|Shares Out. (in M):||35||P/E||18.4||16|
|Market Cap (in $M):||480||P/FCF||18.4||16|
|Net Debt (in $M):||-10||EBIT||33||35|
|Borrow Cost:||General Collateral|
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Marine Products Corp (MPX)
Sometimes shorts are more attractive after the first sign of earnings deterioration arises even if the stock is lower. We believe Marine Products presents a highly asymmetric risk/reward for fundamental investors with more than 40% downside from current levels. The stock trades at 12.5x EBITDA and 16.0x forward earnings estimates as compared to comps at 7.3x EBITDA and 9.3x earnings. Further, these estimates appear way too optimistic when operating income is currently exhibiting a decline (-18% last quarter) and its category end market is in decline (MPX units declined by 18% last quarter). The thesis here is very simple: 1) Comps suggest the stock should be 40% lower today, 2) operational deterioration exhibited in the business last quarter suggests earnings should fall well short of the sole sell-side estimate on the stock, and 3) the company is exposed heavily to a secularly declining end market that has been masked by market share gains over the past few years. As market share gains stalled out, the company is now directly exposed to an area of the boating market that has lost its luster and no one wants to buy. Net net, we believe the stock should trade at ~$7.00 per share, reflective a comp multiple on our estimated 2019 earnings.
While the end market could revert back to growth and exhibit several years of market expansion, we believe we are currently above normalized earnings. EBITDA margins surpassed the 2006 peak in 2017 and are currently at an all-time high. This industry carries significant cyclicality and with incremental/decremental margins in the 30% range the boating industry does not fare well during cyclical downturns. The end market has not had a down year since 2011, but recent trends show that the market finally turned negative in the fourth quarter (see below). Within the boating segment, MPX is the most exposed to Inshore/Offshore part of the Fiber Glass 11-40ft market. This specific end market showed an 8.4% decline in Q4, but the monthly trend significantly deteriorated through the quarter ending with December down 16.1% YoY. While the bulls point to a seasonally weak period to diminish the materiality of the trends, the trend is clear and has been weakening for several months. During the last downturn, industry volumes declined by more than 60% and MPX reported more than 100% decline in profitability with negative EBITDA, EBIT, and Gross Margins. Point being, these are businesses that burn cash in the downturn and this should be incorporated into how one thinks about normalized profitability and the multiple on current cash flow.
Structural End Market Issues:
Marine Products is significantly more exposed to sterndrive boats (engine partially inside the boat), a category that appears to be in a long-term decline. This boat category, once more than 40% of the market, has had only one positive year of growth since 2006 and continues to lose share. The reason for this is due to the significant market share gains in outboard engines. We believe that the decline in popularity of sterndrive boats can be attributed to higher maintenance costs, decline in relative efficiency, and a desire for more power (you can put two engines on an outboard boat, but cannot with a sterndrive). Marine Products has upwards of 40% exposure to sterndrive engines. The one analyst covering the stock did highlight this market risk in a downgrade late last year noting that he “would not be surprised if the recent pressures on sterndrive boats becomes exacerbated while relatively emerging-demand boats (e.g. ski wake boats) experience less of a decline.”
Within the sterndrive segment, MPX has benefitted from share gains as competitors exited the business due to low margins and poor returns. We believe these share gains have largely run its course, leaving MPX far more directly exposed to this end market (MPX lost share last quarter). It could be argued that the boost to MPX’s earnings is akin to a brick and mortar retailer exhibiting an increase in comps due to the bankruptcy of a competitor….If the end market is in structural decline, it’s difficult to put a multiple on a one-time boost to earnings.
Growing Affordability Problem:
The industry has been very aggressive on pricing over the past 10 years and may be pushing the boundaries of affordability. Price increases have occurred through the introduction of higher end models (mix shift) as well as outright increases. This is also evident in commentary from MarineMax (HZO), a large boat dealer, during its last public conference call.
“There’s always a price increase every year and there’s a modestly higher price increase this year basically across the board on every product”.
We believe this is wishful thinking. Price increases occur until they don’t and inevitably consumer demand and competitive dynamics will determine market pricing. During the 10-year period from 2007-2017, boat pricing increased significantly more than household income. Such long-term pricing growth places affordability at 130% of household income/ASP as compared to 110% in 2007. Further, MPX’s ASP was up 12% in 2018 and upwards of 20% in the back half of the year due to favorable mix and pricing. The bulls believe that unit volumes can continue to grow from current levels based on where volumes reached during the last peak. However, this does not incorporate the fact that pricing is materially above previous peak levels.
Marine Products’ EBITDA has grown by more than 70% since 2015 and has led to a stock price appreciation of several hundred percent over the same period of time. However, the business trajectory has materially changed. While MPX’s stock appreciated by 36% in 2018, the quarterly cadence of EBITDA growth tells a very different story regarding the core health of the business. In the first half of the year, EBITDA grew by 29%, but slowed to HSD growth in the back half. Q4 2018 EBITDA declined by 18% year over year driven by a unit decline of 18%. For comparison, Q2 and Q3 unit growth came in at 13% and 8%, respectively. Management blamed part of the fourth quarter volume loss on international volumes, but that only partially explains story as international is only 3% of unit sales. We believe much of this comes down to general weakness in the end market, price points that challenge affordability, and a poorly positioned product portfolio with respect to sterndrive engines.
Inventory has grown significantly over the past several quarters leading to more than a 25% rise in days’ inventory. In the fourth quarter, inventory grew by 23% YoY as units declined by 18%. While revenue growth could snap back and soak up the excess inventory, we think it’s possible that this problem results in production run cuts which could pressure margins. While FIFO based accounting could delay the impact from rising fixed cost allocation per unit, the significant drain on working capital is evident in recent results and the trajectory of industry volumes likely increases pressure to manage inventory levels. With gross margins already down 90bps YoY in the fourth quarter, we believe the street is not pricing in this inherent risk as current 2019 estimates assuming flat margins.
We currently forecast 2019 EBITDA and EPS of $30mm and $.64, respectively (Street@ $36mm EBITDA/$.76 EPS). We assume gross margins are down ~100bps year on year, units decline by ~10% offset by HSD pricing. The company is also dealing with some “labor inefficiencies” noted in the last conference call which is also expected to be a “challenge for at least another couple quarters.” This projection does not assume the industry becomes more price competitive, something that does present a further risk to the extent the market weakens further.
We have valued the company several different ways and conclude the shares to be fundamentally overvalued on every metric. From a comparable analysis perspective, all comps trade at a significant discount to MPX. The two direct boat comps are Malibu Boats (MBUU) and Mastercraft Boats (MCFT). Both of these companies are tied to a more attractive end market (ski/wake), which continues to grow, and both companies significantly grew EBITDA and EPS in fourth quarter. Moreover, margins are structurally higher in the wake/ski market due to fewer players and greater share. Despite these factors, Masftercraft and Malibu trade at a significant discount to MPX. It makes sense that the market has assigned a lower multiple to boating stocks to reflect concerns over the cycle yet MPX continues to trade at a significant premium partly due to its lack of coverage. It’s worth noting that MBUU and MCFT each have seven sell-side analysts covering them as compared to one for MPX.
Below is a comparable valuation using peer multiples for P/E and EV/EBITDA as well as a quick assessment of normalized earnings. We went back and evaluated the cycle margins for this company and industry over the past two cycles. Margins peak in the low double digits and trough below zero. We took an average of historical margins and conservatively assumed that margins during the next downturn would be far more resilient than what was exhibited historically. Furthermore, we assumed the company could grow revenues going forward such that midcycle revenues would be 20% higher than the current run-rate. This analysis also yields a materially overvalued stock price. To the extent one wanted to expand the comp base to include Brunswick (not 100% boats) or companies such as Thor (RVs: similar cyclicality and margin structure) the analysis would yield a similar result.
In summary, we believe MPX presents an attractive short investment opportunity with clear valuation support and evidence of earnings deterioration. When factoring in the significant economic sensitivity and trends that are supportive of a weakening end market, the risk/reward is favorable.
Disclosure: At the time of publication, the author of this article holds a short position in Marine Products Corporation (“MPX”). This article expresses the opinions of the author. The author has no business relationship with any company whose stock is mentioned in this article.
The author of this article has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. Following publication, the author may transact in the securities of the company, and may be long, short or neutral at any time. The author of this report has obtained all information contained herein from sources believed to be accurate and reliable. The author of this report makes no representation, express or implied, as to the accuracy, timeliness or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this article or any of the information contained herein. This is not an offer to sell or a solicitation of an offer to buy any security.
Earnings shortfall in 2019/2020
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