Description
A bit of a quick hitter here, but after the recent decline, Armstrong Flooring, Inc. (AFI) offers a potentially timely entry point for investors willing to look to next year and beyond. The stock is cheap, trading at ~30% of this year’s sales and potentially <2x “normalized” EBITDA. Understanding why the stock is cheap is not difficult. The financials alone paint the picture of a Zombie company, with sales and EBITDA shrinking meaningfully since the spinout from AWI five years ago. But channel checks and various macro inputs suggest there’s a decent case to be made the next earnings report could have actual identifiable green shoots, elements which have been noticeably absent of late. Improving financials and KPIs should bolster the case the company’s turnaround is on track.
Company attributes
- #3 player in flooring products
- 60% commercial / 40% residential sales mix (with growth in the higher margin commercial segment poised to accelerate next year)
- 85% US / 15% international sales mix
- 70% US / 30% internationally sourced production
Company background
- The short version is things have been pretty much disastrous for the company ever since their spin from AWI in 2016. In many ways, the spinoff was used as a dumping ground of sorts for a company with unconsolidated facilities and strong share representation in declining categories like wood flooring.
- A bad situation became worse in 2017 when then management decided to cut costs by outsourcing nearly their entire sales function to distribution. With no reps to provide customer service, the company ceded massive share over the subsequent years.
- Finally, the above was also compounded by the fact the company was out of position from a product standpoint with an over-reliance on VCT, a product line in decline.
Turnaround Highlights
- Michel Vermette, a well-regarded flooring vet from Mohawk, has been in the CEO post since September 2019. His key accomplishments since taking over include:
o Consolidating operations and cutting costs
o Adding new products and hiring new sales reps
o Importantly, he has adjusted their go-to market approach, reemphasizing reps while relying on distribution for smaller, more one-off type jobs
o And perhaps most critically, in March 2021, the company closed on the sale of South Gate plant for $77M
§ Proceeds went to debt paydown, lowering net debt from $66M to $36M while also providing ample liquidity to invest in their turnaround initiatives
Recent events
- Though management has recently implemented a number of initiatives that suggest the company is back on offense with a focus on driving profitable sales, little of this progress has shown up in the numbers.
- In particular, each of the last two quarters were more than a bit messy, resulting in losses at the EBITDA line. Both were hurt by raw material inflation and freight charges. Additionally, 1Q was negatively impacted by $2M from Winter Storm Uri while 2Q had $4.5M of product and asset rationalization charges.
- Though inflation and supply chain impacts will continue to be issues in the near term, the upcoming quarter will be the first with a full slate of new reps who have also benefited from having new well-received products to sell.
Key Investment Considerations / Input from Channel Checks
- Contacts suggest Vermette is pursuing the right strategy, relying on their own reps where they can, and distribution for smaller onesy-twosy type orders where they need to
- A brand that was once the largest in the industry which is still respected in the industry
- New products that are well regarded, with many winning a number of industry awards
- New sales reps, with additions numbering into the 40s
- A heavier US manufacturing presence which has been helpful in this environment
- Focus on non-res/commercial, which is a bit later cycle, but looks to be gearing up now with a strong multi-year outlook
- Likely attractive as a takeout candidate, given the brand retains value; Shaw in particular has been noted to have an intriguing product overlap
Valuation
- Today’s TEV is $204 with an $83M market cap and $121M of net debt, including the pension liability of $57M
- Putting numbers on this is a bit tricky given all the moving parts, particularly in the near term, so we have tried to remain conservative
o Management continues to state there is no structural reason the company cannot have mid 20s gross margins and double-digit EBITDA margins in a few years
o Our 2021 topline of ~$650M assumes 2H revenues grow 7% over 1H
o From $650M, a 7% CAGR on the topline puts the company at ~$744M in FY23 translating to $80M EBITDA at a 10% margin or $52M with a more conservative 7% margin
- A peer multiple of 7x on $52M of FY23 EBITDA implies an EV of ~$365 and a stock price of ~$12+ depending on debt paydown assumptions, suggesting the stock below $4 today offers an attractive risk / reward given the improved balance sheet and progress to date on their turnaround initiatives
Risks
- Economic sensitivity
- Company execution
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst