2023-09-08 01:23:31 ET
Summary
- Resideo Technologies plans to focus on specific product categories, including security video capabilities, the European heat pump market, and connected water leak products.
- The company's near and medium-term outlook signals a drop in revenues and operating income margin due to a slowdown in demand.
- REZI has improved its working capital management and has an enhanced share repurchase program, indicating a balanced capital allocation plan.
Resideo Technologies Looks To Move Sideways For Now
I have been discussing Resideo Technologies (REZI) in the past, and you can read the latest article here . Lower residential new construction activity will hurt Resideo's growth prospect in 2023. As demand slowdown hits its outlook, it plans to focus on specific product categories, including security video capabilities, the European heat pump market, and connected water leak products. The lack of topline growth has forced the management to look inwards, driving costs down and banking on savings from a leaner cost structure.
Nonetheless, due to the volume decline, the company's near and medium-term outlook signals a drop in revenues and operating income margin. REZI has improved its working capital management, which will continue to boost cash flows in FY2023. The company's enhanced share repurchase program indicates a balanced capital allocation plan through additional investment. The stock is reasonably valued. Considering everything, I suggest investors "hold" the stock with limited returns in the near term.
Current Drivers And Cost Management
End market softening and excess channel inventory have adversely affected REZI's recent results. It has also diversified its revenue base by enhancing security video capabilities, strengthening the European heat pump market, and expanding its connected water leak products. Slowing demand will limit the company's incremental price hike opportunity. So, it will likely keep pricing steady across the product lines. In Q1, the company witnessed a volume decline in residential categories, including AV (audio-visual) and intrusion.
The company has been reducing costs by making structural improvements to mitigate the demand challenges. These cost-reduction drives can lower savings by $15 million-$45 million (annualized). Over the medium term, these programs can generate ~$115 million in annual cost savings. However, it can also result in a $25 million restructuring charge in Q3.
End Markets And Strategies
In the US, residential new construction activity is down by double-digits compared to a year earlier. To counter the slowdown, REZI has been adding content. Year-over-year, its average product dollar content for new homes increased by 15% in Q2. This has led to additional sales opportunities for the smoke and co-detector portfolio for First Alert (REZI acquired First Alert in March 2023).
I see progress on the supply chain and sourcing fronts in First Alert as broker activity diminished in this market. The company also manages its variable labor and freight costs better than a year earlier. The availability of semiconductor components and electronics has improved.
Q3 and FY2023 Outlook
Given the end market pressure, REZI's revenues can decrease by 2% (at the guidance mid-point) in FY2023. Its gross margin is expected to be 26.2%-27.2%, a deterioration compared to the 27.7% gross profit margin in FY2022. It can also generate an operating profit of $550 million (at the guidance mid-point). In FY2023, its GAAP EPS can range between $1.15 and $1.35, a sharp fall compared to $1.90 in FY2022.
In Q3 2023, REZI is expected to record $1.54 billion in revenues (at the guidance mid-point), a 4% decline compared to Q2. Its gross margin can range from 26.1% to 27.1%, compared to 27.2% in Q2. Its GAAP EPS can vary between $0.14 and $0.24 in Q3, a sharp fall from $0.34 in Q2. Its adjusted EBITDA can also decrease by 10% in Q3.
Analyzing Products & Solutions Segment Results
The company's revenues decreased by 11% year-over-year in Q2 2023. Weak retail traffic, excess inventory in the HVAC (heating, ventilation, and air conditioning) distribution channel, and reduced home sales following the interest rate hike contributed to the sales fall. A cooler-than-expected spring weather also impacted HVAC sales volume adversely.
However, the income from operations in this segment contracted by 130 basis points year-over-year in Q2 2023 as lower volume adversely affected fixed cost absorption. However, the segment gross margin increased by 100 basis points due to lower freight, raw material, and component costs.
Analyzing ADI Global Distribution Segment Results
Revenues remained nearly unchanged in the ADI Global Distribution segment in Q2 2023 compared to a year ago. In residential AV and security categories, demand softened in Q2 2023. However, the commercial categories showed more promise due to growth in access control.
Gross margin also decreased by 80 basis points in Q2. The absence of transitory and inflationary pricing benefits from last year hurt the segment margin. However, I think pricing optimization, brand power, and growth in touchless sales will keep the near-to-medium-term margin steady in this segment.
Cash Flows And Share Repurchase
In 1H 2023, REZI's cash flow from operations improved remarkably and turned positive compared to a negative CFO a year ago. Although revenues remained nearly unchanged over the past year, improving inventory management led to the cash flow rise. Its free cash flow (or FCF) (excluding acquisition) also turned positive. In FY2023, REZI's management expects inventory days further following committed inventory agreements signed when the supply environment was tight recently.
The company's debt-to-equity (0.53x) is much lower than its competitors (CSWI, GFF, and HAYW). Recently, it approved a $150 million share repurchase program. Its management believes the current share price reflects the operational transformation that can deliver strong and consistent cash generation. The repurchase program is also a part of a balanced capital allocation plan through organic and inorganic investment.
Analyst Rating And Relative Valuation
According to Seeking Alpha, two sell-side analysts rated REZI a "buy" in the past three months (including "Strong Buy"), while three rated it a "hold." None rated it a "sell." The consensus target price is $19.3, suggesting a 17% upside at the current price.
REZI's forward EV/EBITDA multiple is expected to expand versus its current EV/EBITDA. This contrasts with a fall in EV/EBITDA for its peers. This indicates that REZI's EBITDA is expected to decrease versus a rise in EBITDA for its peers. This typically results in a much lower EV/EBITDA versus its peers. The company's EV/EBITDA multiple (5.1x) is significantly lower than its peers' (TGLS, DOOR, and PGTI) average (14.9x). So, the stock appears to be reasonably valued versus its peers.
Why Do I Maintain My Call On REZI?
I had a balanced view of REZI in my previous article. The Acquisition of First Alert provided additional revenue generation opportunities. While the supply chain issues related to semiconductor components and electronics eased, a declining backlog posed concerns over the topline growth. I wrote :
It has adopted a manufacturing facility optimization plan to boost margin, which should provide annual savings once completed. As part of inorganic growth, it acquired First Alert in March 2023, which can also offer $30 million in annualized synergy.
After Q2, it focuses on growth pockets, including video capabilities, the European heat pump market, and connected water leak products. Its working capital management has improved considerably, making cash flows positive in 1H 2023. However, it lacks the value drivers to push its revenue and operating margin in the near-to-medium term. The stock is reasonably valued. So, I maintain my "hold" call on the stock.
What's The Take On REZI?
Amidst Slowing demand from the end markets and limited opportunity to increase prices, REZI is focusing on cost reductions to protect margin. The company is managing its variable labor and freight costs better after the availability of semiconductor components and electronics is improved. Given the fall in residential construction activity, the company's top and bottom lines will likely deteriorate in Q3 and FY2023. So, the stock underperformed the SPDR S&P 500 ETF (SPY) in the past year.
Despite the volume pressure, I think pricing optimization, brand power, and growth in touchless sales would keep the operating margin steady. The company's cash flows improved remarkably and turned positive in 1H 2023. Given the company's proactive working capital management policy, it can improve even further. Although reasonably valued, the stock has a tailwind following REZI's enhanced share repurchase program. This should validate my "hold" call on the stock.
For further details see:
Resideo Technologies: Limited Growth, But Cost Control Measures Are In Place