Summary
- In the near term, Masonite faces headwinds from the housing slowdown and a negative price-cost mix.
- In the long term, the company should continue to benefit from product innovation as well as expansion into other areas of the door system value chain.
- Valuation is cheap.
Investment Thesis
Masonite International Corporation ( DOOR ) faces near-term headwinds from the slowdown in the housing market and macroeconomic weakening. However, with the stock trading at 9.6x FY23 consensus EPS estimate, which is significantly lower than its 5-year average of 14.06x, it seems like these headwinds are already getting priced in at these levels. Moreover, the company’s strategy of increasing average unit price through product innovation as well as expanding into other areas of the door system value chain should drive good growth in the medium to long term. I believe long-term investors can consider buying the stock at the current valuation.
DOOR Revenue Analysis and Outlook
Masonite has delivered good growth post-pandemic due to strong demand in the North American Residential (NA Residential) segment. The robust performance of the segment was primarily driven by a strong new residential market and increased product pricing. Meanwhile, the relatively smaller Europe and Architectural segments didn’t perform as well with the Europe segment witnessing a significant decline due to the stringent lockdown and the architectural segment performing poorly due to late recovery from the pandemic and subsequent supply chain issues.
After two years of strong new residential demand, the NA Residential market has started slowing down due to a steep rise in interest rates. The weak demand in the residential end market resulted in destocking from the wholesale business of the NA Residential segment which also added an additional headwind. In Q3 2022, the company was able to more than offset these headwinds thanks to the strong order backlog. Meanwhile, the Europe segment continued to see deterioration due to ongoing geopolitical tension and severe macroeconomic headwinds. The Architectural segment is doing much better though and has started seeing some recovery of late due to the improving availability of the critically short-supplied Crossband material. In Q3 2022, the segment witnessed positive year-over-year revenue growth for the first time since Q2 2020.
Masonite’s Quarterly Revenue data (Company data, GS Analytics Research, *Q4 2022 and FY2022 numbers are as per management guidance)
Looking forward, I expect the revenue growth trend in the NA Residential segment to get worse. So far, the existing backlog at homebuilders has helped the company despite a rapid slowdown in the new residential starts. However, this cannot continue forever and after the existing high backlog at homebuilders gets converted into revenues, the growth rate in this segment should reflect the current macroeconomic reality.
One comforting factor in these challenging times is that the company derives ~54% of its revenues from the Repair and Remodel (R&R) market which is much more resilient compared to the new housing construction market. Therefore, the volatility in the company’s revenues should be less than that of the new housing starts.
In addition to the weak growth in NA Residential segment, the persistently challenging macro environment in Europe should also be a headwind for the company. On the other hand, the Architectural segment should witness continued growth due to the improving availability of crossband material. However, the architectural segment is a relatively small portion of the business and is unlikely to offset the slowdown in N.A. Residential and European business. So, the near-term revenue outlook for the company remains challenging.
In the long run, the company’s revenue growth should be driven by a mix shift to higher-value products. The company is launching new higher-value products with better functionalities. A good example of this is the company’s M-Pwr smart door . M-pwr smart door is the first-ever integrated smart door with Ring’s video doorbell and Yale’s smart lock integrated with the door. The company had priced this product at a 4-5x price premium over the average exterior door. These types of new high-value product offerings should help the company to constantly provide customers with greater value and increase AUP for the company.
Additionally, the company is expanding its presence to other adjacencies in the door system value chain. Historically the company has been present in door slab manufacturing which is a $5 billion industry. Now the company is expanding its addressable market to other areas of the door system like fabrication, milling, glass addition, framing, and finishing. According to management, the expansion to the other adjacencies should expand the company’s Total Addressable Market to $20 billion. The recent acquisition of Endura Products is one such step that will add the company’s capabilities in the door frames and door system components market.
To sum up, while the company faces near-term headwinds which should slow its growth in FY23, the long-term outlook is encouraging and the company should benefit from higher AUP and increasing TAM. In addition to this, the housing shortage (explained in my earlier article ) should also act as a long-term tailwind for the company once the interest rate cycle turns.
Margin outlook
During the last couple of years, Masonite’s margins have been impacted by inflationary pressures and the company’s efforts to increase Average Unit Price to offset them. In the third quarter of 2022, the company reported a 20% increase in AUP which was more than offset by higher input cost inflation, and, as a result, the company reported a 68 bps Y/Y contraction in the adjusted operating margin.
Looking forward, while the cost inflation is easing, it should take a couple of quarters for its benefit to flow through the company’s P&L given the elevated level of the higher-cost inventory that the company has. Meanwhile, the company should start seeing pushback from homebuilders and big-box retailers like Home Depot ( HD ) and Lowe's ( LOW ) on the pricing front given the slowdown in the housing market.
The headwind on the price front and delayed tailwind on easing inflation should result in a temporary negative price/cost equation for the next couple of quarters. Further, the headwind from volume deleverage due to slowing end markets should also have a negative impact on the margins in the near term. So, I am not optimistic about the margins in the near term.
The medium to long-term prospects are good though with improving product mix, rising AUP, and the eventual benefit from easing raw material cost pressure.
Valuation and Conclusion
Investors are currently viewing DOOR as a cyclical company and, as a result, it is trading at a low P/E multiple due to the typical low valuation for cyclical companies at their peak earnings. This trend is also seen in many other building product companies.
However, DOOR also has a secular growth aspect. The company is shifting its product mix to higher-value offerings and expanding its market from $5 billion to $20 billion by entering new markets such as fabrication, milling, glass addition, framing, and finishing. This could result in outperformance compared to the broader housing market over the cycle. For instance, compared to a peer door manufacturing company, JELD-WEN Holding ( JELD ), DOOR's EPS is expected to decline by 7.79% in FY2023 according to consensus estimates, while JELD-WEN's EPS is expected to decline by ~ 30% . Similarly, DOOR's decline in EPS for FY2023 (7.79%) is lower than other building product peers like UFP Industries ( UFPI ) (25.93%), Owens Corning ( OC ) (18.63%), and American Woodmark ( AMWD ) (18.66%. Note that I have used FY24 consensus estimates of AMWD as its year ends in April). Thus, DOOR should be considered a higher-quality company that deserves a higher P/E multiple.
Additionally, DOOR is currently trading at 10.23x FY23 consensus EPS estimates of $9.11, which is much lower than its five-year average forward P/E of 14.04x. This steep discount indicates that investors are pricing in a significant decline in the company's EPS from the current FY22 peak. However, this should not be the case, and DOOR's EPS should decline less than some of its more cyclical building product peers due to its secular growth initiatives. Furthermore, by expanding into new markets and having a presence across the door systems value chain, DOOR will have a stronger competitive advantage, which could result in a P/E re-rating in the long term.
While there are near-term risks from the housing cycle, DOOR is expected to emerge stronger on the other side of the current slowdown. With its current low valuation multiple, these near-term risks seem to be priced in, making it a potential buying opportunity for long-term investors.
For further details see:
Masonite International: Low Valuation And Good Long-Term Growth Prospects Make It A Buy