Summary
- MBC is an established and high-quality company in the residential cabinet business. It has the biggest market share and a leading brand portfolio.
- The Cabinet industry has consolidated and is set to offer stable long-term growth.
- MBC has borrowed long-term debt to give Fortune brand the cash payments for the spinoff. Earnings are also compromised.
- The stock is somewhat undervalued but not by a wide margin.
MasterBrand, Inc ( MBC ) is a recently created stock that was spun off from Fortune Brands ( FBIN ). With a history of almost 70 years, MBC is North America's foremost manufacturer of residential cabinets and has a strong brand portfolio. Given the low recognition of the stock, I would share of some of my thoughts and discuss why this could be a high-quality business.
Business Overview
With over 4000 dealers nationwide and strong, longstanding relationships, MBC possesses a vast national network. Its manufacturing scale, global supply chain, and operational agility make it a major player in the cabinet industry, poised for sustainable growth.
The MBC has acquired a broad product portfolio throughout its 70 year history. Its product lines typically consist of three categories: stock, semi-custom, and premium. The stock line is characterized by its cost-effective value proposition, limited design options, standardized components, and quicker production time. In contrast, semi-custom products offer a balance of features and styles at a lower cost than the premium line. The premium category, on the other hand, encompasses highly personalized products tailored to meet the exact requirements of the customer.
Growth perspective and competitive advantage
The cabinet industry is closely tied to the US housing market, particularly renovation and remodeling sales. From 2018 to 2021, the average age of US housing stock was around 40 years, leading to a need for remodeling work. Kitchens have also become increasingly important to households, with an estimated addressable market of 18.4 billion. As a result, the company expects a growth rate of 9% for the cabinet industry.
Over the past decade, domestic players in the market have faced challenges from inexpensive imported goods. To stay competitive, MBC is investing in low-cost manufacturing and sourcing practices in cost-effective countries. Due to the cost-conscious nature of cabinet consumers, the industry has a low threshold for entry, making it imperative for MBC to streamline its production methods. This includes standardizing processes and maximizing utilization to create a leaner production line.
Recently, the cabinet market has experienced a great deal of consolidation. Three big players , MBC, American Woodmark, and Masco, now dominate the industry. MBC is likely to maintain its strong market position due to its ability to utilize global supply chains to reduce costs and optimize procurement and manufacturing processes. MBC's large volume and diverse brand portfolio not only give it cost and efficiency benefits but also provide valuable insight into fashion and consumer preferences. The company's operating margins have significantly improved from around 3% in 2013 to the 11% in 2018.
The sales of MBC saw growth from $2.4 billion in 2019 to $2.5 billion in 2020 and further increased to $2.9 billion in 2021, registering a CAGR of around 9% from 2019 to 2021. Astonishingly, the company was able to sustain its margins even in the face of substantial supply chain challenges and inflationary pressures. The future growth should coincide with the 9% trend in the industry. More value could be unlocked through implementing lean operational practices, implementing effective pricing strategies, launching new products, and exploring new distribution channels.
The Balance sheet and earnings power
As a new spinoff, MBC hasn't shown a long track record of financials which may lead to lots of anxiety and uncertainty for investors. However, the business model is very straightforward which should give confidence in financial stability. After the spinoff, MBC borrowed a 750M term loan and 200M under a revolving facility. 940M of those were used to give Fortune Brands as a cash payment (spinoff cost). As of Sep 25, 2022 (table below), MBC will have 2.54B total assets with 1.034 equity. Goodwill and intangibles equal 1.29B. Long-term debt was 929M which makes MBC's long-term debt load heavier than peers like American Woodmark Corporation ( AMWD ). The debt to equity ratio is around 1.5 which is also higher than AMWD.
Due to high debt, MBC's earning capacity will be weakened. An additional interest expense of approximately $53 million is expected. The company filings have estimated the pro forma net income of 101M for the 39 weeks that ended Sep 25, 2022. If the management could navigate the spinoff dis-synergies and synergies well, a possible positive 40M management adjustments may offset some interest expense above. However, this is not guaranteed.
Bottom Line
For the time being, I will overlook the management adjustment and use an estimated starting annual net income of approximately 125 million valuations which gives MBC a PE ratio of 10x. For comparison, AMWD's PE ratio has fluctuated around 18x since 2013. So, MBC's current market cap of 1.21 billion appears to be undervalued with a PE ratio of 10x. I believe MBC has the potential for a higher valuation in the short term, but its long-term prospects are uncertain due to the low barriers to entry and potential housing market downturns. Although MBC benefits from scale and management advantages under the Fortune brand, it is unclear if these benefits will persist if the company were to operate independently. There is just not enough margin of safety. That being said, if MBC's price could drop 30% from here back to previous lows at 7, I would take a serious shot.
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MasterBrand Is A High-Quality Leader In The Residential Cabinet Industry