Description
American Woodmark (AMWD) makes kitchen cabinets. I think earnings estimates are much too high. The short thesis is as follows:
1) Home renovation is tied to existing home sales (lagged 9 months). The explanation is pretty simple- you buy a home, hate the décor, and rip out the kitchen. Existing home sales are falling off a cliff and will only get worse. I can’t paste the chart (get Lehman’s 7/27 note on SWK), but suffice it to say that they are very correlated and existing home sales have gone quite negative. In addition, home equity extraction, which is the major funding source for remodeling, is also drying up.
2) The business is not a great business. Here are some numbers from the past 6 years and consensus estimates for fiscal 2007 and 2008:
|
|
|
F01 |
F02 |
F03 |
F04 |
F05 |
F06 |
F07 |
F08 |
|
revenues |
|
404 |
499 |
563 |
668 |
777 |
838 |
850 |
900 |
|
cogs |
|
315 |
370 |
431 |
530 |
625 |
688 |
|
|
|
sg&a |
|
56 |
75 |
78 |
85 |
94 |
96 |
|
|
|
ebit |
|
50 |
54 |
54 |
52 |
58 |
53 |
72 |
88 |
|
|
|
|
|
|
|
|
|
|
|
|
gross margin |
22.0% |
25.8% |
23.6% |
20.7% |
19.6% |
17.9% |
|
|
|
sg&a margin |
14.0% |
15.1% |
13.9% |
12.7% |
12.1% |
11.5% |
|
|
|
ebit margin |
12.4% |
10.8% |
9.6% |
7.8% |
7.5% |
6.4% |
8.5% |
9.8% |
AMWD has doubled revenues, leveraged sg&a, and made exactly the same amount of operating earnings every single year. Think about that—revenues have doubled, and operating earnings are flat. Yet this monotonic margin pressure—which basically defines every furniture manufacturer, especially those that sell to big box retailers—is expected to magically reverse into a weakening demand environment. The company talks about initiatives to expand gross margin but historically these have all been passed on to the customer.
3) Supply is entering the market. Masco, on its most recent call, discussed how it was building two large cabinet plants. Management conceded that this will lead to industry overcapacity for the next few years, but is comfortable with this dynamic as they are planning on taking share and their horizon stretches past 2007.
4) Channel checks show extreme weakness. A discussion with a supplier to AMWD said that orders to cabinet makers were down 80% year over year. Checks with Lowes and Home Depot district managers show the category down 20-30%. AMWD grew through the weakness in Q1, but how long can this continue?
5) Valuation is stretched. If you believe that AMWD can maintain its level of operating earnings around $55 million (which I believe is very optimistic), then the company trades at 11.3x. Peers are at 8x, and are arguably better companies (and more liquid):
|
|
price |
shares |
mkt cap |
net debt |
tev |
07 ebit |
x 07 ebit |
|
BDK |
$ 70.43 |
78 |
5,465 |
2,000 |
7,465 |
880 |
8.5 |
|
SWK |
$ 46.40 |
83 |
3,851 |
1,300 |
5,151 |
550 |
9.4 |
|
MAS |
$ 27.36 |
402 |
10,999 |
3,400 |
14,399 |
1,800 |
8.0 |
|
STLY |
$ 21.60 |
12 |
266 |
- |
266 |
35 |
7.6 |
6) Potential cost pressues. Particleboard was in short supply in the (fiscal) second quarter due to the closing of a large plant, and prices were up around 50%. Gasoline and paint are higher as well. Lumber prices have moderated recently though.
Catalyst
weak quarter and guidance
investors realize that remodeling will be weak along with new home sales