End market prospects
The recent results were a mixed bag, as estimates were missed but the full year guidance for EPS and free cash flow was maintained at $5.40-$5.65 and $1 billion, respectively. The strength in its mix of business is undoubtedly coming from its construction and do-it-yourself (CDIY) segment and it is set to continue. Meanwhile, its security and industrial segments have more subdued prospects this year.
A breakdown of segmental profits in the quarter.
The results were superficially disappointing. Organic revenue declined 1% overall, and it was only the 4% contribution from acquisitions that caused the top line growth of 3%. Moreover, cash outflows were greater than expected in the quarter and its core CDIY segment saw flat revenue. It gets worse. Security revenue fell 1% on an organic basis as did industrial revenue. So, is this a story of declining organic growth and an over reliance on acquisitions? And where does the confidence to maintain full year guidance come from?
The 2013 guidance is for mid-single digit revenue growth in CDIY, and flat to low single digit growth for security and industrial, respectively. With regards to CDIY, there were three issues of which two look like they will be rectified in due course.
Firstly, there is a late start to the North American outdoor season which was primarily caused by the weather. Secondly, there has been some temporary weakness in Latin America due to a variety of reasons. Interestingly, Whirlpool Corporation (NYSE:WHR) said a similar thing about the region, and in particular with Brazil. Both of these companies are arguing that this is a temporary setback and Whirlpool Corporation (NYSE:WHR) shareholders should take heart from the positive trends expressed for Latin America in these results. Sequentially, things got better in Q1 and this gives confidence that Q2 will be better for both companies.
The third issue is — you guessed it — Europe, but investors need to recall that comparisons are likely to get easier going forward. Security’s exposure to Europe is worrying (and there was some temporary weakness in the Nordic regions), but an extra $15 million of cost synergies from the Niscayah acquistion are expected. This should help out margin growth. It’s a similar story with industrial where moderate U.S. growth is hopefully going to offset weaker conditions in Europe.
Another company displaying confidence in the North American outlook is Masco Corporation (NYSE:MAS). This is more of a leveraged play on new housing construction, and its margin expansion and operational leverage opportunities will come from new builds, but its repair and remodeling market is also expected to grow moderately. Frankly, I think the latter tends to key off the former, and as long as there is good turnover in housing, then prospects will get brighter for all the companies discussed here.
Acquisitions working well
The scorecard over its acquisition strategy over the last few years is positive. It has been a difficult few years for housing and construction related stocks, but I think it has done the right thing in trying to drive cost synergies with its acquisitions. As discussed above, there is an extra $15 million to come from Niscayah (security) which should bring the total for 2013 to $50 million, and management is currently evaluating the potential for increasing the targets for 2014.
Strategic growth initiative
I’ve haven’t got the room to discuss this in great depth here, but investors wanting more color on this can find it in an article linked here.
A graphical summary of the plan to increase revenue by $850 million and profit by $200 million within three years is shown below.
Its early days, but the plans were declared as being ‘on track’. Indeed there was a bit of extra investment in this program although there was no adjustment to the targeted CapEx/Revenue figure of 2.5%-3.5%.
The bottom line
This is an attractive proposition and if it can hit its $1 billion in free cash flow, then the stock would be generating nearly 6% of its enterprise value (based on the current share price of $77). This is cheap for a company expected to grow revenue in mid-single digits and earnings in the mid teens for the next few years.
Ultimately, investors will have to price in the uncertainty that it will hit these targets. If you are positive on the global economy, then this stock is going to give you some upside potential and I think a target price in the mid $80’s is not unreasonable. A good GARP candidate.
The article Is This Stock the Perfect GARP Play for 2013? originally appeared on Fool.com and is written by Lee Samaha.
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