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We think Brunswick represents an opportunity to invest in an underappreciated high-quality business at an extremely depressed valuation of less than 8x next year’s earnings. The impending sale of the company’s fitness business will remove a declining business from the company’s consolidated results that has obscured stellar performance in the core marine business. Further, the use of proceeds for accretive buybacks and debt repayment should drive EPS above street estimates in 2020 and we believe the stock could double in the next year or two.
Brunswick is a manufacturer of recreational marine engines and boats. The company has also been the largest supplier of commercial fitness equipment through its Life Fitness business, but will soon complete the sale of the business to private equity for $490 million (expected to close by the end of this month).
Going forward, the newly streamlined Brunswick will operate two boating-related businesses. First is its Marine Engine segment, which sells engines for freshwater and saltwater boats along with the parts and accessories used to maintain them, which will account for about 85% of the company’s operating income. The other 15% of Brunswick’s operating income is generated by its Boat segment, which sells recreational and fishing boats (key brands include Boston Whaler, Sea Ray, and Lund).
Attractive and Concentrated Market Structure for Marine Engines
We think this is a much higher-quality and less competitive business than investors generally appreciate. In fact, the marine engine industry is highly consolidated with two players, Brunswick’s Mercury brand and Yamaha, accounting for a large portion of the engine market. We estimate each company has about 40% of the U.S. market for a combined market share exceeding 80% (the other 20% is a mix of smaller players). Interestingly, we think this market share statistic perhaps even understates how good the market dynamics are as Mercury and Yamaha each dominates a specific submarket, with Brunswick’s Mercury historically strong in freshwater (we estimate a roughly ~55-60% share) and Yamaha maintaining a leading position in saltwater. However, Brunswick has spent the past few years investing heavily in new product development, leading to quieter, lighter and more fuel efficient engines, which we believe has helped drive saltwater market share gains (we estimate Mercury’s share in saltwater has reached the mid- to high 20% range).
Less Cyclical Given Growing Parts & Accessories Business plus Restructured Boat Business
While investors are concerned about owning economically-sensitive stocks like Brunswick, we think they are underappreciating the steps the company has taken in recent years to enhance the stability of the business through increased exposure to parts and accessories and by restructuring its boat manufacturing footprint.
First, the percentage of revenue the company receives from the sale of high-margin parts and accessories has roughly doubled since 2006 to a current level of almost 40% and now accounts for roughly half of total company profit. Parts and accessories sales were fairly stable during the financial crisis (revenue fell low- to mid-single-digits percent), which is consistent with end-market demand that is mainly driven by the installed base and average age of boats, as opposed to boat sales in any given year.
Second, Brunswick has consolidated its boat manufacturing footprint to just eight boat plants in North America today from 29 in 2006. Combined with a higher quality mix of brands today, we think the boat segment is positioned to perform much better in a tougher economic environment.
Industry Volumes Are Still Below Prior Peak and Replacement Analysis Would Argue for Higher Sales Volumes
For some context, U.S. powerboat unit sales last year were 201k units vs. a 2002-2006 average of ~290k so overall industry volume is still 30% below peak. After dropping dramatically during the recession, U.S. boat sales have been slowly climbing back at a mid-single digit annual growth rate. At the same time, there has been a mix shift to higher value boats that has helped drive overall engine sales (higher average horsepower engines with higher ASPs and more engines per boat).
While we are not predicting a return to the prior peak in unit sales, we think replacement demand would imply a normalized sales level of ~300k units and is supportive of continued steady growth in engine sales. There are 9.5 million registered boats in the U.S. and assuming a typical useful life of 30-35 years implies ~270-315k of annual replacement demand. Alternatively, you would have to assume a useful life of 47 years for current volume levels to be “normal.”
As it relates to more recent industry data, a slow start to this year’s boat selling season is likely the main reason for Brunswick’s poor stock performance in recent months. While Q4 and Q1 are seasonally small contributors, first quarter industry sales were down slightly vs. last year. We think much of the slower start has been driven by poor weather in many key boat markets and expect to see improvement going forward. Recent industry data for April showed modest growth and Brunswick’s commentary at a recent conference indicates that May was similar to April with Memorial Day weekend providing some “encouraging signs.”
Strong Marine Performance Masked by Declining Fitness Operations
Over the past few years, the Fitness business has seen a significant decline in profitability with EBIT falling from $130 million in 2016 to just $62 million in 2018 and to roughly breakeven in the first half of 2019. When looking at the consolidated financials of Brunswick, this Fitness business underperformance obscures the strong momentum that Brunswick has demonstrated in the marine/boat business. Based on our analysis of the Marine-only financials since 2013, we estimate that Brunswick (ex-Fitness) has grown sales at a ~7.5% CAGR and EBIT at a ~22.5% CAGR vs U.S. industry boat sales volumes up ~5.5% annually over that period. With the Fitness sale expected to close by the end of this month, investors can now clearly focus on the well-positioned business with strong operating momentum that remains.
Below we have outlined our estimate of the historical and projected standalone Marine-only financials based on assumptions around 1) stranded Fitness costs, 2) Brunswick retaining all below-the-line items, and 3) deployment of Fitness sale proceeds into buybacks and debt repayment. We think the table below highlights the business’s impressive financial characteristics:
Potential for Meaningful Near-Term Capital Return and Corporate Cost Reductions
In February, Brunswick gave 2020 targets for the Marine-only business of $5.00-5.50 in earnings per share. While they expected Fitness to generate ~$0.35 in earnings in 2019, they neither provided nor included any Fitness contribution in their 2020 targets. But they also didn’t assume any benefit from the deployment of proceeds from a potential sale. Predictably, consensus estimates for 2020 are in the middle of management’s marine-only guidance of $5.25 per share. But with the company about to receive $460 million in net proceeds, if they use 50% of the proceeds to repay 4.5% debt, the annualized earnings uplift (2020 impact) is about $0.09 per share and if they use the other 50% to repurchase shares at $46 per share (a 5% premium to the current price), they’d repurchase 5.0 million shares, which would improve earnings by ~$0.30 per share for a total uplift vs their 2020 target of ~$0.39 per share (8% boost to the midpoint/consensus). We hope that the company will be even more aggressive in prioritizing share repurchases considering the current stock price and the strong cash generation expected in 2019 (>$300 million of 2019 FCF with the coming Q2-Q4 periods accounting for >100% of annual cash flow). The company recently disclosed that it has repurchased ~$70 million in stock so far in Q2, so we have every reason to believe they think the stock is too cheap and plan to be aggressive once the Fitness sale closes.
Further, we think the removal of the Fitness business gives Brunswick management a clear opportunity to meaningfully reduce its corporate footprint. The company currently has ~$80 million in annual corporate expenses (a number that we think will grow to ~$85-90 million due to certain stranded Fitness costs). Going forward, the overhead required to run the smaller, Marine-only business should be materially lower. We believe management is aware of the issue and could provide details on the cost opportunity once the Fitness sale closes.
Valuation - Reasonable Assumptions Drive 100%+ Upside
We think Brunswick can earn $5.65 in 2020 earnings (higher than management’s targets due to deployment of the Fitness proceeds). At the current share price of $44, the stock is trading at less than 8x 2020 earnings (6.2x EBITDA and 7.3x EBIT). We think the marine engine business is a really good business that should trade at ~12x EBIT (or more), while we value the boat business at ~8x EBIT. This results in undemanding blended multiples for the business overall of 11.3x EBIT and ~14x earnings, resulting in a target value for the stock of $80 per share or ~80% upside from the current price. Assuming further steady growth in 2021 would generate EPS of roughly $6.50, which at ~14x would result in a stock price of $90 per share or double the current price in the next 18-24 months.
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