2023-09-15 15:45:23 ET
Summary
- JELD-WEN Holding, Inc. has seen a significant correction in its stock price since its last quarterly earnings report due to management's cautious commentary about the second half.
- Despite concerns, company management has raised the lower end of its revenue guidance and is focused on cost reduction initiatives to improve margins.
- I believe the company can see good EPS growth in FY24 and beyond driven by management's structural cost reduction initiatives.
Investment Thesis
JELD-WEN Holding, Inc. ( JELD ) has seen significant correction since its last quarterly earnings report. While the results were good, the management commentary around the incrementally weaker second half of this year worried some investors about the company's execution.
I believe the second half commentary has more to do with difficult comparisons, the lag between housing starts improving and the company seeing its benefit in sales, and the conservatism on the part of management rather than any issue with the company's execution. The company's turnaround is going well and should result in meaningful improvement in profitability in the coming years. Further, we are likely near the cyclical bottom and the company should see good earnings growth in FY 24 and beyond. The company's low valuations make the risk-reward profile attractive and the stock is a good buy at current levels.
Revenue Analysis and Outlook
After seeing good growth over the last couple of years, the company's growth rate has been impacted by a tough macroeconomic environment of late. In the second quarter of 2023, the company's revenue declined 4.5% Y/Y to $1.1 billion due to a 4% decrease in core revenue and a 1% impact from negative FX translation. Core revenues decreased as a result of an 11% decline in volume/mix, which was somewhat offset by a 7% benefit from price realization. In the North America segment, the revenue decreased 2.6% Y/Y to $817.1 million, driven by an 8% decline in volume/mix as a result of lower market demand, partially offset by a 6% benefit from price realization. The Europe segment's revenue declined 9.2% Y/Y due to lower volume/mix of 17% which outweighed a 6% positive impact from pricing. The unfavorable volume/mix was due to market softness and persistent macroeconomic uncertainty across both North America as well as Europe.
JELD's Historical Revenue Growth (Company data, GS Analytics Research)
Looking forward, the company's near-term sales outlook is muted, and it is not surprising given where the interest rates are. However, one thing that did surprise many investors is that, on the company's last earnings call, management guided for an incremental weakness or another leg down in for the second half of this year in its North American business.
For North America, management had initially guided for 15% to 20% reduction in new home construction and high-single digit decline in repair and remodel markets resulting in a low double-digit reduction in volume for the full year. Despite seeing only mid-single digit decline in volume/mix in the first half (-3% in 1Q,-8% in 2Q), the company maintained its guidance implying mid to high teen decline in the second half.
This has baffled many investors. When we look at the new housing starts data in the U.S. as well as management commentary around channel inventory being low in the repair and remodel, it doesn't seem like the second half should see a significant leg down. Management's guidance has raised concerns among investors about whether the company is experiencing execution issues and this has led to a significant stock price correction after the earnings report.
However, I believe these fears are misplaced and rather than some execution issue there are three reasons behind the company maintaining its North American volume guidance - difficult volume/mix comps in 3Q, lag between new housing starts improving and the company seeing it in its orders, and conservatism on the part of management
If we look at the result of the company's North American segment in 3Q 2022, core revenues rose 23% Y/Y helped by a 17% Y/Y increase in pricing and 6% Y/Y increase in volume/mix. This 6% Y/Y increase in volume/mix was much higher than flat year-over-year volume/mix impact that the company witnessed in 2Q 2022.
So, as we move from 2Q 2023 to 3Q 2023 volume/mix comparisons are getting 6 percentage points tougher. Given volume/mix was down 8% Y/Y in Q2, based on difficult comps alone the company should see a 14% Y/Y decline in 3Q 2023 in its North American business.
Further, regarding improving housing starts, there are a few months of lag between a new home construction starting and the homebuilder ordering doors/windows for it. So, while JELD should see a benefit from a recovery in housing starts, it might take some time.
While this explains the mid-teen anticipated volume decline for 3Q 2023, it doesn't explain a similar level of decline for 4Q 2023 as comparisons are again getting easier in 4Q. I believe it is simply a bit of conservatism on management's side and given the uncertain macro environment they might have chosen not to model any improvement from 3Q 2023 to 4Q 2023.
For Europe, management has changed its guidance from high-single digit volume decline to a low double-digit decline which appears reasonable given the tough macroeconomic environment there.
However, the interesting thing to note is that despite not raising the North American volume guidance and reducing the Europe volume guidance, management actually raised the lower end of revenue guidance. The company's revenue guidance was previously $4 bn to $4.4 bn and management narrowed it to $4.2 bn to $4.4 bn. Even on the EBITDA side, they raised the lower end of their guidance and their current adjusted EBITDA guidance is between $350 mn to $370 mn versus $330 mn to $370 mn previously. So, I believe things aren't as bad, and some of the investor concerns that triggered a steep stock price decline following the company's last quarter earnings might be somewhat exaggerated.
I believe the company's North American business should bottom in the back half of this year with a potential for some recovery in FY24. This recovery is likely to gain significant momentum when the Federal Reserve begins to reverse rates, probably in FY25. On the European side, the recovery may take a bit longer, but I do not anticipate a significant worsening compared to the double-digit volume declines we observed in 2Q 2023.
So, I am expecting a down 2H 2023 with a potential for the company to post better than guided numbers in 4Q 2023 given conservative guidance. Then FY24 should be a year of flat to modestly up revenue and the growth should accelerate from FY25 onward as the interest rate cycle reverses.
Margin Analysis and Outlook
Despite revenue and volume headwinds, the company is doing a really good job in terms of taking out costs and improving its margins.
In Q2 2023, the company was able to effectively offset the unfavorable volume/mix in both segments through positive price/cost realization and improved productivity. As a result, the adjusted EBITDA margin (excluding the Australasia segment) improved 50 bps Y/Y to 9.7%. In the North America segment, the margin expanded by 220 bps Y/Y to 13.3% driven by favorable price/cost relationship, partially offset by unfavorable volume/mix. Europe's segment margin improved 180 bps Y/Y to 7.7% due to productivity gains and favorable price cost realization with the benefit of market and product-specific price increases coupled with lower material cost inflation.
JELD's Segment-Wise Adjusted EBITDA (Company data, GS Analytics Research)
Looking forward, I expect the company to continue benefiting from its cost reduction initiatives. Management has outlined a $100 mn run-rate cost saving target for FY23 and has already achieved $40mn in the cost reduction in the first half and is on its path to achieve the remaining $60 mn in savings in the back half. Management continues to evaluate actions like rightsizing workforce, optimizing footprint, addressing procurement opportunities, etc. to further reduce cost in both the North American and European businesses. Management recently conducted a feedback survey from 80% of its global associates to gain insights to improve organization efficiency and is currently doing bottom-up planning for further cost reduction which they intend to share with the investment community over the next couple of quarters. The company is still in the early phases of its cost reduction initiatives and I see good potential for continued cost reduction in the 2H 2023 and beyond which should help the company grow its margins despite macro headwinds.
Valuations and Conclusion
The company is currently trading at 9.97x FY23 consensus EPS estimates of $1.40. This is a discount versus the company's 5-year historical average P/E of 12.69.
The company's FY23 EPS is likely going to be the bottom-of-the-cycle EPS for the company as, even on flatish revenues, the company should be able to post a good EPS growth in FY24 thanks to its cost savings and margin improvement initiatives. According to the current consensus estimates, the company's EPS is expected to grow 19.61% in FY24.
The company has made good progress so far in its turnaround plans and has made the business simpler by divesting Australasia and using its sale proceeds to reduce its net leverage below 3x. The company continues to focus on cost saving and productivity improvement. I believe JELD is a turnaround candidate where the market is not pricing in turnaround prospects at all. So, there is good potential upside if the company is successful in its turnaround efforts and a limited downside even if it fails given the current low valuations. So, the risk-reward profile is favourable, and hence, I have buy rating on the stock.
For further details see:
JELD-WEN Holding: Recent Correction Is A Buying Opportunity