Whirlpool WHR S W
January 07, 2009 - 12:12am EST by
todd1123
2009 2010
Price: 49.00 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 3,681 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT
Borrow Cost: NA

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Description

I am recommending a short position in Whirlpool (WHR) equity (currently at ~$48 - 49 / share) and long credit protection (CDS currently at 300 / 310 level), which I believe presents a compelling near-term risk / reward proposition, with total return potential of >40% and 50%+, respectively over the next 3 – 6 months (PT of $25 - $30 / share on the equity and credit protection target of >500 bps). WHR is under-covered (Citi and JPM) and mis-understood by the Street. There are various levers to the business (highlighted in more detail further below) that will result in significant earnings power compression and will cause the company to default on a total leverage covenant (likely a Q2 09 event). While the company should be able to get an amendment, the re-pricing (assuming 300 bps of additional interest) should result in approx $1.00 of EPS erosion (which means 09E run-rate earnings power could be less than $1.50 / share (which equates to an approximate 33x earnings multiple).

WHR is one of the largest manufacturers of major appliances and related products, primarily for home use (including laundry appliances – 29% of sales, refrigerators – 30%, cooking appliances – 15%, dishwashers / and mixers / other small household appliances – 26%). WHR generates approximately 59% of its sales in North America, 20% in Europe, 18% in Latin America and 3% in Asia. The equity has traded up significantly in the past couple weeks (up >60% since the November lows) alongside many other "early cyclical" companies (largely driven by the "performance anxiety" rally that we’re witnessing as portfolio managers are afraid to miss the rally). While the stimulus chatter and interest rate moves should help relieve some of the pressure on the consumer (and may ultimately have an incremental impact on moderating the recession), I think WHR is one of the best standalone short bets on the consumer (and more generally on hedging potential uncertainty / volatility ahead).

While the WHR bull case largely relies on the company’s attractive free cash dynamics, there are four primary reasons why I think shorting WHR equity in the near-term is timely / actionable: (i) US consumer concerns (I’m still very concerned about longer-term structural shifts in consumption / saving trends and anticipate significant weakness for companies that are reliant on consumer credit and large ticket item goods are particularly exposed, (ii) Latin America and Europe are showing significantly weaker trends (in total, these two regions contribute ~40% of sales and approx 55 – 60% of total profitability), (iii) the company has a large underfunded pension plan (our best guess using very reasonable assumptions is $2.65Bln underfunded) that could result in a large / n-term obligation payment and (iv) the culmination of #1 - #3 will result in the company defaulting on it loans (assuming creditors agree to an amendment / re-pricing, the modified interest rate will be punitive on "normalized" earnings power given increased cost of capital). It’s worth noting that I still think the company will trigger its total leverage covenant in Q2 / Q3 09E period irrespective of the potential underfunded pension payment. Additional catalysts (noted below) include: margin pressure (given output pricing faster than inputs – namely steel), FX issues, the Sears’ relationship (w/ 12% exposure to SHLD, a potential n-term concern if SHLD experiences further challenges), trade-down effect (seeing consumers trade from high-end appliances to the lower-end offerings of LG, etc) and tax games (Brazil tax credits masked the normalized earnings power of the Latin American arm).

SHORT THESIS:

  1. General economic weakness

    1. Consumer spending on big tix housing items is being pulled back given lack of home equity w/drawals (general lack of credit availability)

  2. Covenant and liquidity issues (see JPM note out from early December – mimicking many of these same underlying credit concerns)

    1. EBITDA covenant is 3x and Co is currently at 2.4 / 2.5x (likely a trip in Q2 / Q3 09 period)

  3. Key Customer Risk - Sears weakness

    1. Approx 12% of total WHR sales

    2. NOTE contract ends in 2010

  4. Big box end-markets (800-pound guerillas)

    1. Both HD and LOW have said one of their major sales issues is moving big ticket items of $500+ (note that WHR’s appliances typically sell for between $500 - $5k)

    2. Compounding the issue is the majority of these items are purchased with credit

  5. Weak Housing / weak US consumer

    1. A prudent hedge vis-à-vis housing (home improvement spend) and consumer taking another large leg down (or simply shifting their consumption / saving habits)

  6. Brazil slowdown (approx 20% of sales / 30%+ of profitability)

    1. Brazilian tax credits will become a headwind (been a huge benefit in the past)

    2. Further weakness in the REAL will also continue to pressure profitability especially with a looming rate cut and some analysts calling for further decline by year end

    3. Note that company provides credit to its Brazilian subsidiary (i.e. Co has ~$331MM of guarantee arrangements that are included in the total leverage covenant calculation)

  7. European consumer weakness (approx 20% of sales)

    1. Slowdown given FX moves and European weakness on standalone should have a significant impact

  8. Pension funding liabilities

    1. Underfunded pension: WHR’s pension was 86% funded as of 12/31/07 with 66% of its assets in equities

    2. Applying reasonable haircuts to its equity / debt portfolios, the pension will be >$2.6Bln underfunded at YE 08 (this is below the 80% funding requirement and may need to do a "catch-up" payment)

  9. Channel checks suggest significant weakness

    1. Volume and pricing trends continue to erode (LG in particular is being aggressive w/ price promotions)

    2. Industry data source (AHAM) will be out w/ December volume trends next Thursday (Jan 15th)

  10. Higher raw material costs

    1. While steel costs / inputs are coming down, notable that end-mkt pricing is coming off faster than input pricing so margin dynamic is getting worse

CAPITALIZATION

8/31/2008

VALUATION MULTIPLES

Cash

$425

EPS - Consensus

$4.20

 

P/E

11.7x

Debt

$3,020

EBITDA - Consensus

$1,202

Est Pension Liability

1,540

TEV / EBITDA

8.6x

Estimated 08 Pension Liab

2,568

Net Debt

6,703

EPS

$2.50

 

P/E

19.6x

Price

$49.00

EBITDA

$763

# FD Shares

75

TEV / EBITDA

13.6x

Market Cap

$3,681

TEV

$10,384

NORM VALUATION

EBITDA

7.0x

Earnings / Share

$1,250

Implied Price

$8,750

Short - Potential Ups

44.4%

VALUATION:

WHR currently trades for approx 20x 09E earnings (>33x if we assume 300 bps re-pricing on the loans) and ~13.6x 09E EBITDA (which compares to building product comps that trade in the range of 8x – 9x range based on 09E EBITDA estimates). The Street has a wide range for 09E EPS ($3 - $7 / share) which compares to my estimate of $2.50 / share (less than $1.50 if we assume 300 bps of re-pricing). Assuming a more reasonable 7x EBITDA multiple to $1.25Bln of "normalized" EBITDA (which compares to peak EBITDA of $1.7Bln in 2007 – tail end of the consumer credit cycle), this implies a TEV of $8.75Bln (and results in >40% downside to the equity).

UPSIDE / DOWNSIDE:

  • UPSIDE: assuming 10x multiple to 09E EPS of $2.50 / share = $25 / share (vs current of $49 / share or approx 50% upside)

  • BASE: assuming 15x multiple to 09E EPS of $2.50 / share = $37.5 / share (vs current of $49 / share or approx 25% upside)

  • DOWNSIDE: assuming 20x multiple to 09E EPS of $2.50 / share = $45 / share (vs current $49 / share or approx 8% upside)

RISKS:

  • Core / normalized earnings power is greater than my view of ~$3.5 – $4.5 longer-term

  • Pricing power: WHR’s answer for many of the issues above is that they have pricing power

    • Recent channel checks would suggest price promotions are significant and pricing will continue to come down (aggressive pricing particularly out of LG, GE, Electrolux)

CATALYSTS:

  • NEAR-TERM (1 / 2 weeks): AHAM (industry publication on appliances) publishes December data on Jan 15th

  • LONGER-TERM (1 / 2 months): WHR reports Q4 results in early February (I’d expect significant negative sequential trends out of Latin America and Europe)

  • LONG-TERM (3 – 6 months): WHR management will be forced to approach their lending group to seek out a waiver / amendment. While the credit markets have shown incremental improvements over the last 2 – 3 weeks, there is still significant stress and WHR negotiations will be difficult. It’s worth noting that for every 100 bps move in rate, equates to approx $20 - 25MM of earnings power dilution (or approx $0.30 - $0.40 / share of eps) so assuming a 300 bps step-up in rate (w/ amended total leverage covenant step-downs), this would equate to approx $1.00 of eps dilution
    • Catalyst

      - NEAR-TERM (1 / 2 weeks): AHAM (industry publication on appliances) publishes December data on Jan 15th
      - LONGER-TERM (1 / 2 months): WHR reports Q4 results in early February (I’d expect significant negative sequential trends out of Latin America and Europe)
      - LONG-TERM (3 – 6 months): WHR management will be forced to approach their lending group to seek out a waiver / amendment. While the credit markets have shown incremental improvements over the last 2 – 3 weeks, there is still significant stress and WHR negotiations will be difficult. It’s worth noting that for every 100 bps move in rate, equates to approx $20 - 25MM of earnings power dilution (or approx $0.30 - $0.40 / share of eps) so assuming a 300 bps step-up in rate (w/ amended total leverage covenant step-downs), this would equate to approx $1.00 of eps dilution
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