2023-08-31 13:58:58 ET
Summary
- Masonite International's stock has seen a good run-up since my previous article but faces near-term headwinds due to weakness in the repair, renovation, and remodel market.
- The company's revenue growth should be negatively impacted by lower demand in the residential market and ongoing macroeconomic uncertainty in Europe.
- The company's near-term margins are likely to be negatively impacted by volume deleveraging and high-cost inventory, but cost-cutting measures are expected to partially offset these factors.
Investment Thesis
Masonite International’s ( DOOR ) stock has seen a good run-up, gaining ~20% since my previous bullish rating in March. The company faces near-term headwinds due to the weakness in the repair, renovation, and remodel end market and ongoing macroeconomic uncertainty in Europe. The valuations aren't as cheap as at the time of my previous article. While improvement in the U.S. new residential construction, recovery in the Architectural segment, and benefits from the Endura acquisition should somewhat limit the revenue downside, I don't find the stock compelling enough. I would prefer to move to the sidelines till the repair, renovation, and remodel market bottoms or the valuation corrects. Hence, I am changing my rating to neutral.
Revenue Analysis and Outlook
Following the pandemic, Masonite experienced significant revenue growth driven by resilient demand in its North American Residential (NA Residential) segment, which outweighed the weaker market demand in the Europe segment and production challenges in the Architectural segment. However, a steep rise in interest rates triggered a slowdown in the NA Residential segment, which adversely impacted sales growth in recent quarters.
In the second quarter of 2023, sales growth continued to face headwinds from lower demand in the residential market, leading to volume declines. As a result, the NA residential segment experienced a 4% Y/Y decline in revenue to $585 million. The volume headwind was partially offset by a 5% Y/Y increase in the average unit price (AUP) and $59 million contribution from the Endura acquisition. The Europe segment continues to witness lower-end market demand due to ongoing macroeconomic uncertainty. The segment’s revenue decreased 11% Y/Y to $66 million, driven by lower base volumes and component sales as a result of overall market dynamics. Meanwhile, in the Architectural segment, the revenue growth rose 16% Y/Y to $88 million, driven by a 24% Y/Y increase in AUP, partially offset by lower component sales and volume. On a consolidated basis, the company’s revenue growth decreased ~3% Y/Y to $742 million, primarily due to continued softness in the end market demand in North American and U.K. residential markets partially offset by the strong pricing and benefits from the Endura acquisition.
Masonite’s Historical Revenue Growth (Company data, GS Analytics Research)
Looking forward, the company’s near-term revenue growth outlook looks concerning due to softening end market demand in residential repair, renovation, and remodeling ((RRR)) channels, which comprise ~54% of total revenue. The RRR channels weakened more than anticipated this year, and what worries me is that this channel has not yet seen inventory destocking or correction, unlike the new construction channel. On the recent earning's call , answering a question on channel inventory correction, the company’s President of Global Residential, Christopher Ball said,
On the RRR side, which is more of the retail side of the business, we haven't seen a correction. There has been, obviously, a weaker trend on RRR than what we had expected coming into the year.”
If declining customer confidence in this inflationary macro environment continues to impact demand, retailers might be forced to reduce their inventories and the company might see a much sharper RRR sales slowdown in the back half of this year. The European residential market also continues to experience a slowdown as a result of rising interest rates and a persistent inflationary environment. While the new construction business has started showing early signs of improvement (as is evident from the housing starts in July) and I like the company’s long-term story, I believe a sharp slowdown in the RRR segment in the back half of this year may overshadow the positives and would be an overhang on the stock.
Masonite’s sales by end market (Company data, GS Analytics Research)
Margin Analysis and Outlook
Last year, the company’s margin growth was negatively impacted by inflationary input costs and volume deleveraging in the architectural and Europe segments.
During Q2 FY23, the company’s adjusted EBITDA margin improved by ~50 bps Y/Y to 16% driven by the strong performance in the Architectural segment, effective price cost management, and savings from restructuring actions which more than offset the volume deleveraging. Segment wise , the NA Residential, and Europe segments saw 50 bps and 750 bps Y/Y decline in adjusted EBITDA margins, respectively due to volume deleveraging, particularly in the higher-margin exterior door business. On the other hand, the Architectural segment experienced an 820 bps Y/Y increase in margins, primarily driven by the carryover impact of price increases and a favorable mix of high AUP project work.
Masonite's historical adjusted EBITDA margin (Company data, GS Analytics Research)
Looking forward, easing material cost inflation is expected to support the company’s margin. However, it should take a couple of quarters for its benefits to flow through the company’s P&L as the company reduces its elevated level of high-cost inventory of raw materials. The company should also face headwinds from volume deleveraging over the next couple of quarters.
To offset these factors, the company is actively driving cost savings measures across its operations. The company implemented a restructuring initiative in December 2022 to improve the business mix through optimizing manufacturing capacity and fixed cost reductions, primarily in the NA Residential and Architectural segments. As a part of NA Residential restructuring, the company closed one of its older and less productive door facilities located in California in Q1 and another legacy plant in Q2. The company also reduced the SG&A headcount by approximately 10% in Q1 in NA Residential. Further, in Q1, the company started evaluating strategic alternatives for the Architectural segment, which include the divestiture of all or a portion of the business. These restructuring actions across the NA Residential segment, Architectural segment, and corporate functions are expected to deliver $15 million to $20 million of annualized cost savings in 2023.
So, volume deleveraging, high-cost raw materials, and work-in-progress inventory are expected to be headwinds for the company’s margins in the near term which should be partially offset by the company’s cost-cutting and productivity improvement initiatives. The margin outlook for FY24 is much better, as DOOR should start benefiting from lower raw material prices and productivity initiatives taking hold by then.
Valuation and Conclusion
Masonite is currently trading at 12.96x FY23 consensus EPS estimates of $7.91 which is at a slight discount versus the company's 5-year average forward P/E of 13.48x.
While I like the company's long-term story and there are some signs of recovery in the new residential construction end-market, the slowdown in the RRR market coupled with a potential for destocking in retail channels worries me. The margin is also likely to face some headwinds from volume deleveraging and high-cost inventory in the near term.
Further, the valuations are higher than they were at the time of my previous article and only slightly below their 5-year average. I don't find margin of safety big enough and believe it is prudent to move to the sidelines and wait for a couple of quarters for fundamentals to bottom before becoming more positive on the stock. Hence, I am moving to a neutral rating.
For further details see:
Masonite International: Moving To The Sidelines After The Recent Run-Up (Rating Downgrade)