2023-12-14 10:00:00 ET
Summary
- Carlisle Companies has generated strong returns for investors, but the recent Vision 2030 Investor Day presentation has left me confused.
- The company's targets for 2030 include adjusted EPS of $40+, ROIC of 25%+, and organic revenue growth of 5%+ annually.
- I believe that Carlisle may be sandbagging investors with its presentation and have concerns about the achievability of the targets and management's credibility.
- I downgrade Carlisle to a hold and continue to hold my shares.
Carlisle Companies (CSL) has been an excellent success for my portfolio, generating total returns of 46% since I bought and initiated coverage in April . In this article I showed my rational for investing in Carlisle, due to its leading position in the building products market, culture of continuous improvement (Carlisle Operating System), resilient margins and attractive valuation.
On the 8th of December, Carlisle released its Vision 2030 , its version of an Investor Day. The event updated Investors on the new long-term vision of the company and what to expect. After reviewing the event, I have to say I am less excited than my valued colleague Leo Nelissen , who wrote a more optimistic piece on this investor day . It is always important to get multiple opinions, so I'd encourage you to give both of us feedback on how you see the event. Without further ado, let's review the event.
Carlisle Companies at a glance
In my previous article, I went into more detail, but Carlisle is a pure play in the building products industry, focused on roofing and related niches. The company has managed to pivot from an industrial conglomerate to a focused company and has realized margin expansion (adjusted EBITDA/AEBITDA from 15% in 2010 to 27% in 2023) and increased ROIC (from teens to 25%).
Carlisle at a glance (Carlisle Vision 2030 presentation)
Vision 2030
Carlisle presented its Vision 2030 to investors. The targets left me puzzled because many of them represent the status quo of the current company, while the overall EPS target is very ambitious and would require operating leverage. Let's dive into the individual targets.
Carlisle has mentioned the following 2030 Targets:
- Adjusted EPS of $40+
- ROIC of 25%+
- Organic Revenue Growth of 5%+ annually
- AEBITDA margin of 25%+
- FCF margin of 15%+
Vision 2030 Key Financial Targets (Carlisle Vision 2030 presentation)
Return On Invested Capital
ROIC is a great way to judge how efficiently a company can reinvest and generate cash flows from its invested capital. The higher the ratio, the better. Generally, we want ROIC to exceed the cost of capital ( for CSL, it is around 7% ) by a meaningful amount. Through its transformation from a conglomerate to a pure play focused on its best segments, Carlisle improved ROIC from 12% to over 20%. After the sale of the CIT segment closed, the company had already exceeded 25%. This is a structural change and is unlikely to revert. Weak businesses have been divested and now only the strong businesses remain. The Construction Materials business already generates 30% ROIC.
Vision 2030 targets ROIC of 25%+; while this is an excellent return on invested capital that few companies can generate, it is the status quo and not an incremental improvement.
Carlisle ROIC transformation (Carlisle Vision 2030 presentation)
Organic Revenue Growth
Carlisle benefits from several secular tailwinds like an increasing average age of roofs prompting more frequent repair jobs, a drive for energy-efficient solutions, a lack of craftsmen producing the need for labor-saving solutions and the shift to integrated building envelopes.
The company sees an immense opportunity in the Green commercial buildings market, which is expected to grow by low to mid double digits through 2030 and currently only accounts for 10% of building starts in the US. 65% of Carlisle's products are qualified for these projects. This is significantly faster than the overall construction materials market , which is expected to grow just slightly above inflation. Furthermore, Carlisle aims to significantly expand R&D investments from under 1% of sales to 3% of sales to boost revenue from new products from 15% to 25%.
Carlisle has had 6% organic revenue growth of 6% since it started its previous Vision 2025, so aiming for 5%+ organic revenue growth again looks conservative to me, especially with the mentioned developments in green commercial buildings and quadrupling the R&D expenses.
Green commercial buildings industry expectations (Carlisle Vision 2030 presentation)
Market share gains should help accelerate growth, due to Carlisle's close relationship to its customers and being a reliable partner. While price is an important factor, service is a vital differentiator for contractors looking for long-term business partners and discourages them from searching for cheaper suppliers.
Margin profile
Carlisle has seen continuous improvement in its AEBITDA margin over time. Vision 2030 aims for 25%+ AEBITDA and 15%+ FCF margin. Currently, AEBITDA is at 27% and FCF at 18% margin. Through Vision 2025, the Carlisle Operating System ((COS)), its continuous improvement/Kaizen framework, has yielded 2% of cost savings, benefits and cost avoidance annually. In the future, Carlisle expects another 1-2% of sales annually to be benefited by COS. Once again, we are targeting below the current margin and expecting improvements.
Continuous margin improvements (Carlisle Vision 2030 presentation)
Adjusted EPS
While I usually prefer to use Free Cash Flow per share instead of EPS, the two metrics are good proxies for each other. Carlisle aims to reach $40 Adjust EPS (AEPS), more than double its current $15 AEPS. This represents a projected mid-teens AEPS CAGR. Going from 5% organic revenue growth to mid-teens in AEPS growth is a significant divergence. There are three leverages besides organic revenue growth Carlisle can pull:
- Margins are already at a high level and the target. We won't see as much operating leverage as in the past.
- Acquisitions are expected to happen and expand the business into new geographic and adjacent product niches. CSL has a current TAM of $30 billion and $40 billion in adjacent opportunities. This seems an essential part of the $40 AEPS target, yet it is not discussed in much detail.
- Share repurchases have been an effective tool over the last five years, reducing shares by 20%, but once again are not discussed in detail.
Carlisle seems to be leaving investors in the dark regarding the importance of these levers, which, in my opinion, are much more significant than margins in the future. It is odd to see low expectations everywhere besides AEPS; after all, AEPS is the result of the other targets.
Cash Deployment (Carlisle Vision 2030 presentation)
Management compensation
Management compensation is currently linked to Vision 2025 targets:
- Sales (25%)
- Operating Income Margins (20%)
- Average Working Capital /Sales (15%)
- GAAP Net Income (40%)
Vision 2030 will again be the underlying for management compensation. Carlisle has a management with lots of experience in the industry and long tenures within Carlisle. Low expectations would make hitting compensation targets easier; that's the only explanation that makes sense to me. This Investor Day did not inspire me because it raised questions about the AEPS targets' achievability and management's credibility. Don't get me wrong, I prefer conservative management teams that set expectations low, but in this context, it should be an ambitious goal to set and achieve. A vision shouldn't be as close by as this one looks like. It lays out the status quo in most aspects besides AEPS and does not explain how the company expects to hit its goals.
Carlisle management tenure (Carlisle Vision 2030 presentation)
Carlisle is fairly priced
To value Carlisle, I use an inverse DCF model. I use a 12% discount rate to account for the cyclical risks of its industry. I use $25 million as growth capex, a small amount to be conservative. Using the model, we get to a required growth rate of 13% for the next five years, followed by five years of 9% growth. While a mid-teens AEPS growth would far exceed this target, I do not understand how management aims to achieve its target and prefer not to use assumptions that are too aggressive in my model. I am confused about how management set up the targets for Vision 2030 and will downgrade Carlisle to hold while I observe how the story continues. I plan to keep all my shares and hope for the $40 AEPS to materialize.
Carlisle Inverse DCF Model (Authors Model)
For further details see:
Carlisle's New Vision 2030 Guidance Leaves Me Puzzled