflation is expected to help the company’s margins. However, there should be a couple of quarters lag before this benefit starts showing in the company’s P&L as the company runs down its high-cost inventory. The company's margins should also benefit from cost savings from restructuring efforts and synergies from Endura Products' acquisition. The restructuring plan announced in December is expected to yield an annualized saving of ~$15-20 million starting in 2023. Moreover, the management expects to realize ~$8 million of cost synergies from the recent acquisition of Endura Products.

Further, improving product mix and rising average unit price should also help margins. I am optimistic about the company’s medium to long-term margin expansion prospects.

Valuation and Conclusion

DOOR is trading at 10.75x FY23 consensus EPS estimate of $7.87 and 9.17x FY24 consensus EPS estimate of $9.23. This is a discount compared to its five-year average forward P/E of 13.91x. While there are some near-term headwinds from the weak housing market, a potential for a less hawkish stance by the Federal Reserve indicates that the bottom is near. The company has several long-term drivers like expanding TAM, increasing average unit price, low supply in new residential end markets, and high homeowner equity, which should drive longer-term upside. Hence, I have a buy rating on the stock.

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