2023-12-03 00:13:35 ET
Summary
- Resideo Technologies has taken cost restructuring actions to improve margins, which may impact earnings in the near term but result in savings in the medium term.
- The company is facing volume decline in HVAC products and constraints in the distribution channel but is working on improving working capital management and cash flows.
- Despite challenges in the residential sector, Resideo has opened a new distribution center, introduced new products, and seen improvements in its order book. The stock is reasonably valued.
Margin Protection Is In Focus
I have been discussing Resideo Technologies ( REZI ) in the past, and you can read the latest article here . While lower residential new construction activity hurt Resideo’s growth prospect in 2023, I think the recent stability in the market is a positive sign despite the uncertain economic condition. So, the company took various cost restructuring actions to improve margins. Although the actions can take a toll on its earnings in the near term, the savings from the initiatives will show in the medium term.
Nonetheless, the volume decline in HVAC (Heating, Ventilation, and Air Conditioning) products and constraints in the distribution channel will remain in the near term. The residential market is unlikely to see any dramatic improvement, either. In this scenario, REZI will continue to improve its working capital management and cash flows. The stock is reasonably valued. Given the delicate balance, I continue to ask investors to “hold” the stock with an expectation of increasing returns in the medium term.
Cost Reduction Efforts
Over the past few quarters, REZI has reduced near-term and long-term structural costs. The challenges in the residential sector triggered the actions. Investors should note that the home repair and remodel activity is a critical driver for the company’s performance. However, the housing market and the new security installations have underperformed as the number of new units built in 2023 has fallen below a year ago.
These slow-moving residential end markets necessitated cost restructuring actions, which resulted in a $38 million charge in Q3. This brings restructuring and a cumulative $60 million over the past four quarters. However, the restructuring can also result in annual gross cost savings of $125 million.
Despite the stagnancy, there has been a recent surge in new housing stock and investments in homes. So, I think the consolidation in the housing sector is a positive sign despite the uncertain economic condition in the global market.
Future Drivers
In September 2023, REZI opened its new Super Center distribution center in Dallas that can accommodate more than two million units of inventory. It also has advanced warehouse automation technologies and inventory management. The facility will optimize supply chain operations and enhance capacity for long-term growth.
In the Products & Solutions segment, the company plans to introduce its new outdoor security camera and launch the First Alert smoke and fire alarm products in Q4. It has recently introduced ProSeries security products in Europe, the Middle East, and Africa, which can drive sales in the coming quarters.
Q3 and FY2023 Outlook
REZI’s revenues can decrease by 2% (at the guidance mid-point) in Q4 2023. Its gross margin is expected to be 26%-27%, a deterioration of 30 basis points compared to Q3. It can also generate an operating profit of $142 million (at the guidance mid-point).
In FY2023, REZI is expected to record $6.22 billion in revenues (at the guidance mid-point), a 2.3% decline compared to FY2022. Its gross margin can range from 26.6% to 27.2%. Its operating profit can range from $535 million to $555 million.
Challenges
In Q3, REZI faced volume contraction in the Products & Solutions segment. The slowdown resulted in lower volume in the air and energy product categories, particularly in the HVAC products and their distribution channel. In Q3, orders in this segment improved compared to a quarter ago, an encouraging sign of stabilization in the key channels.
Due to its diverse commercial exposure, the company is insulated from the negative trends discussed above in the ADI Global Distribution segment. However, I expect the headwinds in the residential intrusion market will continue to depress sales. According to the company’s estimates, the residential intrusion market accounts for 20% of the segment sales.
Analyzing Q3 Segment Results
The company's Products & Solutions segment revenues decreased by 7% year-over-year in Q3 2023. Lower demand in HVAC (heating, ventilation, and air conditioning) and an unsettled distribution channel following declining furnished unit volumes contributed to the sales fall. On top of that, regulatory shifts related to natural gas products across Europe affected volume adversely. However, the gross in this segment expanded by 250 basis points year-over-year in Q3 2023 as new product introductions improved margins.
Year-over-year, revenues in the ADI Global Distribution segment remained nearly unchanged in Q3 2023 compared to a year ago. E-commerce, which represented 19% of total ADI revenues, grew 5% in Q3 compared to last year. The gross margin also decreased by 100 basis points in Q3. Lower vendor rebates due to lower volumes and more competitive pricing and costs related to restructuring activities hurt the segment margin.
Cash Flows And Share Repurchase
In 9M 2023, REZI's cash flow from operations improved remarkably, by 12.6x, compared to a year ago. Although revenues remained nearly unchanged over the past year, lower accounts receivable, inventory, and other current assets led to a rise in cash flow. Its free cash flow (or FCF) (excluding acquisition) also turned positive.
The company's debt-to-equity (0.53x) is much lower than its competitors (CSWI, GFF, and HAYW). Of the recently approved $150 million share repurchase program, it spent $28 million in Q3. The repurchase program is also a part of a balanced capital allocation plan through organic and inorganic investment.
Analyst Rating
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." The consensus target price is $19.3, suggesting a 19% upside at the current price.
Relative Valuation
REZI's forward EV/EBITDA multiple expands versus its current EV/EBITDA, which is steeper than its peers. This indicates that REZI’s EBITDA will decrease more sharply than its peers in the next four quarters. This typically results in a lower EV/EBITDA versus its peers. The company's EV/EBITDA multiple (5.0x) is significantly lower than its peers' (CSWI, GFF, and HAYW) average (13.5x). So, the stock appears to be reasonably valued, with a moderate positive bias, compared to its peers.
Given the recessionary fear in the US, I do not see the stock improving sharply in the short term. However, if it trades at the past average in the medium term, it can climb 61% from the current level.
Why Do I Maintain My Call On REZI?
In my previous iteration after Q2, I discussed the growth pockets, including its video capability products, the European heat pump market, and connected water leak products. I also addressed the cash flow strength it garnered. However, I also pointed out that the topline and operating margin lacked momentum. I wrote :
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.
After Q3, slow-moving residential end markets necessitated cost restructuring actions that can mitigate the pressure on profitability. Also, the recent uptick in new housing stock and home investment can trigger a turnaround. Its order book also improved in Q3. I do not see any significant value driver in the near horizon. So, I maintain my “hold” call on the stock.
What’s The Take On REZI?
REZI has been concentrating on various cost-reduction actions to improve profitability. Recently, it opened its new Super Center distribution center in Dallas. It has introduced a new outdoor security camera, the First Alert smoke and fire alarm, and ProSeries security products in the EMEA region. Its gross in the Products & Solutions segment expanded in Q3. The costs related to the restructuring can lower the margin in the short term, but the positive effects will yield in the medium term.
The housing market remains challenging, although the signs of recovery appear to be surfacing. So, the stock underperformed the SPDR S&P 500 ETF Trust ( SPY ) in the past year. The company’s cash flows improved remarkably in 9M 2023. So, I reiterate my “hold” call on the stock.
For further details see:
Resideo Technologies: Recovery Measures Look To Outdo The End Market Concerns