- The company has just posted extraordinarily good financial results. Revenue, operating profit, and net income are up massively. There's more debt, but it's not excessive.
- The problem is valuation. The market recently entered "unprecedented" territory when it comes to the valuation. I did well when I bought at a cheap price. The current price isn't cheap.
- While I might normally recommend selling deep out-of-the-money puts, the premia for reasonable strikes in the $50-$55 range are non-existent. I must wait for the inevitable drop.
It's been about 4½ months since I sold my stake in Masonite International Corporation ( DOOR ) and in that time the shares are down by about 1% against a loss of about 7% for the S&P 500. The firm has posted earnings since, so I thought I'd review the name yet again to see if it's time to buy back in. I'll make the determination by looking at these results and comparing them to the current valuation. These shares have done reasonably well for me in the past, and I want to see if it's possible to repeat that performance.
If you read my stuff regularly, you may have come to the conclusion that my writing can be "a bit much." I acknowledge that, and, being the generous person that I obviously am, I want to extend an olive branch to the readers. My olive branch consists of a "thesis statement" paragraph that gives you the summary of the article. This allows you to extract most of the "juice" of my analysis without having to go through the challenging "squeeze" of 1,400 words of "undiluted Doyle." You're very welcome. Although Masonite posted very strong results recently, I can't recommend the shares. This is because they are trading at valuations that are very nearly unprecedented. In other words, only very recently the shares started trading at a very elevated level, and I don't think this can be good for people who buy at current prices. While the shares may continue to stretch from current levels, we'd be wise to remember that there's a strong negative relationship between price paid and subsequent returns. I think this valuation is particularly strange in light of demographic trends over the next few decades.
My Take On Housing
Before getting into the analysis properly, I think it makes sense to offer up my own biases about housing. The housing market has always been interesting to me because we tend to make very thin-sliced, short-term forecasts about assets that literally last decades. My view of housing has become much simpler since I sat down for a four-hour interview with Stephen Jarislowsky (Canada's Warren Buffett) in 2010. He spoke to me about both housing stock and house prices. The former can only grow by the rate of population growth, and the latter can only grow at the rate of productivity growth, plus inflation. If it grew more over time, the law of compounding would mean that sooner or later housing would be out of reach for a growing number of people, or would collapse in price. While access to housing is a societal problem, it's not so pernicious that healthy individuals risk multi-year housing insecurity.
Since demographics drive housing demand for obvious reasons, I want to spend some time thinking about demographic trends.
Additionally, a significant component of this growth will be among the elderly, and that demographic consumes relatively less of everything relative to other groups, including housing. Specifically, it's expected that by the year 2034 (not long in the life of a company like Masonite), the elderly will outnumber the young for the first time in U.S. history.
Finally, the population of the United States is expected to grow at a relatively anemic rate of a CAGR of ~.5% to 2060, and we should remember that the United States is one of the world's demographic bright spots. Demographic trends outside of the United States are even more anemic.
Given the above, I'm not a long-term housing bull, and this informs my take on companies like Masonite International. While I would be willing to buy the stock at the right price, I think it's going to be increasingly challenging for the company over time.
Financial Snapshot
In my opinion, the most recent financial performance here has been quite strong. Specifically, revenue, gross profit, and net income are up by 13.7%, 12.6%, and 52% higher in 2022 than they were in 2021 respectively. When compared to the same period in 2019, things look even more impressive, with revenue and net income in 2022 higher by about 36% and 357% respectively.
It's not all animated bluebirds and lollipops over at Masonite, though. The capital structure has deteriorated, with the level of debt up by about 9.4% and cash down by about 29% over the past year. While I don't foresee any immediate trouble from this, higher levels of indebtedness obviously increase the level of risk and that should be reflected in the stock price in my estimation. That written, I am willing to buy this stock at the right price. As I hinted above, I don't consider this to be a viable long-term hold over the decades, but I'm certainly willing to pick up a few hundred shares if they're on sale.
Masonite International Financials (Masonite International investor relations)
The Stock
If you read my stuff regularly for some reason, you must know by now that I consider the stock and the company to be very different things. The company takes inputs, adds value to those inputs, and sells the doors, and door frames and the like at a profit. The stock, on the other hand, is often a poor proxy for what's going on at the firm. The stock is influenced by the crowd's ever-changing views about the long-term future for a given company. The stock is influenced by the pronouncement about a given company, or about the housing market in very general terms. The stock is influenced by the crowd's beliefs about the desirability of "stocks" as an asset class.
All of this suggests that the stock is an instrument that's much more volatile than the underlying business. While this is tedious in some ways, it's also potentially profitable. If we can spot discrepancies between the crowd's perspective and what subsequently happens, we make money. In fact, I think spotting disconnects between the current view and subsequent reality is the only way to generate consistent profits investing in stocks. It's typically the case that you make the most money when you buy shares that are overly cheap relative to the future profitability of the firm. For example, I became bullish on Masonite years ago when the price to free cash flow was sitting around 18 times . I then took my chips off the table when the crowd caught up and drove the shares to what I considered an excessive valuation of 32.29 times free cash flow. This is because a great, profitable business can be a terrible investment if you overpay for it. Fast-forward to the present, and the shares are about 13% more expensive per the following:
In addition to looking at simple ratios, I want to try to unpack the assumptions currently embedded in price. If you read me regularly, you know that I rely on the work of Professor Stephen Penman, and increasingly Mauboussin and Rappaport to do this. This approach uses stock price itself as a source of information. It involves "reverse engineering" the assumptions that cause the current price. Using this approach, the market is currently forecasting a fairly low growth rate of ~1.8% for Masonite going forward. While this is admittedly reasonably pessimistic, it's not pessimistic enough in my view. The valuation scares me off.
In spite of the recent financial strength, I can't buy the shares at current prices. I think the housing market will chug along at a somnambulant pace over the years, and that will drive Masonite's business. While I don't think the company is in danger of dying anytime soon, I think the shares are in danger of falling in price. I'd like to write something like "the last time they were this expensive, they went on to underperform" or similar. The problem is that they're trading near multi-year high valuations, and so the current valuation is literally unprecedented. This can't be good for people who buy at current prices, in my estimation. I'd be happy to buy these shares in the $55 range, but at the moment they are egregiously expensive in my view.
For further details see:
Still Avoiding Masonite International