Description
American Woodmark (AMWD) is the third largest manufacturer of kitchen cabinets in the US. It is quite profitable and has been gaining market share. AMWD has a Return on Equity (ROE) of 25.3% and Return on Assets (ROA) of 15.5%. With trailing diluted earnings of $3.81 (vs $2.14 and $1.79 in the 2 prior years) for the year ending April 02, its P/E = 12 and P/S = .75. Despite a multi-year capacity expansion program, its balance sheet is strong.
The company’s guidance for the current quarter is $0.97 - $1.02 per diluted share vs prior year $0.89 on a 15% revenue increase. Given AMWD’s competitive strengths and track record, it is likely that in 2-3 years their earnings will be in the $5-$6 per share range with Free Cash Flow slightly less and an even stronger balance sheet than it has today. To determine AMWD’s fair value, I took into account today’s low interest rates and the company’s high and sustained profitability, strong balance sheet, market share gains, and low rate of technology change in the industry. We could spend hours discussing the appropriate discount rate to use, but I think we would all agree that the current PE of 12 is the cautious side. The stock is currently selling at 46. I’d expect that in 2-3 years AMWD would have a fair value around 80 and its current fair value is close to 60, using my rule of thumb of a 15 P/E for this kind of company. The stock is volatile, so it wouldn’t surprise me to see a dip below 40 in the interim. AMWD does not fall into the “bargain of the year category” but it is significantly undervalued and offers a good long term margin of safety.
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Let me move on to a more detailed description of the company.
According to AMWD, at the end of FY01 it was one of the top 5 manufacturers of kitchen cabinets; a year later that had improved to being in the top 3. Woodmark’s largest competitor is Masco. In FY02, 65% of sales went to the remodeling market and 35% to the new home market; in the prior year the split was 75% / 25%. Home Depot and Lowe’s account for 63% of sales. As of a month ago, AMWD characterized its backlog level as in the normal range.
AMWD primarily has a build-to-order, vertically integrated supply chain and manufacturing operation. 2/3 of the product is shipped directly to a home or job site. Their orders from Home Depot and Lowe’s are basically special order sales which are turned into finished product by AMWD in a few days. Home Depot, for example, delivers semi-custom kitchens to the customer in 4 weeks.
Woodmark has a strategy of building capacity proactively to gain market share but even so have gotten behind the curve. They have doubled capacity in the past 4 years. There have not been any significant recent acquisitions.
Capacity utilization has been close to 100% this quarter and last. Target utilization is 85-90%. New factories are coming on-line which will help a bit. The new capacity needs to be brought on in a systematic way. It takes time to bring the new employees up to speed. There is always a danger of overshooting when it comes to building new capacity; still it is the kind of problem more companies would like to have.
Here is a summary of their financial performance:
Million $
FY 2002 2001 2000
Revenue 499.0 404.1 368.0
Net Earn 32.2 17.4 14.5
CFOP 53.5 21.5 21.3
Net CapEx 39.8 17.4 40.8
FCF 13.6 4.1 -19.5
GM% 25.8% 22.0% 21.4%
Current Debt plus all LT liabilities are just 16% of capital.
ROE has fluctuated between 16% and 26% over the past 5 years.
Executive compensation is heavily performance oriented. It seems reasonable and not overly greedy. The Chairman owns 26% of the shares.
Last week, AMWD traded 380,600 shares (approx $17 million) so it is fairly liquid. It’s market cap is $376 Million.
Risks and Weaknesses
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Free Cash Flow is lower than I would like, although it is increasing nicely. However, much of the capital expenditures are for increases in capacity, not to maintain the current level of revenue. This is not like the airline or semiconductor industry, where you have to spend like crazy to stay in place. 2003 CapEx at $25-30 million will be lower than 2002 Cap Ex of $40 million giving a big boost to FCF.
The Housing boom may end. However, the AMWD’s remodeling business should stay strong.
AMWD is quite dependent on sales to Lowe’ and Home Depot who put strong pricing pressure on their suppliers. AMWD has been increasing sales per unit by gradually doing upscale.
AMWD benefited from generally low Raw Material pricing last year. If there were a spike in these costs it might squeeze their margins; however it probably would not affect their ability to continue to increase market share. In the past, their increasing volume has brought enough economies of scale to partially or totally offset any spike.
The increase in capacity brings inexperienced labor into the company. It takes a year or two to get them up to speed, which puts pressure on Gross Margins. With so much new capacity coming on line, this year’s GM% may temporarily suffer.
They do have an Unfunded Pension Liability of $7.4 Million. Their rate of return assumption of 8% is more conservative than many companies.
Competing with a Masco that also has faucets and sinks under their corporate umbrella could give Masco an advantage. That has not prevented AMWD’s market share gains, but could be a long term issue.
Catalyst
Mr. Market mellows out a bit.