|Shares Out. (in M):||140||P/E||12.4||10.8|
|Market Cap (in $M):||6,440||P/FCF||12.4||10.8|
|Net Debt (in $M):||2,071||EBIT||780||840|
“Despite a relatively short history as a public company, we regard FBHS as one of the bellwether names in our coverage universe”
– Barclay’s February 2013
“FBHS is considered to be a "best in class" home products company with strong brands that have leading market positions in cabinets, plumbing, and security and storage products.”
– RBC January 2014
“We believe that Fortune is among the best positioned names within our building products coverage.”
– Credit Suisse June 2017
Trader Talk: Opportunity to buy best in class building products company at an attractive valuation on macro fears where a defensive business mix should hold up better than peers in the event of a housing downturn
Fortune Brands (FBHS) is a leading manufacturer of home and security products, with a focus on plumbing fixtures, cabinets, doors, and security. FBHS’s segments have leading market shares and well-known brands including Moen, Masterlock, Therma-Tru, and Fiberon.
FBHS is a consensus “blue-chip” business that has fallen along with other building products companies due to cyclical fears and, to a lesser extent, minor operational misses. At ~12.5x 2019 EPS and under 10x 2021 EPS, I believe FBHS shares are attractively priced in all but the most draconian housing scenarios and can rally substantially as FBHS executes and housing fears prove exaggerated.
Regarding housing macro, I do not believe a significant contraction in housing is likely. First, new residential construction is below mid-cycle, there remains significant pent up demand from years of underbuilding, and strong demographic trends favor an above mid-cycle demand picture. Second, repair and remodel (R&R) trends are normal and R&R is generally far less cyclical than new constructions. Regarding FBHS specifically, while the cabinet segment has been under pressure in recent years, FBHS’s Global Plumbing Group (GPG) and Doors and Security (D&S ) segments, which comprise ~50% and ~25% of operating profits respectively, are high-quality businesses that have consistently outgrown their end markets, own widely respected brands with leading market shares, and boast mid-teens to low-twenties operating margins. Finally, in the event we do enter a significant housing contraction, FBHS’s ~56% R&R and ~16% international mix, reasonable leveraged, and high-margin product focus make FBHS’s earnings far less cyclical than most building products companies.
I believe FBHS has 50-100% one-to-two year upside, similar to many building product stocks, without comparable downside EPS risk if the housing market enters a modest cyclical downturn.
Note: I do not provide a model here as there are dozens of sellside sources. However, roughly speaking my numbers are more conservative on the Cabinets segment, in-line on Doors and Security, and more bullish on GPG and capital redeployment.
Upside – If housing remains strong or accelerates into 2020/2021, I believe FBHS can earn ~$4-$4.50 in 2020 and $5-$6 in 2021, depending upon M&A outlook and shareholder buybacks. This is modestly above the Street but inline with management’s 2021 guidance. Assuming a 14-18x multiple implies 50-100% upside on a one-to-two year basis.
Downside – If housing enters a modestly severe downturn, I believe FBHS operating profits would at worst fall ~30% and EPS to ~$2.50. 12x yields ~$30, down 35%. I believe my estimate of a 30% decline in operating profits is conservative in all but a “once in fifty-years storm” housing environment
Severe Housing Downturn – In the unlikely event home prices fall substantially and new construction and R&R severely contract, building products will not be a good investment (Captain Obvious comment...).
Continued Pressure in Cabinets – Cabinets is the lowest-quality segment in FBHS, facing threats from Chinese imports as well as a fragmented domestic market. However, cabinets are only ~25% of EBIT and FBHS has been proactive addressing their issues.
Poor Capital Allocation – FBHS generates significant FCF. M&A and buybacks are significant features of their earnings growth story, and poor decisions could lower outer year estimates.
Spring Selling Season – While early, the US spring selling season is off to a decent start in 2019, with NAHB sentiment index improving from a rough Q4 and most homebuilders reporting sequential improvement in January and February. If new home construction appears set to improve and grow in 2019, I believe FBHS shares can rally.
Cabinet Anti-Dumping Case – The American Kitchen Cabinet Alliance, which includes Fortune Brands, recently filed a trade case against China with the ITC. Timing and ultimate impact are unclear, but a positive resolution could boost FBHS’s shares.
Good Capital Allocation – FBHS believes they have ~$3B (~$1.7B in FCF + additional available leverage) in capital investment capacity over the next three years versus a current market cap of ~$6.5B.
I will keep this section informal as I believe any macro forecast should be taken with a grain of salt. The big points are 1) US new residential construction is still well below mid-cycle and in an undersupply while all previous large housing contractions came after a period of oversupply and 2) R&R spending is far less cyclical than new construction, hence I believe any slowdown in housing is likely to be modest even in the event of a recession.
For the general housing bull thesis, the gist is that since 2008 the US has significantly underproduced homes directly into a wave of demand from millennials, which creates a strong fundamental backdrop for rising home prices and continued strong new home demand. While there can be ups and downs along the way, particularly around credit, rates, and employment, I believe the general “up and to the right” trend for US housing has strong fundaments and is likely to continue for years. My old VIC post goes deeper into details here: https://www.valueinvestorsclub.com/idea/US_Residential_Construction_Equities/1936185598
Point #1 – Housing Still Below Mid-Cycle